In June, a delegation of Mexican government officials went to Calgary to drum up energy investment. That wouldn’t be unusual if they were from Colombia, say, or (until recently) Iraq. But for Mexico it was a first. The country’s oil and gas industry was nationalized back in 1938. For 75 years, foreign investment was kept to the sector’s margins, in oilfield services and pipelines. Exploration and production was exclusively the domain of state-owned Petróleos Mexicanos, or Pemex.
Last December, Mexico’s congress amended the constitution to change that. Lawmakers are still in the process of drafting subsidiary legislation that will establish a new regulatory regime and open the door to, for example, joint ventures with Pemex and more foreign investment in the service sector. The government of President Enrique Peña Nieto was motivated by the fact that crude oil production has been falling: to 2.5 million barrels a day today from 3.4 million a decade ago. Like national oil companies everywhere, Pemex lacks the incentive, the expertise and the capital of its private-sector peers to discover new reserves as fast as the old ones are depleted. This, despite Mexico having shale oil and gas deposits comparable to those that have reversed production declines north of the Rio Grande.
“Mexico is fully committed to the transformation of the energy sector,” said Leonardo Beltran Rodrigues, undersecretary of planning and energy transition at Mexico’s secretariat for energy and natural resources, in a speech at the Calgary Petroleum Club in June. “We can do it with many people, but we would rather do it with friends.”
Notably, the delegation chose to visit Calgary first, over Houston and New York. To Carlo Dade, director of the Centre for Trade & Investment Policy with the Canada West Foundation, this sent a clear signal “that they welcome Canadian investment and also Canadian technical assistance with regulation, legislation, et cetera.” To a country with still fervent opposition to the reforms, Canadian operators may be seen as less threatening than America’s big oil companies, while still knowledgeable about shale. A few, like TransCanada Corp. and Trinidad Drilling, already have operations in Mexico. If the country’s energy perestroika proceeds as its proponents envision, many more could opt to get in on the ground floor of the reopening of one of the world’s largest oil and gas producing regions.
INFOGRAPHIC: How Mexico is overtaking Canada’s auto sector »
Right now, privatization of the industry, as we in Canada understand it, is not likely. Both Pemex and electrical utility Comisión Federal de Electricidad (CFE) will remain firmly under state control. (Needless to say, the subsurface resource itself will remain publicly owned, as it is in most of Canada.) What is being privatized is the oil and gas infrastructure and royalty streams. If the early version of the legislation is passed, Canadian companies will have the option to partner with Pemex and CFE or with other foreign companies seeking ventures in Mexico.
Under the North American Free Trade Agreement, Canadian companies in other sectors have become fixtures in Mexico, Dade notes. He cautions that “returns are lower than [in] some other places, but the lower risks in Mexico should offset this.” Believe it or not, crime is less of an issue in Mexico than in other areas of the world where Canadian oil money is invested, namely parts of Africa. The homicide rate in Tabasco, one of Mexico’s bustling oil towns, is around five per 100,000, the same as oil boom towns in Texas, Dade says.
Mexico is believed to sit on the fifth-largest tight-oil reserve in the world. It’s also believed to have the world’s sixth-largest shale gas reserves, which remains entirely untapped, apart from a few exploratory wells that came up dry.
As yet, only a handful of Canadian companies are operating in the Mexican energy sector and none in exploration and production. Investors will have to wait and see who takes the government up on its invitation. Once a company announces it will be venturing into Mexico, investors should consider its international experience, its track record at turning exploration into production and its debt-to-reserve ratio, advises David McColl, an energy analyst with Morningstar. Canadian mid-sized oil producers—the ones most likely to receive a bump from entering a new region—tend to be highly leveraged. Examine candidate companies’ debt-to-equity ratio and interest coverage ratio, as those looking to expand will rely on their ability to access capital, either through selling stock or debt.
Maria Adelaida Velasquez Mejia, an analyst for Serfinco based in Colombia, says the greatest opportunities for exploration and production companies will arise on the onshore side of the business, where the shale fields are. That points to companies like Toronto-based Pacific Rubiales Energy, which is the largest independent oil and gas producer in Colombia and, though it hasn’t yet dipped its toe into Mexico, has a major Mexican shareholder. McColl is also watching Gran Tierra Energy of Calgary to see if it takes the plunge. The company targets light oil plays and has a business model that uses cash flow to fund expansion.
There remains a risk that Mexico could backpedal on its reforms. The government hasn’t exactly amassed public support on the matter, according to public policy expert Miriam Grunstein Dickter. It seems more a matter of citizens failing to understand the breadth of the constitutional changes than any tacit support. Dickter, a scholar at the Baker Institute for Public Policy in Houston, says she’s “very, very surprised to see we haven’t had substantial mobilizations or demonstrations,” in response to the reforms. Members of the opposition in Mexico appear to have been caught flat-footed, lacking the proper leadership to amass any popular backlash. If the changes succeed in boosting production and government revenue, and creating jobs, however, they may develop their own momentum.
It’s important to understand this is a very long-term investment play, says McColl. It’s expected to take a year before the doors to further foreign investment open in any significant way. Those interested in investing for just a year or two are unlikely to see results from exposure to Mexico’s emerging oil and gas scene. Ten years on, however, should Mexico’s production be ramping back up with the help of foreign capital and expertise, it could end up looking like a wise move.