Nationalistic Energy lockdown: without greater support--and boost of foreign investment--withered oil and gas industry faces troubled future.

As a Texan, Tony Garza doesn't need a State Department briefing to tell him Mexico's oil and gas industry is off limits to foreigners. As a Texan, he probably knows foreign cash is what it desperately needs.

The Mexican government can't afford the US$65 billion it estimates the electricity industry needs between now and 2010, let alone US$15 billion a year for oil and gas. Its US$150 billion annual budget is needed for health, education and poverty relief in a country where half the population lives in want.

The situation is so acute the International Energy Agency is now forecasting Mexico will become an importer of crude oil by 2020. This may seem unthinkable for such a hydrocarbon-carbon rich nation, but it is already a net importer of natural gas despite having some of the world's largest reserves of the fuel. It also imports gasoline.

The Fox administration wants to solve this by attracting more foreign investment, but Congress won't pass new laws and the schemes in place aren't attracting enough interest. One auction in 2001 to build a new power plant was cancelled after only one bid was received. Contracts to drill for natural gas are also going begging. The situation could eventually become more acute for the government as the lack of investment threatens the profitability of a cash cow, state oil monopoly Petroleos Mexicanos (Pemex), that provides a third of its revenue. Everyone agrees it is a crisis, but politicians can't agree on a solution.

Noe Hernandez, a member of Fox's National Action Party and secretary of the Energy Commission in the Chamber of Deputies, hopes Congress will pass a new law early this year to make it easier for foreigners to at least build generating plants. He has no hope for natural gas and knows even the slightest progress on electricity reform is unlikely before elections in July.

"I hope senators and deputies put the interests of the country ahead of the interests of their political parties," he says. "The closer the elections come the harder it will be." Meanwhile, "we worry about the lack of exploration for oil and gas," he says.

A PROBLEM IN THE MAKING

The seeds of the blossoming problem have been sown over the last 20 years as successive governments, including the current one, have bled Pemex of any surplus cash. In addition, federal requirements that oblige electricity companies to charge low rates to residential users and farmers translates into a subsidy equal to 2% of the annual gross domestic product (GDP), according to World Bank estimates. Pemex had a net loss of 11 billion pesos in the first nine months of last year as it paid more in taxes to the government than it made in profit. It also struggles to get permission to borrow money from a Finance Secretariat dedicated to fiscal stability, leaving it helpless to invest.

The result of this symphony of woes is an oil-rich nation that imports more than US$10 billion a year worth of petrochemicals and 586 million cubic feet a day of natural gas. Another sign of under investment is that Mexico--with 29 billion barrels of reserves of crude oil--produces 3.1 million barrels a day. The United Kingdom produces 2.4 million barrels a day from just 5 billion barrels of reserves. The effects of this lack of investment as well as state control ripple through the economy. The first result is gasoline prices that are sometimes double those in the United States, driving up the cost of transportation for companies.

Electricity prices, though subsidized for residential users, can be as much as 80% higher than in the United States for businesses. This makes Mexico less competitive in heavy manufacturing such as steel and automobiles, cutting into the edge that cheap labor provides.

Opposition to foreign investment in energy is strong among Mexicans and hence a vote winner because Pemex, since its 1938 nationalization, has become a symbol of the country's independence from foreigners and its ability to develop economically without them. Electricity was privatized much later but much of the same emotion is felt there.

Government propaganda over the years has also made the nationalization by former President Lazaro Cardenas a nationalistic point of pride. In doing this, history was rewritten to a certain extent, as Cardenas was very reluctant to take over the industry. U.S. and British companies forced him into it through appalling pay and conditions for workers that led to severe outbreaks of labor unrest and threatened social stability in some parts of the country.

Since then, it has been presented as a victory over foreign interests, which it partly was. But at the time and in the decades to follow, Cardenas now-celebrated move failed to stand as a triumph for the country. Despite being one of the world's largest oil producers as early as the 1920s, it wasn't until the 1970s that Mexico again became a major player with the discovery of the Cantarell field in the Gulf of Mexico.

