During the recent presidential campaign, President Andres Manuel Lopez Obrador (commonly referred to as AMLO) stated his intention to fund additional gasoline refining capacity for PEMEX, the monopoly state-owned national oil company. It is expected that PEMEX will double its refining capacity by building a new refinery and by upgrading three of the six existing refineries to handle heavy crude oil, which is the bulk of Mexico’s production.
Overall, imports of gasoline to Mexico rose from 45% of consumption in 2013 to nearly 70% in 2017. Increased imports were driven by a significant decline in Mexican gasoline production attributable to a major contraction in production of crude, as well as some reduction in refining capacity. The United States largely filled the gap. During the period 2013-2017, U.S. gasoline exports averaged $11 billion and supplied approximately 80% of Mexico’s gasoline imports. Assuming the new refining capacity comes on line in 2023 as planned, U.S. gasoline exports could decrease by up to $4.8 billion per year.
Since AMLO’s inauguration, the Mexican Government has issued plans to spend at least $8 billion to build the new refinery, with the cost of upgrading the three existing refineries estimated at an additional $3 billion. The Mexican Congress in December passed the 2019 federal budget that follows up on those plans by including a first tranche of $2.8 billion in initial funding for building a new refinery and upgrading the existing three refineries.
In general, subsidies to producers in one country that harm producers in another country may be subject to legal action. While both the NAFTA and the WTO Agreement on Subsidies and Countervailing Measures provide a legal basis for challenging subsidies to privately-owned companies, the United States Mexico Canada Agreement (“USMCA”), the recently signed but not yet ratified successor to the NAFTA, contains provisions that directly address subsidies to state-owned companies. Paragraph 4 of Article 22:6 of the USMCA provides that no Party “shall cause adverse effects to the interests of another Party through the use of non-commercial assistance … to any of its state-owned enterprises.” PEMEX is a state-owned enterprise as defined by the USMCA and federal funding consisting of grants to pay for new and expanded PEMEX refining capacity would constitute “non-commercial assistance.” Both the stated intention and likely effect of the additional refining capacity is to reduce the volume of imports of gasoline. In addition, various market dynamics and relatively low refining capacity utilization rates in Mexico raise questions about the economic viability of new refining capacity.
Even though Mexico signed the USMCA on November 30, 2018 containing a provision that would appear to prohibit subsidies for expanding Mexican refining capacity, it nonetheless took initial steps to provide such subsidies less than one month later. But because the USMCA has not yet entered into force, litigation under USMCA Article 22:6 is not an option for any party who might consider themselves aggrieved.
The AMLO administration is also taking actions directly affecting the downstream segment of the gasoline market. Although opening retail sales of gasoline to foreign investment and the liberalization of the retail price of gasoline were the hallmarks of the energy reforms implemented by the previous government, the AMLO administration has now reintroduced price controls on retail sales of gasoline. In particular, the Minister of Finance has announced that yearly price increases in retail sales of gasoline will be capped at the annual domestic inflation rate. This policy could have profound implications for the profitability of foreign-owned gasoline stations in Mexico when the price of crude rises and/or the Mexican peso depreciates in a proportion greater than Mexico’s inflation rate. The investor-state dispute settlement provisions of both the current NAFTA and the USMCA provide a potential legal basis for challenging these price controls.
It remains to be seen whether these issues will be raised by any government or private parties during the legislative consideration of the USMCA and ratification processes in each country. However, the actions of the Mexican government regarding expanded refining capacity and the failure to date to pass certain required labor law amendments raise questions about the degree to which other provisions of the agreement Mexico just signed may be honored.