Update from Mexico: PEMEX Reform, Private Investment, and the Government’s Anti-Corruption Gamble

Two days before the Mexican government unveiled draft regulations for its ambitious opening of the state-run energy sector to private participation late last month, Oscar-winning director Alfonso Cuarón published a letter posing ten questions to Mexican President Enrique Peña Nieto.  “The reform will result in multimillion-dollar contracts” for private companies, wrote Cuarón. “In a country such as ours with a weak (and often nonexistent) rule of law, how can large-scale corruption be avoided?”  To the surprise of some, the President’s office issued a point-by-point response just a week later, naming a spectrum of anti-corruption measures adopted in the new regulations such as public bidding and agreements, disclosure of contractor expenses, a commissioner code of ethics, and institutional and procedural checks and balances unified under the oversight of the Secretary of Energy.  (Full text in Spanish here.)

The project to reform Mexico’s energy sector – particularly the state oil company PEMEX, which generates one-third of all government revenue and is bestowed of both a powerful workers union and tremendous symbolic importance in Mexican history – was always going to be controversial.  President Peña Nieto’s success in getting the law passed in December 2013 has been his signature achievement, lauded by the Washington Post as turning Mexico into “the Latin oil producer to watch — and a model of how democracy can serve a developing country.”

But both critics and many supporters of the reform recognize that corruption is an elephant in the room.

Corruption within PEMEX is no secret: 88 percent of respondents in a 2013 poll said that there was some or lots of corruption within PEMEX, and past exposés have uncovered PEMEX officials engaging in everything from price-inflation and preferential award of contracts to helping criminal groups steal fuel.   On the supply side, bribery of PEMEX has attracted the attention of U.S. law enforcement: in April, Hewlett Packard settled with the Department of Justice for $108 million for, among other offenses, having allegedly paid $1.41 million to obtain hardware and software contracts with PEMEX.  Meanwhile, the Justice Department is reportedly conducting a criminal investigation into the involvement of U.S. Citigroup employees in connection with a $400 million loan fraud of its Mexican subsidiary by Oceanografía, a Mexican PEMEX contractor with a reputation for being “politically connected but financially shaky.  PEMEX has been less successful in tackling the problem itself.  In December 2012, the company filed RICO and fraud claims against German giant Siemens and South Korean firm SK Construction for bribing officials in connection with a troubled $500 million refinery overhaul in the late 1990s, but last July a New York federal court dismissed the suit on extraterritoriality grounds.  (Meanwhile, a commercial ICC arbitration initiated by Siemens and SK against PEMEX proceeds.)

PEMEX leadership admitted in 2013 that the company suffered from serious corruption problems due to both organized crime and “unnecessary flexibility” exercised by mid-level managers, suggesting a renewed willingness to address the problem (or at least appear to be doing so).  But the political consequences of cleaning up the firm are undoubtedly the greatest barrier to real change.  Though only the foreign firms were defendants in the New York lawsuit, two high-level members of Mexico’s opposition PAN party were named in the complaint as receiving bribes, former party leader and ex-General Counsel for PEMEX Cesar Nava Vazquez and current candidate for PAN leadership Gustavo Madeiro Quiróz.  Both Nava and Madeiro are also among the targets of a high-level commission formed this spring to investigate the Oceanografía fraud.  At the same time, the head of the oil workers union, a Senator for Peña Nieto’s PRI party, was provocatively listed by Forbes Magazine as one of the Ten Most Corrupt Mexicans of 2013, with millions of dollars in assets and spending despite an ostensible salary of less than $30,000 per year.  In short, genuine investigation into past wrongdoing is dangerous because both the current and past governments all have dirty hands.

So what will happen?  There is bitter disagreement over whether the entry of private companies into exploration and drilling will help the problem or make things worse, and one’s view may depend on the anticorruption theory to which one subscribes.  Proponents of reform point to evidence that private investment reduces corruption and that the greater participation by foreign firms subject to high compliance standards could have positive collateral effects for local industry.  But critics say the experience of other resource-rich states shows that opening the industry will only make matters worse unless corruption is addressed first.  Mexico has no shortage of anti-corruption and transparency laws on the books, including a specialized National Anti-Corruption Agency and an Anti-Corruption Prosecutor’s Office that, though relatively new, are regarded skeptically.  As its response to Cuarón shows, the government believes the PEMEX reform can showcase a more technocratic, market-driven approach to reducing corruption, perhaps without the need for too many embarrassing witch hunts.  The President’s reputation and billions of dollars are riding on that bet.

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