In Mexico, 50 billion barrels of oil are up for grabs

This week the Mexican president, Enrique Peña Nieto, is coming to London to promote Mexico to British investors. For Peña Nieto and his team, the mission is clear: they want to persuade investors to look beyond the headlines of drug violence and corruption, and focus on Mexico’s economic potential. In particular, they want to drum up interest in Mexico’s landmark energy reform.

Of course investors can’t afford to be fooled by politicians’ speeches. A far more reliable measure, especially in emerging markets, is to follow the local money. By that measure, Mexico looks promising. Over the last few months we’ve started to see more and more Mexican investors make moves in the Mexican energy sector. The reform is moving from being a political plan to a business reality.

Mexico isn’t going to make Brazil’s mistake

The most striking thing about Mexico’s reform is just how wide-ranging it is: it covers everything from power plants to petrol stations. On the power side, private electricity generation, which had been restricted so that generators could only produce for themselves or for the state, is being opened up to allow companies to sell electricity directly to end users.

As for oil and gas, Mexico’s state-owned oil firm, Pemex, is losing its monopoly. This means private-sector companies can now be involved in all parts of the energy business, and because Mexico is an energy behemoth, the scale of the opportunity is huge.

Pemex believes that there could be up to 50 billion barrels of oil equivalent (BOE) in Mexico’s part of the Gulf of Mexico. Mexico also has great shale oil and gas reserves: according to the US Energy Administration Agency, Mexico has the world’s fourth-biggest shale oil reserves. The Mexicans themselves are a bit more conservative, but even they put the figure of their total shale oil and gas reserves at around 60 billion BOE.

Of course, oil on its own is not enough. You also need to create the right environment for investors to spend billions of dollars on exploration and production. Brazil got it so wrong: when huge oil and gas discoveries were made, the government created new, much tougher rules for private oil companies. As a result, the first auction held under the new rules attracted just one bidder.

Fortunately the Mexicans have taken a different approach and created a more market-friendly regime. We’re starting to see signs that it’s paying off.

Local dealmakers

Last month, one of Mexico’s richest men announced his entry to the country’s energy sector. Alberto Bailleres, the owner of Grupo Bal, which includes London-listed silver miner Fresnillo, is backing a new oil and gas firm called Petrobal. Grupo Bal doesn’t have any energy experience, but it has snapped up Pemex’s former head of exploration and production, Carlos Morales.

Another local firm to make a move is Mexican cement producer Cemex. It has created Cemex Energia to focus on renewable electricity generation. The plan is for a joint venture with US firm Pattern Energy that has the ambitious target of developing 1,000MW of renewable energy over the next five years. If they pull it off it, Cemex Energia would supply around 5% of the country’s power.

Energy is an incredibly popular move for Mexican investors at the moment. Local conglomerate Alfa has announced plans to raise $1bn to finance deals in the local energy sector. It’s little surprise the Mexico’s richest man, Carlos Slim, is also said to be encouraging his Tabasco Oil to take advantage of the reform.

This flurry of activity from local investors is important. Last year I spent a few months in Mexico researching a report on the country’s economy, and it was notable that Mexicans were often more sceptical than foreigners. They told me that they’d seen plenty of false dawns before. If they’re getting involved now, it’s because they finally believe that this reform is going to make them rich.

Can Mexican Energy survive plunging oil?

The big elephant in the room is, of course, the plunging oil price. It might seem odd to be talking about energy investments while the price is falling, but the current level of $60 a barrel won’t derail the reform. That’s because Mexico has a range of different options to offer investors. Shallow water production, for example, is profitable at $60. Deep-water is also still profitable, but less so. New shale projects will probably feel the impact of cheap oil most, as they have the highest costs. In effect, what looks likely to happen is that the Mexican government will receive less money from the bidders than it had hoped for, but the process will still continue.

The first auction is set to take place this July, and it will offer a mix of shallow exploration and production prospects. So far, 26 firms have already paid for the seismic data for the exploration blocks. Thereafter there will be an auction every year for the next ten years as Mexico slowly parcels out its huge energy assets.

Over the years we’ve tracked this story from when it was just a hope to it becoming a real investment theme. Unfortunately, UK-based private investors will find it’s still not easy to play. There are some US-listed firms that have exposure, such as Sempra Energy, but nothing that gives us a direct way in. Another option is to invest in local names that will benefit. Petrochemicals outfit Mexichem, for example, should gain from cheaper feedstock. But this is just the start of a story that’s going to run and run. It will change the face of Mexico and make some investors very rich in the process. We’re going to have to be patient, but eventually a pure play will emerge.