Will Energy Prices Zap Mexico?
At first blush, the hike in oil prices wrought by the twin tempests of late summer -- hurricanes Katrina and Rita -- is good news for Mexico. After all, costlier oil has always meant more money for the government. And there has been a strong positive correlation between the strength of the Mexican peso and the price of crude.
But in fact, the runup in energy prices poses problems for the Mexican economy. For starters, Mexico imports both refined gasoline and natural gas. Second, the government-controlled oil concern, Pemex, may have difficulty passing on higher costs to the country's consumers. And finally, Mexico's export industries are sensitive to factory demand north of the border.
Oil revenues make up 35% of Mexican government income, up from 30% a few years ago, when oil prices were lower. Through the first five years of President Vincente Fox's six-year term, oil prices have been unusually high.
The average price today of a barrel of export Mexican crude is about 60% higher than the average historical price. The average over 2004-05 is expected to be just over $36 per barrel. In the last two years of the Zedillo Administration, 1999 and 2000, it was slightly over $20.
The rise in crude prices has been a politician's dream: Thanks to higher revenues, noninterest expenditures could continue growing more rapidly than tax income, while at the same time the public sector deficit fell as a percentage of GDP. The deficit, as traditionally measured, should be 0.2% of GDP this year, down from 0.3% last year and 1.1% in 2000, Zedillo's last year in office.
The broader measure of the deficit -- the public sector borrowing requirement -- should be 2.2% this year, excluding the cost of the voluntary retirement program. Why take the political heat for harder limits on the growth of current expenditures if oil prices let you sidestep it?
The Fox Administration has proposed legislation to limit the government's ability to use Pemex as its cash cow. There's broad support in Congress, but not enough. The bill that can finally be approved might be better than nothing, however.
Although oil revenues now only contribute around 14% of total export revenues, on the margin the level of oil prices makes a big difference. In the first half of the year, the trade account deficit without oil revenues would have been four times higher than it actually was -- $10.22 billion instead of $2.54 billion. The current account deficit would have been equivalent to 2.8% of GDP, instead of 0.7%.
But things look less rosy upon closer examination. Mexico is a net importer of natural gas, notwithstanding the prodigious natural-gas resources it is blessed with. Worse, Mexico imports gas from the U.S., itself a net importer.
Worse still, it's highly unlikely that the positive points in Fox's post-Katrina energy "Ten Commandments" -- limited opening to private-sector participation -- will be approved. And it's very likely that subsidies proposed for the oil industry will get the nod from Mexico's Congress. This is bad news for public-sector finances.
Mexico also imports gasoline and, as anyone who fills up in the U.S. knows, gasoline prices are way up. Political realities and concern about inflation make it extremely unlikely that Pemex can pass on the higher prices for imported gasoline to its customers. This is further bad news for the government finances, and for Pemex' ability to make much-needed investments.
If the soaring cost of natural gas, or inability to refine enough gasoline to satisfy domestic demand, led to effective actions to attack the problems head-on, that would be one thing. It doesn't seem likely, though.
While Pemex goes on burning off natural gas, the government is seriously considering building a liquefied natural-gas plant in a joint venture in Peru. Pemex has already used the joint-venture strategy to build a refinery in Deer Park, Tex. Since the Mexican Constitution forbids private participation in refining, Pemex exports oil to Texas, then ships it back to Mexico as gasoline.
Higher oil prices might also affect remittances -- monies sent back home by Mexicans working abroad -- which have become nearly as important in limiting the size of the current account deficit as oil revenues. Between 1998 and 2000, net transfers (almost entirely remittances) averaged $6.44 billion per year.
In 2004 and 2005, net transfers should average more than $17.0 billion per year, which is nearly twice the size of the average current account deficit in each year. In the first six months of this year alone, net remittances totaled $9.51 billion.
Without remittances, but including oil revenues, the current account deficit would have been 3.3% of GDP instead of 0.7%. Without remittances and without oil, it would have been a thumping $22.26 billion, or 6.1% of GDP.
To the extent the jump in gasoline prices in the U.S. channels more of migrants' income into putting fuel in their tanks or heating their dwellings, it will cut into what they can afford to send home. That's not to say remittances will fall, but it might mean they don't continue growing at last year's 23% rate, or the 17.2% year-over-year rate of the first half of this year.
There's also the question of the impact of high oil prices on the growth of Mexico's manufacturing sector. Manufactured exports accounted for 81.7% of export revenues in the first seven months of the year, and exports have consistently been an engine of growth in the past 15 to 20 years.
Before Katrina, there were signs that Mexican manufacturing (excluding maquiladoras -- border-area factories controlled by U.S. manufacturers) hadn't responded to the recovery of the U.S. manufacturing sector this year with the same alacrity as in the past. To the extent Katrina and Rita mean higher commodity prices -- or depress the growth of U.S. manufacturing -- it's more bad news for Mexican manufacturers.
Overall, it seems that while America's neighbor to the south escaped physical damage from the terrible late-summer storms, the economic toll may be serious.
From Action Economics staff analysts