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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Mexico Risks Trade War With U.S. Over Energy Reform Roll Back

  • AMLO’s roll back of reforms aimed at opening the country’s power and oil markets have angered the U.S. and Canada.
  • The Office of the United States Trade Representative will make a"final offer" to Mexico negotiators to open up its markets and agree to increased oversight.
  • Mexico’s move to reduce crude exports in order to refine its own crude may have a negative impact on the country’s economy.

The former U.S. administration was characterized by numerous trade wars involving multiple battles with various countries, including close American allies such as Canada. The battles frequently followed a particular U.S. legal rationale, with Trump labeling foreign imports a national security threat before imposing tariffs and/or quotas on imports. 

The current administration has a slightly better track record, with Biden rolling back some Trump-era tariffs including removing tariffs on Canadian solar products, but electing to keep most of them in place. And now, Washington finds itself on the precipice of yet another trade war, with the Biden administration planning to send Mexico an "act now or else" message in the coming weeks as their energy dispute threatens to boil over. 

The decision by Mexican President Andres Manuel Lopez Obrador toroll back reforms aimed at opening Mexico's power and oil markets to outside competition has angered the U.S., Canada and Europe and triggered bipartisan calls for the U.S. to get tougher on its southern neighbor. In recent years, U.S. Big Oil companies, such as Chevron Corp. (NYSE:CVX) and Marathon Petroleum Corp. (NYSE:MPC), alongside a host of solar and wind energy companies, have struggled to obtain permits to operate in Mexico.

The Office of the United States Trade Representative (USTR) will make a"final offer" to Mexico negotiators to open up its markets and agree to increased oversight. If they fail to accept the final offer, the U.S. will request an independent dispute settlement panel under the USMCA trade agreement. The U.S. and Canadademanded dispute settlement talks with Mexico nearly a year ago, far more time than the 75 days required under USMCA rules before aggrieved parties can request a dispute settlement panel if they fail to reach an agreement.

These developments increase the risk of another full-blown trade war between the U.S. and Mexico. The U.S. is Mexico’s largest oil export market, with the Latin American nation selling American refineries 710,000 barrels per day in 2021 while also importing 1.16 million b/d. Previously, Trump had imposed a25 percent levy on Mexican steel and 10 percent on aluminum, arguing that cheap imports were a national security threat and were decimating whole communities. However, he later lifted the tariffs, marking the first time the iconoclastic president backed down on protection once it had been imposed. 

Energy Independence

Since becoming Mexico’s president in 2018, Obrador has undertaken various radical reforms in the country’s energy and power sectors as he endeavors to achieve elusive energy independence. Two years ago, he announced a rather controversial plan to phase down oil imports, reversing a major reform plan enshrined in the constitution in 2013. 

As part of the plan, Mexico’s NOC Petroleos Mexicanos aka Pemex, was to cut crude oil exports from over a million barrels per day to just 435,000 barrels a day in 2023. The move is part of President Andrés Manuel López Obrador’s (AMLO’s) drive to lower imports of costly refined products, such as gasoline and diesel, and instead rely more on domestic production. “Practically 100% of Mexican crude will be refined in our country,” Pemex head Octavio Romero Oropeza said at the much-heralded opening of a new refinery in the southeastern state of Tabasco.  Related: How Herd Mentality Sparked Chaos In Oil Markets

But high oil prices and an uncertain economic outlook including high inflation might see those plans shelved by the Mexican government.

Like most oil companies, high oil and gas prices helped Pemex to post its first annual profit in a decade, prompting the president to declare that Pemex, “was in bankruptcy and it is now being reborn”. Although oil revenues are no longer as important to Mexico’s economy as they once were, economist Victor Gomez has told Efe it is “improbable the Mexican government can stop relying on the export of petroleum as a source of funds”. Gomez is a former Finance Secretariat official who now works in the private sector.

According to Gomez, the financial windfall from oil sales “is a positive note” for public accounts. However, much of the oil profits have gone to cover the nearly $21 billion in uncollected taxes after the Mexican government suspended retail fuel taxes. Last year, people living in the United States have been driving across the border into Mexico in search of lower gas prices.

But oil is just one of the energy commodities that Obrador has sought to secure. In another act of protectionism, he sought to reform the electricity sector such that it would guarantee state electricity group CFE 54% of the market. The proposal aimed to transform the regulatory landscape for the electricity sector, including canceling power generation permits and prioritizing CFE power over private renewables on the national grid. However, the bill was defeated in Mexico’s Congress.

Obrador is also pushing ahead with plans to nationalize the country’s lithium sector after nationalizing lithium deposits last April, saying “There will be a company to explore for it, extract it, commercialize it.” Last month, he signed a decree handing over responsibility for lithium reserves to the energy ministry.

Bad Idea

The energy independence that Obrador dreams of might not be a very good idea. Indeed, a cross-section of analysts has pointed out that self-sufficiency would not be good for Mexico, and are even skeptical whether such a goal is economically viable. 

“The supposed benefit of self-sufficiency doesn’t exist. So ending all petroleum exports doesn’t look like a real possibility.” Gabriela Siller Pagaza, head of economic analysis at the financial firm Banco Base, has said. According to Siller, energy security, defined by theInternational Energy Agency as “the uninterrupted availability of energy sources at an affordable price,” is more important to Mexico than self-sufficiency. 

She has also pointed out that for Mexico to achieve its goal, it would have to incentivize other export products and/or boost the country’s tourism industry, noting that no such plans are currently on the table. “If Mexico were to stop exporting oil without a backup plan to compensate for the loss of capital, the Mexican economy would be at grave risk.”

Eric Smith, associate director of the Tulane Energy Institute, has concurred and says ending oil exports is not a feasible option for Mexico and the announcement by the president is little more than political posturing.

I think what’s going on is that the president is trying to convince Mexico to essentially add more value to the crude oil it produces, and in order to do that, it needs more refining capacity and petrochemical processing capacity, and things like that, all of which take capital,”he has said.

Source: Trading Economics

Mexico’s economy is a fairly energy intensive one requiring large amounts of petroleum, liquids and natural gas. In turn, rising natural gas consumption has led to the need for more infrastructure, including new pipelines to import U.S. natural gas. 

However, Mexico is a classic example of a Jekyll and Hyde economy. On one hand, the country boasts a trillion-dollars in gross domestic product (GDP), making it one of the highest for a developing nation. However, the relatively big economy is overshadowed by the fact that ~44% of its population lives below the poverty line, with the country also having the third-highest degree of income inequality amongst the 39 member nations of the Organisation for Economic Co-operation and Development (OECD).

Meanwhile, the nation’s energy industry is riddled with rampant oil theft and a thriving black market.

Criminal syndicates associated with powerful drug trafficking cartels have frequently targeted Pemex’s pipelines to steal crude oil and derivative products. The problem has become so entrenched that by the time Obrador took office, the country was losing a whopping 80,000 barrels or more of petroleum and derivative products per day to oil thieves. 

By Alex Kimani for Oilprice.com

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