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Negotiations and Legislative Strategies for Allowing Private Investment in Mexico’s Electric Sector

Luis Cueto Preciado
The Monterey Institute of International Studies
May 1, 2002

Index

Introduction
Roadmap of this Paper

PART I

1. Historical Context of the Privatization Conflict

2.  Mexico’s Electric Sector

3. Legal Framework of the Electricity Sector in Mexico

The Mexican Constitution
Electric Energy Public Sector Law (LSPEE)
Required Legal Reforms for Mexico’s Electric Sector

Part II: Negotiation Round Analysis

Round I

1. President Zedillo’s initiative: February 1999

Background
Zedillo’s Proposal
Reactions and Responses to the Zedillo Initiative

2.     Other Initiatives and Activities of the First Round

Initiatives during the Fox Presidency

Round II

Stakeholders: people, interests, options, and objective criteria

1. President Fox

2. PAN

3. PRI

4. PRD

5. Unions: SUTERM & SME

6. Private Sector & Foreign Investors

7. The Media

8. Mexican Electricity Consumers

PART III: Legislative and Negotiation Strategies for President Fox and the PAN 

Legislative Strategy
If the legislative strategy does not work

An Interest-Based Negotiating Strategy for President Fox and the PAN

People and Interests

President Fox and the PAN

Mr. Madrazo and the PRI

The PRD

Energy Secretariat (SENER)

CFE and LFC

Labor Unions

Private Investors

Table: Major Political Stakeholders and their Interests

Options for President Fox and the PAN

Developing Objective Criteria

A Negotiating Strategy for Mr. Fox and the PAN

A BATNA For Mr. Fox and the PAN

Conclusions

Stakeholder Charts

Glossary

Bibliography

Appendix: Preliminary Cost Benefit Analysis of opening Mexico’s electric sector to private investment

Introduction

Amidst an uproar of public outrage and political controversy Mexico’s federal government reduced subsidies to electricity consumers by 25%. The increase of electricity rates is designed to increase government revenues by US $ 1 billion in the fiscal year 2002. The federal government claims that the rate increases will only affect large electricity consumers and will not affect 75% of the population. However, according to the data published by Mexico’s Federal Electric Commission (CFE1), electric bills will increase proportionally more for small consumers.[1] 

In the midst of a media finger pointing war, the Institutional Revolutionary Party (PRI) and the Democratic Revolution Party (PRD), two of Mexico’s largest political parties, condemned the rate increases and President Fox’s government for targeting Mexico’s weakest economic classes. President Fox’s National Action Party (PAN) responded that the rate increases are necessary even if they are unpopular. PAN legislators emphasized that the important thing is to protect lower income families and to begin the much needed restructuring of Mexico’s electric sector.[2] 

Rosendo Flores, leader of Mexico’s Electricians Union (SME), says that the rate increases are a government scheme to give electric workers a bad name and pave the road for the privatization of the energy sector. According to Mr. Flores, privatizing the electric sector would hurt lower income Mexicans and raise their electric bills up to 300%. Flores blames the federal government for the energy crisis stating that it has failed to make badly needed investments in the last thirty years.[3]  

The rate increase got mixed reviews from the private sector. Javier Prieto, President of the Confederation Chamber of Industrialists says that the rate increase is a negative signal and says he will not sign the National Development Pact, an agreement between labor and capital representatives being promoted by the federal government to help Mexico’s ailing economy.[4]  Meanwhile, Jorge Espina President of Mexico’s Confederation of Mexican Employers (COPARMEX); says that the rate increases are a positive if they come coupled with opening the electric sector to competition.[5]  

Mexico’s Central Bank (BANXICO), reports that the average electricity rate increase is 30% and that it could trigger a surge in inflation so it has decided to tighten the money supply and increase interest rates.[6]  This effort to slow down the economy to prevent inflation comes at a particularly bad time. The slowing down of the US economy has already resulted in the loss of over 437,000 jobs in Mexico. Only 32% of the Mexican Active Economic Population (PEA) is formally employed. At the beginning of 2001, Mexico’s GDP was expected to grow by 6.9%. Because of the US recession, Analysts are now estimating that the Mexican economy will have a negative growth of 0.4% in 2001.[7]    

The need to improve operations and financial performance while making massive new investments in the power sector is the result of the accumulated effect of inadequate rate levels and ineffective investment strategies (which are now being corrected). Efforts to allocate resources to meet these needs, however, are handicapped by the pressures faced by the financially strapped governments to fund basic socio-economic programs and obtain financing for critical non-power infrastructure projects.[8] Thus significant private capital investment will be required in Mexico as in other developing countries.[9]

This Paper 

The purpose of this paper is to analyze the negotiations for opening Mexico’s electric sector to private investment. In part I, this paper will first review the historical context of privatizations in Mexico and then go on to analyze the investment needs of the Mexican electric sector and its legal framework that have prompted the latest privatization conflict. 

For organization purposes, negotiations have been divided into two rounds. Part II of this paper will analyze the negotiation rounds. The first round of negotiations is covered in the first section of part II of the paper. It began with the Zedillo initiative in 1999 and culminated at the end of 2001. 

The second round will be taking place during 2002. In the second section of part II of this paper, stakeholders, their interests, their options, and objective criteria, for the second round will be analyzed. 

Part III or the conclusion of the paper will offer a negotiation strategy for the PAN so that it can reach its objective of opening the electric sector to private competition.      

