Uncertainty in Mexico as new president takes office

Uncertainty in Mexico as new president takes office

December 18, 2018 | By Carlos Campuzano in Mexico City and Raquel Bierzwinsky in New York | Mexico City

Many people have been asking since Andrés Manuel López Obrador took office as Mexican president in early December what this means for the power and infrastructure sectors in the country.

The short answer is that unlike the new Mexico City airport project, López Obrador has not moved yet to dismantle the energy reforms that the previous government put in place in 2013. He is taking time to evaluate the reforms even though he criticized them on the campaign trail and continues to do so.

López Obrador — or AMLO as he is known in Mexico — rode to victory at the head of a left-leaning populist movement after running unsuccessfully for the presidency in 2006
and 2012.

Mexican voters were ready for a change after nine decades of increasing inequality in a country flush with natural resources and a privileged location.

The new political party he formed for the 2018 election, Movimiento Regeneración Nacional or Morena, surged ahead of the PRI and PAN, the two parties that have ruled Mexico for the last 90 years to win not only the presidency, but also control of both houses of the Mexican Congress and the governors’ races in five states. Morena now controls the state legislatures in 19 of 32 states. AMLO took 53% of the popular vote.

AMLO made a number of promises during the campaign that were not well received by investors and the markets in general.

As in many countries, a degree of political uncertainty can be expected when a new administration takes office.

Mexican presidents serve for a single term of six years. Thus, the Mexican federal government usually experiences a transition phase after each new administration takes office. The transition can be more jarring when the new president belongs to a different party.

Just as in the United States, in Mexico the first 100 days of a new administration are crucial for the incoming government to make progress on implementing its agenda.

With new government officials replacing outgoing ones, it is not uncommon in Mexico for business as usual to slow significantly for the first six months of any new administration, especially in a case like this one where a fundamental shift in direction is expected.

It is not surprising for officials to suspend, at least temporarily, some of the plans carried out by the former administration, as happened when the Trump administration took office in the United States. This buys time for the new government to analyze what fits with its policies and campaign commitments.

President López Obrador made the central theme of his campaign to end corruption, fight poverty and give a stronger voice to the people in the federal government’s most important decisions.

AMLO also ran a platform of complete repudiation of “neoliberal” policies of the last 36 years that he said left behind a significant share of the population, impoverished the middle class and enriched particular sectors of society. Recent governments have been plagued by corruption scandals.

Mexico City Airport

AMLO promised during the campaign to cancel the new Mexico City airport, even though it is about a third built. He called it “a monument to corruption.”

The project is expected to cost US$13 billion, most of which is supposed to come from private sources through the issuance of bonds in international capital markets and the issuance of local bonds through a real estate investment trust vehicle known as a Fibra E. (For more information about the Fibra E structure, see “Fibra E Rules Relaxed” in the June 2016 NewsWire.)

AMLO based his corruption charge on the fact that many of the construction contracts for the project were awarded without a competitive tender process, but no actual evidence of corruption has emerged thus far.

This past October, while still president-elect, AMLO held a skewed public consultation for people in Mexico City to vote on whether to continue or cancel the project. The polling stations were set up by his party without involvement of the Federal Electoral Commission, and the polling stations were strategically located in areas of Mexico City that support his political party. Fewer than a million people voted. Predictably, the results were against the airport.

The consultation has created anxiety among the investor community. Roughly US$2 billion in liquid capital is reported to have left the country since the referendum and the Mexican peso has been trending weaker after suffering big losses in value earlier against the dollar after AMLO was elected. The erosion in investor confidence led AMLO to clarify that not all federal government decisions will be subject to public consultation.

The Mexican government also clarified that all commitments made to holders of airport bonds will be honored by the government since cancellation of the airport project is a default under the bonds that can lead to an obligation for immediate repayment.

The federal government and the bondholders are negotiating a buyback. The government has made three proposals so far, all of which have been rejected by bondholders.

The more recent proposal made by the federal government included the repayment of US$1.8 billion of the US$6 billion in bonds outstanding at the par price plus interest accrued, as well as a $10 premium for every $1,000 repurchased, in exchange for adequate repayment assurances. Repayment of the remaining US$4.2 billion would be secured by the current Mexico City airport’s user fee.

The bondholders said they rejected the most recent proposal over concern that the government’s plans to build two new runways at a nearby air field, Santa Lucía, where the Mexican military currently has an air base, and to increase the capacity of a nearby airport in the city of Toluca cast doubt on the projected user fees that will be earned at the Mexico City airport.

In an effort to assuage these concerns, the government offered a commitment to maintain the passenger volume at the Mexico City airport and revised the bond terms to make it an event of default if there is a decrease in user-fee collections due to operation of an alternate airport within 70 kilometers of the current airport and if commercial operations at the Toluca airport increase beyond five million passengers a year.

The new default trigger is at odds with the policy of expanding the capacity of nearby airports to alleviate congestion at the Mexico City airport.