And the issue has also become a rallying point for opponents of the government policies that have made Mexico one of the most open economies in the world with free trade agreements with 32 countries. They argue national sovereignty has been sacrificed and the country no longer controls its own destiny. And Fox's lack of a majority in Congress is making change almost impossible. A majority of deputies, all of whom face re-election in July, are determined to block reform efforts. Rosario Tapia of the Party of the Democratic Revolution is among this opposition bloc. "We worry about public services getting into the hands of foreign companies who are only interested in profits," she says.

COULD PRIVATIZATION REALLY WORK?

From Argentina to Bolivia to Mexico, a decade of privatization has done little to boost wealth levels for the most impoverished citizens. Since Argentina's economic meltdown, criticizing policies of open economies has become popular within prominent circles of Latin American industry and government. In Mexico, the privatization of banks is held up as an example of what can happen and how the rich inevitably stand as the principal beneficiaries of grand privatization plans.

In 1995, the government spent US$100 billion to prevent a collapse of the monetary system after the infamous peso devaluation, to rescue the banks. Six years later the owners of Banamex, the nation's largest bank, sold out to Citigroup Inc., pocketing US$12.5 billion. To be fair, shareholders had lost everything and put up fresh capital in the rescue. Without government cash, depositors would have lost their money. However, the lingering perception among the public was one of unfairness and unchecked greed. Given this, politicians are looking foran escape hatch. The favorite is to privatize with a rule that says foreigners can own just 49% of any asset. Institutional Revolutionary Party Sen. Alejandro Gutierrez wants a law by February allowing foreigners to own 49% of an electricity-generating plant outright without it being tied to a long-term supply contract because the Federal Electricity Commission "has no way to finance or generate the necessary investments." One additional problem for the state monopoly is a 182 billion-peso pension fund and workers compensation liability.

The last time this format was attempted was the sale of the petrochemical plant Cosoleacaque in the mid-1990s, which collapsed when the only bidder pulled out. No foreign company wants to be a minority partner in Mexico, and few Mexican companies have the needed capital.

THE WRONG WAY TO FINANCE

For the last decade, the government has financed the investments with off budget debt, getting private foreign companies to finance the construction of refineries and gas pipelines as well as a billion-dollar nitrogen plant. But although this debt is kept off the books, the annual payments have to be made. And as the World Bank said in its 2001 survey of developing Mexico entitled "A Comprehensive Development Agenda for the New Era"--"the various schemes employed for attracting private financing have proven costly and are ultimately unsustainable."

The US$2.4 billion project to upgrade the Cadereyta refinery in northern Mexico is an example of this. The actual cost of the work was US$1.6 billion; the rest was financing costs. A Korean engineering outfit, the SK Group, won the contract. The project was eventually finished more than two years late, forcing Pemex to import even more gasoline.

Some of the holdup came waiting for parts from Korea, and Pemex had no option--other than reopening the bidding process and setting the project back at least another year--rather than wait for the parts to arrive. In the meantime, Pemex cancelled the bidding for two other refmery projects after SK Group again came in with the lowest bid, unwilling to risk having the same contractor doing all the work and unable by law to award the project to any but the lowest bidder.

Natural gas is another area where current laws have hamstrung Pemex. In a bid to get foreigners to invest in developing extensive fields in northern Mexico, it designed contracts whereby it would pay companies for gas extracted at a fixed rate.

So as not to violate the Constitution, the contracts don't give companies the chance to make more money if they find more gas or if gas prices rise. Unsurprisingly, Pemex has had to postpone this plan due to lack of interest.

Whichever way the government and the state oil monopoly turn, no quick fix to the slow slide of Mexico's energy industry has presented itself. Opposition deputy Tapia, in talking about Congress and the stalled energy legislation, summed up the situation best. "We are paralyzed," she said.

John Moody, a former reporter for Bloomberg News, has covered energy issues in Mexico for almost a decade.