Last week, Mexico's Senate approved an energy reform that should prove transformational for its $1.2 trillion economy.
The reform would not only enable the country, which has the fourth-largest shale gas reserves in the world, to join the US in the shale energy revolution . It could also increase Mexico's GDP growth by as much as 1.6 percentage points a year, at a time when some other parts of the developing world are facing significant headwinds.
The reform, together with others recently approved, makes Mexico one of the few countries trying to enhance its competitiveness at a time when the Fed is to begin reining in its stimulus measures and reducing liquidity in the financial system while competition for capital is set to increase.
The Mexican upper and lower chambers passed legislation breaking a 73-year old Mexican taboo stopping private investment in Mexican oil and gas exploration, extraction and refining. The bill is expected to be signed by the president this week and secondary laws will then be approved in the next 120 days. In a sign of the times, street protests and opposition resistance to the reform have been relatively muted.
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The depth and breadth of the reform being discussed is more ambitious than the one presented by President Peña Nieto in past months and exceeds even the rosiest expectations. The variety of structures under which private companies would be allowed to participate in oil and gas drilling is the key positive surprise.
The reform contemplates service concessions as well as profit-sharing and production-sharing contracts – which allows companies to book reserves. Additionally, Pemex, the national oil giant, would remove representatives of its workers union from the board of directors, the electric power sector would be open to private investment, and a sovereign wealth fund run by the central bank would be established to manage energy revenues. This reform looks to have all the ingredients needed to unleash the country's energy potential.
The U.S. shale revolution has drastically increased gas production, reduced the cost of energy and therefore improved the economic competitiveness of its businesses, added hundreds of thousands of new jobs, and strengthened its current-account balance.
Mexico is well-positioned to rapidly adopt the knowledge and technology needed to exploit shale formations. Given its close trading ties with the U.S. and expected competitive gains, Mexico would be also be well-placed to extract a further share of the U.S. manufacturing market from competitors like China, a country which also just recently announced ambitious reform plans.
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After the U.S. Federal Reserve first hinted in May that it might taper its quantitative easing program, the sell-off in emerging market assets should have represented a wake-up call to all developing countries. In a world where monetary conditions may tighten andthe placement of international capital is becoming more discerning, investors will pay great attention to structural reforms.
Mexico still has to implement some of its other recent policy moves effectively, and challenges remain in areas like security and the rule of law. But withtheir new energy framework, Mexican politicians and policymakers have shown they understand that in the competition for scarcer capital, only the fittest will outperform.
Jorge Mariscal is Emerging Markets Chief Investment Officer at UBS Wealth Management.