The government has also offered to apply the Santa Lucía and Toluca airport user fees toward repayment of the Mexico City airport bonds and potentially to increase such fees. This is an unpopular proposal among many airport users, who may be willing to pay higher user fees if the end result is construction of a new airport, but not to repay debt for an abandoned project.

Local pension funds will also play a key role. During the first quarter of 2018, local pension funds invested more than
US$650 million toward construction of the new airport through a Fibra E. So far, the government has only focused on repaying the bondholders first. It has yet to announce a plan to repay the pension funds.

The government has four main options. One is to cancel the airport project and be sued in both Mexican and international courts (including New York) by the bondholders and be left with a massive debt that will significantly harm the finances of the country, probably leading to a downgrade of Mexico’s credit rating and increase the cost of borrowing for the entire country. This would also lead to a significant drain on funds from the national budget, preventing AMLO from implementing all the social and anti-poverty programs on which he campaigned. It would be political suicide.

The second option is to attempt to buy back part of the outstanding bonds and convince the remaining bondholders to modify the terms of the notes and the contractors to convert their contracts to construction of the Santa Lucía airport. This option is not viable, as numerous aviation and aeronautics experts have voiced strong opposition to it on safety and economic grounds.

The third option is to continue with construction of the project and audit the contracts awarded by the previous government to root out any corruption in the awards, recognizing that the airport is a key building block of infrastructure modernization in Mexico. Unfortunately, the referendum results make this too difficult as it would infuriate AMLO’s base.

The fourth option is to privatize the project by putting the airport concession out for tender to the private sector, relieving the government of the financial burden. This would be the most sensible outcome for the country and one that is being strongly lobbied by the private sector.

Austerity measures

One of President López Obrador’s favorite slogans is that “a rich government cannot exist when its people are poor.”

He believes that public officials should have a true vocation for public service rather than seek high salaries. These ideals have earned him the sympathy of many Mexicans and contributed to his political success. He is proposing to implement a government austerity plan as one of his main campaign commitments.

In line with this commitment, the Mexican Congress voted in November to cap the salaries of Mexican public officials so that none of them earns more than the president. In line with this, AMLO is committed to lower his monthly salary to MX$108,000 (approximately, US$5,270) starting next year.

Although the effects of this are yet to be seen, many public employees have voiced discontent and a significant number, particularly in decision-making positions, are leaving for the private sector.

The Mexican Supreme Court issued an injunction to suspend implementation of the cap until the case can be heard and a final judgement is entered.

Foreign investment

President López Obrador committed in his inaugural address to safeguard investments based on clear rules, honesty, economic growth and trust.

Some commitments made by AMLO during the campaign that were also mentioned in his inaugural address touched on the energy sector.

He is determined to strengthen the government-owned oil & gas company, PEMEX, by investing in exploration and production infrastructure, refurbishing six oil refineries and building a new one in his home state of Tabasco in southeastern Mexico. He also wants to help the Mexican electric utility, CFE, by modernizing, retrofitting and expanding its existing power plants, principally the hydroelectric ones, and by promoting clean energy power sources.

López Obrador criticized past privatizations of public assets. He also criticized the energy reforms of 2013 that gave independent generators a stronger foothold in the electricity sector. He called the results of the reforms disappointing and said they have led to reductions in oil production and increases in gasoline, gas and electricity prices.

At the same time, he has assured investors that all existing contracts entered into with foreign and Mexican companies as an outgrowth of the energy reforms will be honored, while urging winners of the oil exploration and production tenders to demonstrate the benefits to the country within a three-year “truce period.” Until then, he has cancelled any further E&P tenders.

His views about the 2013 reforms are not shared by the authors of this article. The energy reforms were desperately overdue. Oil production had decreased alarmingly before the reforms due to corruption and mismanagement of resources and PEMEX’s finances, including crippling obligations to the PEMEX labor union. PEMEX and the Mexican government lacks the technology, expertise and resources to continue to develop the country’s natural resources. It is cheaper for the country to have its crude oil refined in the United States than to do it locally. PEMEX was the Mexican government’s cash cow until this became unsustainable.

On the power side, the same can be said of CFE. CFE has been unable to match the country’s growth with its old fleet of majority heavy-fuel oil power plants that have kept electricity prices high. Not having a competitive and open power market that relies more on cheap natural gas and renewable energy was no longer viable. The Mexican energy sector cannot rely solely on two government-owned entities.


One of AMLO’s objectives is to strengthen PEMEX and CFE. Even though AMLO is a populist, he is a native of the state of Tabasco, one of the states where PEMEX has its main production areas and employs a significant percentage of the local labor force. He wants to increase oil and gas production, and significantly decrease the dependency on natural gas coming from Texas and the US portion of the Gulf of Mexico.

He also wants to reverse what he calls the “dismantling” of CFE as part of the 2013 reforms.

