La reforma energética y tu vida: edición 2, ¡no se olvide el propósito!

Some people seem to lose sight of the purpose behind the energy reform, even though it is spelled out explicitly in the constitutional amendments.

The purpose is not to generate more jobs in the energy industry. It almost certainly succeed in doing that, but the number of jobs so generated is unlikely to make a huge difference to the employment prospects of most Mexicans. Energy is too capital-intensive and Mexico is too large.

Nor is the purpose to lower natural gas prices in Mexico. Natural gas prices will eventually fall in Mexico, but because of pipeline connections to the United States, not the upstream energy reforms.

Finally, the purpose is not to produce more oil! Some recent commentary appears to forget this point.

The purpose is to maximize revenue for the Mexican federal government. That may involve maximizing production or it may involve tightly rationing license rounds and writing in high royalty rates after cost recovery. (It depends on exploration risk.) I suspect the latter ... and that is the direction in which I would err were I a Mexican policymaker.

NAFTA’s investment protections will make it very difficult for a future government to dramatically alter the terms of the initial conces ... er, licenses. Better a botched initial round, I would think. No?

Energy reform will boost production in two ways: first, it will allow more capital to flow into the industry (Pemex is liquidity-constrained); and second, it will put Pemex under competitive pressure (although I have my doubts that this will accomplish much). But the point is not to boost production for its own sake; the point is to maximize government revenue. Some opportunities will almost certainly be left on the table ... and should be.

Don’t forget the point.

Comments

[Federico]

"The purpose is to maximize revenue for the Mexican federal government. That may involve maximizing production or it may involve tightly rationing license rounds and writing in high royalty rates after cost recovery. (It depends on exploration risk.) I suspect the latter". I completely agree with the first sentence. But can you explain your suspicion more? I would suspect that conditional on the govt expecting to stick around for many years (decades?) the former option would maximize revenue (consider tax revenue elasticity to GDP growth besides direct royalties).

[Noel Maurer]

Good question!

There are two moving parts: the auction and the tax-and-royalty system.

Taxes in hydrocarbons have a Laffer-curve-like quality for new developments. The higher the tax rate, the more marginal sites become uneconomical to explore or develop. A tax-and-royalty system designed to maximize government revenue will, almost by definition, keep some production off the market.

One way to square the circle are the way PSAs allow for cost-recovery (including a guaranteed return) before the production-sharing kicks in. But even there, you are taking away some of the upside from the private investor and pricing out some otherwise promising blocks at the margin.

The auctions, though, are a different story. (I hadn't really thought about this until your question, Federico. Thank you!) High prices will of course leave some license blocks undeveloped ... but they will also risk the winner's curse, lowering future revenue.

E.g., the highest bidders are likely to be the most overoptimistic rather than the best at E&P. Future production will be both lower and arrive later.

Does that make sense?

[Federico]

Thanks for the clarification. For the auctions part -- can't the govt implement something like using pricing from the second best bidder (I can't remember what the formal name for this is) to avoid the winner's curse? I don't know of any govt that does this, but it would still be interesting to think about. Nonetheless there is still one extra point I wanted to raise -- the added tax revenue that the govt can get from higher GDP growth. If you believe that higher oil production would have some spillovers, then maximizing tax revenue involves maximizing the tax revenue from both the oil part and the spillovers. My guess is that this maximization problem would result in higher oil production compared to the oil production if you just tried to maximize revenue from the oil part.