The Fuse

Mexico Takes Positive Step by Nixing Fuel Subsidies, But Economic Pain Ensues

by Matt Piotrowski | January 04, 2017

Since the oil price crash of 2014, there has been strong momentum for cutting fossil fuel subsidies, with a number of emerging market countries taking action to align gasoline and diesel prices with the global market. The reforms have been well overdue and will hopefully continue, as lifting subsidies has the potential to reduce wasteful spending and increase government revenue. Most importantly, bringing retail prices in line with the global market can help limit oil demand growth, improving energy security worldwide.

Scrapping subsidies is an important and positive action taken by the Mexican authorities, but the move has spurred widespread consternation among consumers and will bring about more unintended consequences.

Mexico is the latest country to get rid of fuel subsidies. This is an important and positive action taken by the Mexican authorities, but the move has spurred widespread consternation among consumers and will bring about more unintended consequences. The price deregulation, which began at the beginning of 2017 and has forced motorists to pay 20 percent more for fuel, has sparked protests throughout the country. That should hardly be surprising, given that the price increase was sharp and subsidies are typically popular with consumers. Governments worldwide have dragged their feet with reforming fuel prices because of worries of backlash and social unrest.

While the subsidy reform was badly needed, it comes at a difficult time for Mexico’s economy. The liberalization will be rolled out in different stages throughout the year, and will increase transportation costs, hurting the likes of farmers, taxi drivers and middle-class consumers, while also possibly adding to inflation. The Mexican president, Enrique Pena Nieto, on Wednesday defended the measure, saying that not taking steps for reform now would lead to more pain in the future, but his rhetoric is unlikely to calm angry consumers.

“Government officials downplayed the immediate negative effects of liberalizing prices in order to get people on board for reform.”

“Government officials downplayed the immediate negative effects of liberalizing prices in order to get people on board for reform,” said Lisa Viscidi, director of the energy, climate change and extractive industries program at the Inter-American Dialogue, told The Fuse. “But it comes at a bad time politically and economically for the country. The government is unpopular because of corruption scandals and the economy is doing poorly with PEMEX’s production falling and the value of the peso losing value.”

The Mexican peso hit a record low versus the dollar on Wednesday, a development that will make imports more expensive for the country. Government corruption, declining oil output, and higher retail prices are occurring at the same time Donald Trump will take office in the U.S. Given Trump’s attempts to keep U.S. firms from moving activity to Mexico, the country is worried it could lose business or see trade take a hit.

Demand slows as economy struggles, prices rise

Mexico relies heavily on U.S. refiners for gasoline, importing some 450,000 b/d from its northern neighbor in late 2016, reflecting how costly fuel is for Mexico, particularly with the decline of the peso.

The country currently consumes roughly 1.95 million barrels per day (mbd). Demand fell by approximately 60,000 b/d in 2016 and is expected to decline slightly again this year, particularly now that consumers will pay higher retail prices. Because of its lack of refining capacity, Mexico has to import almost half of its refined products, with about 950,000 b/d coming from the U.S. In fact, the country relies heavily on U.S. refiners for gasoline, importing some 450,000 b/d from its northern neighbor in late 2016, reflecting how costly fuel is for Mexico, particularly with the decline of the peso.

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Even though Mexico is opening its upstream assets to foreign players in an effort to reverse its industry’s fortunes and help the economy, forecasts show that output is expected to drop in the near term. Mexico joined OPEC and other non-OPEC countries in coordinated cuts at the end of last year in order to rebalance fundamentals and push up prices. For the most part, Mexico won’t have any difficulty meeting its commitment of a 100,000 b/d cut since natural declines are set to pull down production anyway. The graphic below (via the International Energy Agency) shows how much the country’s oil industry is struggling. By the end of 2017, production is expected to be just above 2.2 mbd, down more than 20 percent from the beginning of 2014.

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Curbing oil demand growth

In the past couple of years, countries such as Indonesia, Malaysia, Ghana, China, and a number of OPEC producers, including Saudi Arabia, took necessary steps to reform subsidies. Low oil prices and soaring budget deficits have provided motivation to scrap the status quo. Despite short-term pain from liberalizing prices, as seen currently in Mexico, longer-run benefits of curbing oil demand growth will emerge.

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