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Mexican energy reform will impact foreign manufacturing investment

When Mexico’s oil industry was nationalized in 1938, the state company, Petroleos Mexicanos (PEMEX), took over all operations, banning private foreign companies from entering into contracts with the Mexican government oil monopoly to explore and drill for oil and gas for energy needs. This has led to high energy costs, particularly for Mexican manufacturing, and an a generalized depressed rate of growth in foreign direct investment in industrial activities that are intensive in their use of energy.  Under these circumstances, Mexican energy reform has been sorely needed to boost the country’s productive sector in the face of intense global competition.

Over the past decade, Mexico’s oil production has slumped by a quarter, prompting a rise in costly energy imports. Because of this, Mexican industry in the past year has paid 45% more for its electricity than US factories.

In 2012, Mexico’s petrochemical trade deficit was over eight billion dollars, and was over five billion dollars for products that originated from petrochemicals according to Mexico’s National Institute of Geography and Statistics (Instituto Nacional de Estadistica y Geografia, INEGI).

Additionally, Mexico’s robust manufacturing sector, which is a significant consumer of plastics and other petrochemicals, has been at a historic disadvantage due to a limited supply of natural gas. Net annual investments in manufacturing have averaged $20 billion over the last five years, but oil, gas, and power have only received $360 million during the same time period. Increased exploitation of oil and gas would not only create jobs in this sector of the economy, but would also make it economically attractive for industries that are significant users of these resources to set up shop in the country. Historic legislation amending the Mexican Constitution  was passed on December 12, 2013, constitutes a Mexican energy reform that will change how the country’s promising energy sector operates, allowing foreign energy investors to participate. This move makes room for Mexico’s oil and electricity monopolies, Pemex and CFE, to become “productive enterprises.” It paves the way for private oil companies to explore for and produce oil and gas under licenses and production or profit-sharing agreements. Furthermore, it allows for private power companies to generate and sell electricity. Also, it opens an economically feasible path for energy intensive industry to thrive in the country.

Thomas Donahue, president of the U.S. Chamber of Commerce, is one prominent business leader that has estimated that the increase in oil and coal supply will be beneficial to both Mexican manufacturing and manufacturing in North America as a whole. Many see the most important aspect of the revamp not in the actual oil and gas, but in the lower costs for manufacturing due to the newly expanded supply of energy. Mexico’s largest bank, BBVA Bancomer, estimates the potential for economic output growth in the new year, due to more abundant natural gas, to be more than three percent. Marco Oviedo at Barclays says investment could swell to 3.5% of gross domestic product in the coming years, from less than two percent now.

The reduced fuel costs that the Mexican energy reform will result in in the medium term could cement the country as one of the most across the board cost-effective locations for manufacturing.  Additionally, Mexican manufacturers could become more integrated, since they could both manufacture parts that require significant energy inputs, and assemble those parts into final products. For example, due to high energy costs, Mexico’s automotive industry imports most of its steel and glass, rather than make it locally. The lower cost of energy from increased oil and gas competition, and production, will, thus provide a more competitive manufacturing capacity for both assembly and the production of inputs to these two industries. An increased energy supply could bolster foreign investment in factories and manufacturers in Mexico, due to the reduced fuel costs producers would face.

Some estimates predict that the Mexican energy reform will set the ground work for a yearly average of foreign direct investment (FDI) of  approximately fifty billion dollars in the next decade.

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