Fragile rule of law threatens Mexico’s one chance at energy reform

MEXICO CITY — For 75 years Mexico protected its state-run energy sector with a strong sense of national pride. March 17, the day commemorating Mexico’s 1938 expropriation of the oil industry, was a national holiday celebrated with gusto by a country that took a rabid stance against privatization.

All that has changed in the past few years. President Enrique Peña Nieto managed to break the privatization taboo by passing a bold energy reform that this month opened the oil industry to private investment for the first time since the late 1930s.

But convincing lawmakers to support the reform may have been the easy part; the real challenges that lie ahead will be far more complicated. Over-regulation, government corruption and lack of transparency in bidding processes could threaten to turn what was meant to be windfall for Mexican society into a cookie jar that only a select few can stick their hands into.

This month the first round of bidding for oil and gas exploration was smooth, but fell short of expectations. Only nine of 25 participants entered bids, and only two of the 14 initial exploration blocks in the Gulf of Mexico were awarded to a Mexican consortium. Private foreign companies will likely jump into subsequent bidding rounds, but with global oil prices dipping to new lows, Mexico’s timing to market couldn’t be worse.

“The reasons behind the recent lackluster performance in the first round are likely a combination of low global prices, terms of the governmental contracts, the fields’ small size, and geological considerations,” former U.S. Ambassador to Mexico Antonio Garza told Fusion.

In future rounds the government will need to “aggressively review all commercial terms to make sure they are as attractive as possible for future investors,” Garza added.

Establishing trust — something the government has struggled to do with its own citizenry — will need to be priority to lure the right type of companies to future bidding processes, said the former ambassador and counsel to the White & Case law firm.

“While bold steps and a strong policy agenda may be too little too late for regaining Mexicans’ trust in their government, they are absolutely critical to maintaining investor confidence in the country’s reform initiatives going forward and attracting the kinds of companies that Mexico needs to build a vibrant and sustainable energy sector. Any less and the efforts will falter,” he said.

Meanwhile, Mexico’s state-owned Pemex oil company seems to be struggling to keep its own house in order.

One week before the first bidding process opened, Pemex announced that one of its officials was under investigation for extortion. The official allegedly demanded more than $600,000 and two vehicles from a private company in exchange for awarding a food and hospitality contract on an oil platform off the coast of the southern state of Campeche. Although the incident wasn’t connected to the larger bidding process, to some leery observers it foreshadows the type of problems that could arise once big-time multinationals and hundreds of new contracts are thrown into the mix.

Mexico’s energy sector is no stranger to bribery scandals. According to Bloomberg, Pemex in 2012 sued German conglomerate Siemens and South Korea-based SK Engineering and Construction Co for allegedly bribing Pemex officials “to win and keep refinery construction projects.” Pemex and Siemens recently settled out of court.

“Pemex has severe corruption problems,” Miriam Grunstein, a former official at Mexico’s Federal Energy Regulatory Commission and energy law consultant, told Fusion. Grunstein downplayed concerns that Pemex suffers from systemic corruption, but warns it’s hard to stop rogue individual employees from making side deals to stuff their pockets.

“So far no top official has been arrested,” she stressed. “only low-level public servants have been put on trial.”

Grunstein says big foreign companies will likely view incidents of corruption in Mexico as a concern rather than an opportunity to do some palm-greasing of their own; most will likely be more cautious than “unscrupulous,” since a scandal could easily affect their profit margins, she says.

“Lately this country has given a bunch of reasons to scare away investors,” Grunstein said.

Mexico has seen its share of corruption scandals in the past two years. There was the poor handling of the real estate scandals involving the president, his wife, and the finance minister. And there have been serious concerns about the lack of transparency in other government bidding processes, such as the Mexico City-Querétaro high speed train. Though none of those incidents are linked to Pemex or the oil industry, analysts say they cloud the investment climate in a way that can’t be ignored.

Some say it’s too early to make assumptions or dismiss the nascent bidding process as corrupt.

“It would be premature to say new contracts will likely unleash a new wave of scandals; it would be unfair and there is no basis to support those claims,” said Alfredo Coutiño, director for Latin America at Moody’s Analytics. However, he added, the government has done little to safeguard against corruption, which represents an important “risk factor” — one, he thinks, that could have negative influence on future rounds of bidding.

“I would call the recent auction a failure,” Coutiño told Fusion. “The Mexican government expected a minimum of four blocks, but only two were awarded.” He said many investors where not convinced with the regulations the Mexican government proposed. “Investors are also fearful of potential transparency problems during the assignation of contracts.”

“Corruption and lack of transparency are nothing new. It’s a cancer that has always been there.” — Alfredo Coutiño, director for Latin America at Moody’s Analytics

The analyst says this could be a golden opportunity for Mexico, but the country will need strong political leadership to navigate the process without tripping over the same stumbling blocks of the past.

“We need political leadership that ends the old problem of concessioning privileges and pres-sales to certain groups,” Coutiño stressed. “That only enriches some and creates obstacles for others, culminating in bad wealth distribution.”

Some believe Pemex needs to be reformed as well.

Former Mexican Foreign Affairs Minister Jorge G. Castañeda says President Peña Nieto’s energy reform used to have a central premise. “Pemex was going to be reformed, become more competitive, transparent and efficient thanks to the change in surrounding and context. More internal competition through the licitation of blocks, more external competition through the participation of operations outside Mexico would force Pemex to reform itself,” Castañeda wrote in Mexican daily Milenio.

So far this doesn’t seem to be happening. But just fixing Pemex isn’t enough.

What Mexico really needs is a true restructuring of its fragile rule of law, which has lately affected all levels of government, tainted some bidding processes, embarrassed the justice system with a high-profile drug kingpin’s second prison break, and now poses a threat to one of Mexico’s most valuable resources.