Rule of Law Changes Needed to Ensure Mexico Energy Reform Success

Francisco Monaldi, a fellow in Latin American Energy Policy at Rice’s Baker Institute, said that investors have good reason to worry about Latin American investments, given the cycle of these countries opening their oil sectors to foreign investment, then expropriating assets without allowing companies to recover their initial investment. The fiscal regimes of these countries typically are regressive, meaning that they don’t capture additional rent when oil prices go up. So when prices rise, governments want to renegotiate contracts. Governments also have an incentive to change the rules once a significant amount of proven reserves are found; in many situations, investors are stuck because they’ve already put so much into a project.

Mexico did not follow the trend of liberalizing its oil sector in the 1990s because it didn’t need to then. That changed when production began to collapse; to reverse production declines, Mexico needed additional investment in its deepwater, shale and conventional oil resources.

A government who is heavily, fiscally dependent oil should scare investors in terms of property rights. If they’re that dependent, they have strong incentives to change fiscal rules. However, a variety of conditions make Mexico different from other Latin American countries, including its constitutional reform and the cumbersome checks and balances system developed as part of that reform, Monaldi said. Its diversified economy and higher than average perception of effective rule of law also are advantages.

Undoing the reform would be a difficult process, but it could occur in two ways, Monaldi said. One way is the more dramatic cases seen in Venezuela or Ecuador, where contracts were forcefully renegotiated. Or the country could do what Brazil did, honor existing contracts but change rules for new ones. The fact that the changes to Mexico’s constitution are very progressive should make it less likely that the government would want to renegotiate contracts as in the case of Venezuela. But at some point, the taxation rate could change.

“Law isn’t a science,” Posadas notes. “There’s a huge cultural element to law. You don’t after 70 years of rule suddenly have an authoritative government that is transparent.”


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