Financial markets, currencies, banks, government budget estimates, financial results, etc., are impacted by the price of crude, and Mexico is no exception. The acute weakening in oil prices over the past months has put Mexico´s economy in a difficult position, considering that Mexico is an oil-producing country; nonetheless, the global oil market is cyclical: lower prices lead to higher consumption, which in turn leads to an increase in price. Oil has fallen to its lowest price in the last four years, falling oil prices remains one of the most important risk to Mexico’s economy this year. Mexico´s economic output, as measured by Gross Domestic Product (GDP) was $2.140 trillion in 2014. This was much less than its primary trading partner, the United States ($17.49 trillion) but larger than its other NAFTA partner, Canada ($1.578 trillion).
The decline in the price of oil brings important economic and political implications to Mexico. The price of oil is of crucial concern to Mexican economy, given that Mexico is the world’s eighth largest producer of oil, exporting 1/4 of the oil, at nearly three million barrels per day, being the United States second-largest export partner. This is less than Canada, Iran, or Iraq but more than other sizable exporters such as Kuwait or Brazil; hence, this will feature the need for greater coordination and cooperation among Canada, the United States, and Mexico. Although Mexico ranks as Latin America’s second largest oil producer, a widely diversified economy and a strong hedging program implemented by Pemex will barely limit the impact of low oil prices over the next year, considering the hedges acquired by the government of Mexico to protect against fluctuations in oil prices, as the gas tax will have a balancing effect on public finances.
The current downturn is mainly due to the decision of the OPEC to maintain unchanged production levels despite the global increase in supply observed in recent years, especially since 2012, when the United States began operating through new methods of extracting oil. One of the main factors that will determine the depth and duration of the current stagnation in oil prices is the extent and timing of a resulting overcome in demand. If the current weakness in oil prices continues, it could delay or reduce investment flows to the oil sector, especially those related to deepwater fields and unconventional sources. The decline in oil prices and reduced oil production pose threats for the Mexican economy, especially for the fiscal accounts. Mexico needs to prepare for a scenario where oil prices remains low and output of crude may not be as steep as forecasted, preparing public finances to react to such risks. The government will have to make changes in tax related issues if the decline in prices is prolonged till 2016.
It is fair to say that Mexican economy has diversified away from oil in the past decades, but the government still depends on oil exports, with 1/3 of the federal budget financed by oil revenues; the impact of oil price fluctuations are mainly felt in public finance, as oil-related fiscal revenues account for 33% of the government’s proceeds. Lower oil prices also translate into slower foreign reserve accumulation. Mexico is advancing to offer in coming months the first oil blocks for private investors in almost 80 years, the state has plans to sell off 169 oil and gas blocks in 2015, which would represent a great challenge in the short term on how international investors will react to the first set of auctions.
Falling oil prices and a very troublesome global economic climate have placed a restraint on confidence for Mexico´s economy, which is hurt by both a weak peso (Mexico’s peso fell by 13.1 percent during the course of 2014) and by historically low oil prices. As Mexico unbarred its oil sector to offer production contracts, low oil prices can deplete investor interest in financing projects and thrust Mexico into an economic debacle. Moreover, larger oil price drops might seriously challenge the Mexican government’s fiscal situation. Mexico would face the choice of cutting spending, (Mexican government will cut this year spending by 0.7% of GDP on the assumption that oil process will endure low), raising debt (Mexico would be forced to borrow money to meet its spending commitments) or raising other revenue (the impact of low oil prices on the economy appear to be manageable, as the Mexican economy is relatively well diversified and is benefiting from other support factors).
The fact that oil is at such low levels has several implications and many political and geostrategic implications. Oil falls, leaving aside the political clashes between oil exporters, there is more supply and demand fears wane, supply is higher and demand expectations are lowered nearly every day. The price per barrel of crude is at its lowest level since October 2010, the currencies of exporting countries such as Mexico continue to fall, and the price of oil prices largely determines the progress of the economies of the main producing countries. Another direct result of a fall in oil prices would be a drop in inflation, falling prices of energy, in theory, pushes down inflation. For those who decide to invest in commodities, this is a relevant technical situation.
Growth prospects for Mexico remain adequately positive, but downside risks to the 2015 outlook prevail. Oil prices are expected to continue low for some time or fall even further. The anticipation of lower prices will make oil and gas firms start to cut investment projects and eventually slow production, allowing supply and demand to adjust and prices to recover to some degree.
Three peripheral issues will be fundamental determinants of Mexico’s near‐term economic achievement. The first is sustainable U.S. economic strength. The second is uneasiness on the timing and pace of U.S. monetary policy normalization. Third, lower oil prices loom to be here to stay transiently, and prices could even fall further before the trend turnabout.
The questioning for the subsequent actions taken by Mexico as a producer is how to deal with the current market setting. The pivotal issue will be the readiness of its production and coping with the energy reform to transform actively its economy to a less dependent one on a commodity whose price is as fluctuating as this one. Lower oil prices means less revenue, thus, less liquidity, and this might allow the central bank to keep interest rates lower for a longer period of time with the risk of depreciating even more our currency.