Editor’s Note: This is the first piece of a three-part series examining the impact of declining oil prices in Latin America.
By Allison Fedirka
At the start of the year, Geopolitical Futures assessed which countries throughout the world would suffer most from the exporters’ crisis. One major driver behind this crisis is low oil prices, which have a significant impact on many exporting countries that are highly dependent on oil revenue. For the foreseeable future, low oil and commodity prices are the reality in which these countries must operate. Many have attempted to adjust their 2016 budgets to reflect this new normal. Some, like Saudi Arabia, have taken more drastic measures to try and shore up their ability to face low oil prices.
Approximately 20 percent of the world’s proven oil reserves are located in Latin America, which is noticeably absent from the top 10 list of countries suffering from the exporters’ crisis. Six countries – Argentina, Brazil, Colombia, Ecuador, Mexico and Venezuela – produce nearly all of the region’s oil. Continued low oil prices justify taking a closer look at the impact this will have on these countries. Given our 2016 forecast, we are interested in how these prices may affect stability and investment in the region. The exporters’ crisis has started to contribute to a shift in investment patterns and could affect our expectation that foreign direct investment (FDI) in Latin America will increase in 2016 compared to the previous year.
In the first of our three-part series, we will examine the country that appears to be effectively confronting lower oil prices and is currently experiencing a stable political environment: Mexico. Save an astronomical increase in production – which has yet to occur – any country receiving revenue from oil exports will experience some degree of financial hardship due to a decrease in revenue. However, the impact of revenue decline can vary greatly. The higher a country’s dependency on oil revenue, the more likely it is to financially struggle as a result of low oil prices. Other factors that shape the impact of lost revenue include the ability to make budget cuts, introduction of non-oil revenue policies and public reaction to such measures. Just as every country’s financial situation is unique, so is the public’s reaction to government policies. So, when we assert a country has “effectively confronted oil prices,” we mean that despite the fall in revenue the government has managed to meet its financial obligations in such a way that has not sparked major public unrest. Of the six major oil-producing countries in the region, Mexico appears to have been able to best manage the crisis without suffering economic decline or domestic unrest. Its diversified economy, decreased dependency on oil revenue and the government’s proactive policies have helped the country mitigate the effects of lower oil prices on the domestic economy.
Mexico’s current net exposure to oil (the difference between imports and exports) is equivalent to about 0.2 percent of GDP. In 2015, oil revenue accounted for about 5.3 percent of GDP. This year, the government expects oil revenue to account for 2.5 percent of GDP. While the lower price of oil has contributed to the decline of its share of GDP, it is important to remember that oil production in Mexico has been on the decline for about a decade. This means that for the last decade, there have been attempts to diversify the economy to compensate for lower production levels, despite an ongoing effort to simultaneously revive the oil sector.
It is also worth noting that companies are still interested in investing in Mexico’s recently opened oil fields despite lower prices. Last December, the third round of auctions for onshore oil fields saw successful tenders and licenses issued for all 25 fields up for bidding. This is one indicator that lower prices have made oil produced from land wells more attractive than offshore sources. During the second round of bidding in October 2015, the government successfully awarded only three of five offshore production-sharing contracts.
Government Handling of Declining Oil Revenue
To compensate for the drop in oil revenue, the government has managed to find other ways to handle its expenses. First, the government’s $282 billion budget for 2016 is $13 billion lower than the previous year. It has also been proactive in getting revenue from non-oil sources. Historically, 30 percent of the Mexican government’s funds for expenditures came from oil revenue. Yet, this number has declined in recent years, and in 2015 only 20 percent of funds for government spending came from oil. Some economic analysts see this as a problem because they assume it is entirely a result of declining oil revenue. But such a view is overly simplistic as it does not account for changes in other revenue.
Non-oil revenue brought in by the Mexican government increased by 27 percent last year, from 2.11 billion pesos ($118 million) in 2014 to 2.77 billion pesos in 2015. This increase exceeded the drop in oil revenue by 4 percent of total revenue. Additionally, while oil prices declined by about 50 percent, the introduction of a tax on gasoline in 2014 – which is uncommon in other Latin American countries – meant revenue only dropped by 30 percent. Lastly, prudent fiscal and economic management has allowed the government to help mitigate the effect of lower oil prices for domestic producers. Last year, the government spent $773 million to hedge oil prices at $79 per barrel. This year, it will continue to act in a similar manner. One billion dollars has been set aside to secure a hedge on oil prices, this time for 212 million barrels at $49 per barrel.
Throughout all this, Mexico has managed to maintain a positive economic trajectory and has not experienced major oil-related protests – in contrast to Venezuela, Ecuador and Colombia, which have experienced varying degrees of social unrest linked to declining oil prices. Issues related to falling oil revenue are not among the top priorities for Mexicans. A 2015 Pew Research study shows that the public’s main issues with the government are drug-related crime, corruption and education. The decline in President Enrique Peña Nieto’s approval ratings, which dropped below 50 percent last year, coincided with the escape of notorious drug criminal Joaquín “El Chapo” Guzmán.
On the economic front, growth in 2015 was 2.5 percent while this year the economy is expected to grow between 2 percent and 3 percent. Inflation has also been kept at bay. Last year, inflation registered at 2.13 percent, the lowest rate in over 20 years. So far this year, the government has managed to keep the 12-month inflation rate below the 3 percent target. Mexico also remains a very attractive destination for FDI. In 2015, the country received $28.3 billion in FDI, up 25 percent from the previous year. The successful oil tenders and FDI increase indicate foreign companies and investors are confident in the Mexican economy in the midst of lower oil prices.
Mexico has not seen drastic domestic ramifications from the decline in oil prices. The diversification of the Mexican economy and prudent government policies have helped the country avoid the negative effects felt by other oil exporters. However, as we will explain in the coming weeks, Mexico is an outlier and other Latin American countries have not been so fortunate.