The reality is that the reforms are meant to restore both PEMEX and CFE to financial stability by restructuring the companies, implementing much-needed corporate governance structures, maintaining a monopoly in strategic sectors where a monopoly is still warranted (for example, power transmission and distribution), while making PEMEX and CFE compete in areas where private competition will benefit the industry and will bring down energy prices.

Most of the details of what the new government plans are still to come.

However, on December 8, one week after taking office, López Obrador and the new head of the CFE — Manuel Bartlett — announced the government’s new plan for the electricity sector. Although no official document has been published, AMLO said the CFE will be audited to determine whether private entities have unduly benefited from CFE’s restructuring by selling expensive energy to CFE.

He was probably not referring to the clean energy power auctions that were undertaken after the 2013 reforms, as these have led to the lowest electricity prices yet for CFE. The average price for energy sold to CFE and other offtakers in the third long-term power auction was US$20.57 a megawatt hour. The lowest price bid in the auction for an awarded bid was US$17.76 a megawatt hour.

He probably was referring to the independent power contracts awarded before the energy reforms under the old regulatory scheme, mainly to owners of gas-fired power projects, many of which depend for fuel on private natural gas pipelines that have long-term transportation and maintenance contracts with the CFE and are still under construction to bring natural gas to northern and central Mexico. AMLO has said these pipelines that were promoted and tendered by CFE are too expensive and without enough benefit to justify the high cost.

As part of his plan and consistent with his campaign agenda, AMLO repeated after the inauguration that he supports renewable energy, particularly hydro, solar and wind.

During the announcement of the government’s new plan for the electricity sector, López Obrador and Bartlett indicated that, besides refurbishing many of the CFE heavy-fuel-oil power plants, they are considering trying to increase Mexico’s hydropower capacity by 26%, equivalent to 3,300 megawatts, but without building new hydroelectric plants.

The previous government did an assessment of the CFE generation fleet and concluded that the utility has 10,000 megawatts of obsolete and inefficient power plants that run on heavy fuels and should be replaced with renewable and gas-fired power plants. Most of the replacement plants were to be built and operated by the private sector and supply their power to the CFE.

The new government drew headlines when the independent system operator, CENACE, announced the suspension of the fourth long-term power auction that was scheduled to take place on December 18.

The suspension does not come as a surprise as the new government wants to review the objectives and scope of the auction and to allow time for the new heads of the CFE, Ministry of Energy and CENACE to take office and familiarize themselves with the reforms. The suspension does not mean the fourth long-term energy auction or auctions in general have been canceled. Even among auction participants, the suspension is considered a reasonable and expected outcome.

The electricity sector reforms created a wholesale electricity market with complex regulations that members of AMLO’s government will need time to master.

New faces

President López Obrador has appointed new heads for each of the public entities in charge of managing, regulating and operating the power sector, as well as CFE and PEMEX. Some of these positions have been filled by people with vast experience in the energy sector while others are being used for political patronage.

The new Minister of Energy is Rocío Nahle García. Ms. Nahle is a chemical engineer, specializing in petrochemistry, who worked for both PEMEX and private companies. Most recently, she served as a congresswoman for Morena and advisor to the Mexican Congress on energy-related matters. As the head of the Ministry of Energy, Ms. Nahle will be in charge of implementing the federal government’s energy policy.

Alfonso Morcos Flores is the new director of CENACE. Mr. Morcos is a mechanical electrical engineer with more than 50 years of experience in the electricity sector. He worked at CFE from 1966 to 1989 and was the head of CENACE from 1983 to 1989, when CENACE was part of the CFE. After leaving the CFE, Mr. Morcos became a consultant in the private sector. CENACE is responsible for operating of the national electricity grid and the wholesale power market.

The Energy Regulatory Commission, called the CRE, has not had any changes, as it is governed by a board of commissioners with staggered seven-year appointments that are not revocable by the president. The chairman was appointed in 2016 and his term ends in April 2023. Although the CRE is a federal government entity, it has autonomy and acts independently. It regulates both the electricity and the midstream and downstream oil & gas sectors.

The new head of the CFE is Manuel Bartlett. Mr. Bartlett is a former member of the long-time governing political party, the PRI, where he pursued a political career from 1962 to 2006. His past roles have included serving as head of the national executive committee of the PRI, Minister of the Interior from 1982 to 1988, Minister of Education from 1988 to 1992, and governor of the state of Puebla. He has been a vocal opponent of the 2013 energy reforms.

Despite AMLO’s opposition to the 2013 energy reforms, so far he has not publicly threatened to undo them. The energy reforms in the oil & gas sector are the most at risk as AMLO, Ms. Nahle and Morena have harshly criticized them. They charge the effect is to sell off the public resources and in a manner that has been tailored specifically to benefit certain interest groups. The reforms would require a constitutional amendment to cancel. Both houses of the Mexican Congress would have to pass any such amendment by two thirds votes. In addition, a majority of Mexican states would also have to ratify the amendment.

Rather than undo the reforms, AMLO has said he wants to review existing processes and contracts and work within the existing regulations.