Today's date:
Summer 2005

Tapping Mexico’s Potential

José Alberro was the negotiator for PEMEX, the Mexican state oil company, on the NAFTA treaty. Jorgé Castañeda, the former foreign minister of Mexico, is a candidate for the Mexican presidency. Nathan Gardels, editor of NPQ, was executive director of the Governor’s Public Investment Task Force in California and director of the State of California Pension Investment Unit from 1979-1983.

Mexico City—When George W. Bush and Vicente Fox, the Mexican president, met in Guanajuato, Mexico, in February 2001, they issued a joint statement that called for "a North American approach to the important issue of energy resources." That communique also committed the two presidents "to consolidate a North American economic community whose benefits reach the lesser developed areas of the region and extend to the most vulnerable social groups in our countries."

There is a way this initiative can still be fulfilled that decreases America’s energy dependency on the Middle East while boosting development in Mexico, thus also tackling the issue of massive cross-border immigration.

Per capita gross domestic product in Mexico will not continue to grow over the long term without structural change to boost productivity. This requires investment in infrastructure, human resources and technology to create jobs and alleviate poverty. The Mexican government needs to take the lead while eliminating obstacles to private investment. Given Mexico’s weak public revenues, financing such projects can only come from leveraging Mexico’s large hydrocarbon resources.

Mexico has the largest proved oil reserves in North America. It has become the top source for oil imported by the United States, exporting 90 percent of its oil there.

There are indications that unexplored reserves in the Gulf of Mexico are as large as the ones currently identified. However, developing this resource has stalled because Mexico’s constitution prohibits private investment in the sector.

To surmount this obstacle, a North American Energy Fund, overseen by an independent and transparent board, could be established to issue $75 billion of securities backed by oil revenues (not the oil itself) to finance the rapid expansion of Mexico’s oil production, leading to the doubling of exports by 2010.

According to Jose Alberro, who was the negotiator for PEMEX, the Mexican state oil company, on the North American Free Trade Agreement and who helped develop this proposal, as long as the price of Mexican oil does not fall below $25 a barrel, profits from these expanded future oil sales would yield $12 billion a year in revenues.

That could be invested in the justice system, education, infrastructure and technology in Mexico, which could in turn lift Mexican productivity and create jobs—ultimately, the only route out of poverty.

The main institutional investors in the US, public and private pension funds, would likely find this project an attractive investment similar to the first-mortgage bonds they have purchased over the last 50 years that financed the growth of the American electric utility industry.

Because pension funds have billions in assets searching for long-term returns, they are the best match for capital-intensive projects that pay out over 10, 20 or 30 years. Public pensions alone in the US have over $2 trillion in assets.

For the US, this project would lessen the dependency on Middle Eastern oil and provide a "shock absorber" of reliable supplies as China soaks up ever more of the world’s energy. For Mexico it would mean being able to finance investment to accelerate development, thereby helping to stem immigration to California, Arizona, Texas and elsewhere.

For the pension funds, it would mean solid and safe returns guaranteed by oil revenues comparable to the mortgage-backed securities they now hold in massive quantities. China, which has recently started buying up mortgage-backed securities in the US with its huge foreign reserves, would, no doubt, also be attracted to such an investment opportunity.

Collateralizing financing with future oil revenues does not break new ground: Mexico did it to finance the construction of the Cactus Reynosa 1,000-mile pipeline in 1977, after the 1982 debt moratorium, in 1986 when oil prices collapsed by more than 50 percent and again in 1995 after the Tequila crisis. What does break new ground is using the same mechanism proactively instead of reactively.

No matter who wins the Mexican presidential elections in 2006, this concept will remain the most viable means to raise the necessary capital for economic development in Mexico without privatization of Mexico’s oil resources.

How Financing Might Work

At a recent Milken Global Conference, Gardels, Castaneda and Alberro sat down with energy and investment experts from the US and Mexico to discuss how this plan might be put into practice. These additional ideas emerged about how the NAEF financing might work:

The $75 billion could be raised in tranches of $1-3 billion each, linked to specific projects. Ideally, a US government guarantee would stand behind the initial issues—much as the Clinton administration proposed in the Tequila crisis bailout when the first $10 of $50 billion was guaranteed. Because these securities are backed by oil revenues, the Office of Management and Budget should score them as "off budget" and thus not in breach of the congressional budget ceiling.

This government credit enhancement would reduce the NAEF cost of borrowing significantly. To reduce that cost further, the Mexican general fund might contribute to paying a percentage of the borrowing cost of each tranche so that the securities floated have a sufficiently attractive rate for the large institutional investors.

With the credibility and viability of the NAEF thus established, its costs of capital on later issues would fall.

The initial government guarantee would also encourage the creation of a secondary market for NAEF securities, creating the kind of liquidity enjoyed today by mortgage-backed bonds and enabling NAEF to continue to access capital markets for its full needs.

Investor confidence could be further enhanced by a forward commitment by the US to purchase Mexican oil for the Strategic Reserve and/or long-term sales contracts to Exxon, Mobil or BP, which would bring the additional benefit of access to deep-water drilling technology. In both cases, the attractiveness of the securities would be enhanced by "leveraging the balance sheet" of either the US government or the largest state-of-the-art oil companies. Large financial institutions, such as J.P. Morgan, could also purchase these contracts and trade them.

—Nathan Gardels