Lessons for Mexico in Brazil’s Boom

In the energy sector, open markets work

“God is Brazilian!” declared President Luiz Inácio Lula da Silva upon the recent discovery of massive new oil reserves off Brazil’s coast. But while God deserves a share of the credit for Brazil’s good fortune, so too does former president Fernando Henrique Cardoso, who fought to reform Brazil’s state oil company, Petrobras, in the mid-1990s. As Mexican president Felipe Calderón considers reforming Mexico’s national oil company, Pemex, he would do well to reflect on how Brazil became a world leader in energy production.

During his two administrations, from 1995 to 2003, Cardoso continued a privatization program initiated by a predecessor, President Fernando Collor de Mello, that transformed many of Brazil’s most prominent government-owned enterprises into publicly traded corporations. Companies such as Acesita (steel), Embraer (airplanes), Telebras (telephones), and CVRD: Companhia Vale do Rio Doce (mining) went public and have exhibited astonishing growth ever since—becoming respected world leaders in their industries and creating jobs and wealth for the Brazilian people.

None of these full privatizations, however, was as controversial as the partial privatization of the Brazilian oil company Petrobras. Shortly after taking office, Cardoso faced a strike by the oil workers’ union that shut down production for more than a month. Taking a page from the Margaret Thatcher and Ronald Reagan playbooks, Cardoso ordered the strikers to return to work or face dismissal. As gasoline and natural-gas supplies began to dwindle, public opinion turned in his favor, and Cardoso was able to push through legislation that turned Petrobras into a quasi-public corporation open to foreign investment and competition. The company raised capital through a listing on the New York Stock Exchange. Today, under Petrobras’s two-tier stock structure, the federal government maintains a slight majority of voting shares, but about 60 percent of overall equity is now in the hands of outside shareholders. Foreign operators can enter into partnership agreements with Petrobras or even bid against the company for offshore drilling rights. The creation of an independent board of directors has improved corporate governance, as has the adoption of international accounting standards and other transparency measures.

As a result, over the past decade Petrobras has gone from an inefficient industry laggard to one of the world’s most respected publicly traded energy firms. Petrobras is now a leader in deep-water oil exploration and natural-gas discovery and delivery. The company has also been at the forefront of Brazil’s efforts to produce efficient sugarcane-derived ethanol. Brazil’s domestic oil production and reserves have doubled, and Petrobras now has a market capitalization of over $200 billion, with operations in 27 countries, including the United States.

Mexico, on the other hand, forbids private investment in its energy sector, strictly interpreting its 1917 constitution’s statement that all subsoil resources belong to the Mexican people. But while many countries, from Canada to Norway to China, regard oil and gas reserves as national assets, only Mexico and North Korea ban any type of foreign—or even private domestic—investment in those industries. Private firms haven’t played any real role in Mexico’s energy sector since March 18, 1938, when President Lázaro Cárdenas seized the assets of British and American petroleum companies—a date still celebrated in Mexico as “Expropriation Day.”

As a result, Mexico’s national oil company, Pemex, is notoriously inefficient, less a corporation than an arm of the Mexican government. Because the government depends on Pemex to fund over a third of the federal budget, there is often little money left over to invest in expensive exploration in the Gulf of Mexico’s deep waters, where experts believe vast reserves of untapped oil and natural gas exist. And as a result of years of underinvestment, Mexico’s oil production has begun to stall.

President Calderón gave a major address in September, telling the Mexican people that “oil reserves have been consistently falling” and that the decline was “severely threatening” government finances. He warned that current reserves would last only nine years. Given the critical nature of the situation, one would think that Mexicans would be eager to open up their energy sector; but Mexico’s “oil patrimony” has long been a political third rail. Andres Manuel López Obrador, the populist who lost a close presidential race last year, recently held a rally in Mexico City and said he would call for mass demonstrations if the Calderón administration tries to “hand the nation’s oil over to foreigners.”

Public opinion polls, however, suggest that Mexicans may be moving away from López Obrador’s nineteenth-century heroic nationalism and toward Calderón’s twenty-first-century pro-business pragmatism. Common sense is gaining a foothold in Mexico, and the idea of at least “partnering” with foreign companies (such as Petrobras) is no longer taboo. In fact, Pemex has recently begun offering some very limited service contracts to foreign firms. Recently adopted legislation slightly reduces Pemex’s tax burden and promises billions in investment—but still much less than what experts say is needed. As energy analyst George Baker puts it, “Giving Pemex more money is all very well, but a commercial framework is needed to control, administer, and account for the money.”

What Mexico needs is Brazil-style reforms that would create a real corporate-governance structure for Pemex and open up the nation’s energy monopoly to foreign investment, competition, and expertise. President Calderón is expected to introduce an energy-reform proposal in the coming weeks. His campaign slogan in last year’s election was “mas inversion, mas empleos” (more investment, more jobs). The Brazil example shows how much a country can gain with that philosophy; will Calderón and Mexico have the will to adopt it?

* Charles Sahm directs a Latin American initiative for the Manhattan Institute and is president of Inter-American Advisors, LLC.