The Wall Street Journal-20080215-Politics - Economics- Crunch Time for Mexican Oil- Political Will Lacking For Production Overhaul As Output Tumbles

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Politics & Economics: Crunch Time for Mexican Oil; Political Will Lacking For Production Overhaul As Output Tumbles

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MEXICO CITY -- Mexico's oil industry is in decay and production is falling. But it doesn't appear the country is going to do anything about it anytime soon.

President Felipe Calderon has made energy overhaul his top legislative priority for this year. But the evidence of the past few weeks suggests he faces long odds at a time when high oil prices mask the country's looming production crunch.

Mexico's declining production could have a wide impact on oil markets, which are already under pressure from higher demand and price constraints, pushing oil from $30 a barrel to near $100 in four years.

Mexican oil output has declined steadily from its peak of 3.4 million barrels a day in 2004 and is expected to fall to 2.8 million barrels a day by the end of this year. If that continues, Mexico will likely stop exporting oil within seven years. The country relies on oil exports for about a third of government revenue. And Mexico is the third-largest supplier of oil to the U.S., behind Canada and Saudi Arabia.

Mr. Calderon needs to strike a balance between the country's history of oil nationalism and the need for new capital and technology to expand oil production, especially in the deep waters of the Gulf of Mexico. But defeating the forces of nationalism won't be easy. Mexico was the first major oil producer to kick out foreign companies, in 1938, a key event that is still celebrated in school textbooks there.

Despite optimism from the Calderon team in the past few months, the signs aren't encouraging for significant change. With the country moving toward the 70th anniversary of the nationalization on March 18, lawmakers have shied away from tackling the politically charged issue. Two of the three main parties are now asking Mr. Calderon, of the conservative National Action Party, to send an overhaul plan before launching debates, thereby washing their hands of any initial political backlash.

"At the end of the day, any chances of a broad reform are limited," says John Padilla, a Mexico analyst with IPD, an energy consulting firm based in New York.

The political players agree the industry needs more cash for exploration and production as the country's low-cost oil fields run dry, but there is little agreement on where the money should come from.

The government wants to allow the private sector to join forces with state monopoly Petroleos Mexicanos, or Pemex. "We're looking for [Pemex] to have the flexibility to form associations like all the companies in the world," Energy Minister Georgina Kessel said during a television interview yesterday.

The leftist Party of the Democratic Revolution wants to let Pemex go it alone, giving the company more money to invest by cutting its tax bill.

In the past few weeks, lawmakers from the former ruling Institutional Revolutionary Party, known by its Spanish acronym PRI, whose support is critical for the government, shifted their focus from trying to allow private investment to giving Pemex more money. One reason why some PRI members don't feel the need for urgent change is that high oil prices allow Mexico to make more money despite less output.

"With high prices this is one of the best moments for the industry. And it is now that we are going to share [by opening it up]?" says Francisco Rojas, a PRI member and former Pemex chief.

Many top Mexican officials, and most economists, feel that Pemex's monopoly encourages corruption and waste. Pemex's budget has risen from about $2 billion in the mid 1990s to nearly $20 billion this year. But production is still falling and the company has made no major finds.

Complicating matters, the oil debate has played into the hands of leftist Andres Manuel Lopez Obrador, who narrowly lost the 2006 presidential election to Mr. Calderon and has seized on the issue to try to become relevant again on a national level. "They want to hand our oil to foreign companies," Mr. Lopez Obrador said to flag-waving supporters at a recent rally. "We will stop them, even if we have to paralyze the country."

Depending on who wins, the energy overhaul will either be Mr. Calderon's biggest achievement to date or his first major stumble. Since the showdown over the 2006 election, the president has taken pride in his ability to pass legislation through a divided congress by striking closed-door deals with the PRI and even some PRD members, despite opposition to nearly every initiative from Mr. Lopez Obrador. This time around, the Calderon team hoped to have an agreement in place with the PRI before even sending a bill to Mexico's Congress.

But as a result, the public doesn't know exactly what the government wants from the reforms, allowing Mr. Lopez Obrador to take the initiative and accuse the government of trying to sell out the country.

"Mexico needs to have an open and honest debate about its oil industry, and until that happens real change will be difficult," says Luis de la Calle, a political consultant and former trade negotiator.

Polls show a majority of Mexicans are opposed to letting private investment enter the oil industry. But polls also show many here misunderstand the issue. Half of all Mexicans think that allowing private investment means selling off Pemex to the private sector, rather than keeping Pemex in state hands and allowing it to partner with private or other state-run firms.

It is a misconception that Mr. Lopez Obrador exploits every day, accusing the government of wanting to privatize Pemex.

"Oil is not just a commodity in Mexico, it's a political commodity," said pollster Jorge Buendia, the director in Mexico for Ipsos, a Paris polling firm. Mr. Buendia thinks the government needs to do a better job of making its case and explaining to the public what is at stake.