PART I

1. Historical Context of the Privatization Conflict 

It is widely accepted that the electricity sector is in dire need of a restructuring process. The big question is where the money will come from. An estimated U.S. $59 billion in 2000 prices will be required to build the necessary infrastructure for electricity generation to meet the country’s growing demand for electricity. Mexico’s public finances cannot cover these huge costs. The Mexican government currently collects 21.87% of Mexico’s GDP in revenues.[10] However, it only collects about 10% of GDP in taxes.[11] A third of the government’s revenues are from oil sales. Every US dollar that the barrel of oil drops in price per annum costs the Mexican government US $9.2 billion in lost revenues.[12] 

In February of 1999 the government first addressed this need by submitting to congress proposed amendments to the Constitution aimed at further opening it to private investment accompanied by a new electricity law introducing competition in different segments of the industry. The reforms would involve the creation of an independent system and market operators, and separate generation, transmission and distribution companies.[13] 

The Mexican Congress blocked the reforms to the electricity sector proposed by Mexico’s former President, Ernesto Zedillo. Mexico’s new President, Vicente Fox, is trying to get the New Mexican Congress to open the electric sector to private investment. But this will not be easy since he will need the support of the Institutional Revolutionary Party (PRI), which Fox defeated in the 2000 election, to muster enough votes to pass these reforms to Mexico’s Constitution.[14]  

Needless to say, the debate over opening the energy sector to private investment is a heated one. The energy industry has long been a banner of Mexico’s sovereignty and independence. President Lazaro Cardenas nationalized the oil industry in 1938. President Cardenas competes with President Juarez for the title of most beloved Mexican President. The oil industry at the time belonged to: American, British, and Dutch oil companies that were viewed as exploiters of Mexico’s resources and workers.  Mexican ownership of the energy industry has been a source of national pride.[15] 

Unfortunately, in the past corrupt politicians and Union leaders have reaped the benefits of running Mexico’s energy industries as if they were their own private properties. Even today, a few thousand Mexicans that constitute the privileged bureaucracy of Mexico’s Parastatal energy companies enjoy special benefits at the expense of the efficiency of these key strategic industries. These few Mexicans protect their privileges masked under a populist national pride. A single example of how this issue affects the great bulk of Mexicans and the country’s economy is Mexico’s sale of crude oil to the US; the same oil is bought back from US oil refiners as gasoline for a higher price that Mexican consumers pay at the gas pumps.[16] 

Mexican government ownership of the Mexican energy industry has now become a hot electoral issue. Members of the PRI and of the PRD are making President Fox’s efforts to attract private investment and modernize these industries a very difficult process.[17] In fact, President Fox has had to continually vow that he will not privatize the energy sector. Mr. Fox has repeatedly stated that he wants to allow private investment and foster competition but without compromising national security and the patrimony of all Mexicans.[18] 

Speaking of privatizing is politically unwise in Mexico at this time because previous privatizations are regarded as massive and expensive failures. TELMEX; the former parastatal corporation, was privatized by former President Carlos Salinas in 1991. The CARSO group property of Carlos Slim, the richest man in Latin America, won the bid for TELMEX in a less than transparent process.[19] As part of the deal TELMEX received from the Mexican government a five-year "grace-period", during which the Mexican telecomm firm would have no competition, so Mexican investors could amortize their investment costs.[20]  In Mexico’s telecom privatization consumers were the only losers because of rate increases even though quality of service gains from privatizing have been substantial.[21] 

Another major privatization gone awry in Mexico is that of the banks. In a populist gesture President Lopez Portillo nationalized Mexican banks in 1982. Banks profitability and efficiency began to suffer because they were placed in the hands of bureaucrats with no private sector banking experience. 

In the early 1990’s President Salinas privatized hundreds of state enterprises to raise money to pay international creditors and start badly needed social projects. Among these enterprises were the nationalized banks. Little detail was observed on who the buyers were. Bad decisions, lack of experience, and greed, resulted in excessive bad loans. During President Zedillo’s term, the recently privatized banks were on the verge of bankruptcy. President Zedillo was forced to bail out the banks to prevent the collapse of Mexico’s financial system. Until then, Mexican depositors had no insurance program to protect depositors like the FDIC does in the U.S. The cost of bailing out the banks is over U.S. $65 billion plus interest. The bill will have to be paid by Mexican taxpayers over the next generation while the bailed out bankers continue to live in the lap of luxury. Large amounts of the nation’s budget are now unavailable for badly needed social spending because of this public debt. 

The privatization and rescuing of banks and highways may have been a determinant factor in the PRI"s first time loss of the Presidential race. It is no surprise then that Mexicans are weary of privatizations.

2. Mexico’s Electric Sector

The Federal Electricity Commission (CFE) and Luz y Fuerza Centro (LFC) are Mexico's two state-owned electricity companies. CFE has enjoyed a monopoly in the electric power sector for decades, although reforms instituted in 1992 allow independent power producers (IPPs) and co generators limited involvement. CFE generates about 92% of Mexican electricity. LFC contributes about 2%, with most of its customers in Mexico City. Pemex generates 4%, while the remainder is generated by the private sector.[22]

In 1999 electricity consumption in Mexico was 1348 KWh per capita, approximately 10% of the per capita electricity consumption in the U.S. An increase in electricity consumption is expected as Mexicans improve their productivity and raise their living standards. Mexico’s economic growth must stay ahead of its population growth. In 1999 GDP per capita was US $4,900 for its near 100 million population.[23]

Electricity prices in Mexico are not determined by the market but by the Federal Electricity Commission (CFE). During the 1990’s Mexico’s inefficiency in the generation, transmission, and distribution of electricity, resulted in its commercial and industrial consumers having to pay rates that on average were 48% higher than their US counterparts for electricity. Mexico’s commercial and industrial sectors have heavily subsidized electricity rates for residential and agricultural electricity consumers. While residential consumers in the US paid 8.24 cents per KWh, Mexican consumers paid 5.67 for KWh or 37% less. The cost per KWh for agricultural consumers in the US was 6.24 cents while their Mexican counterparts paid 5.6 cents. [24] 

During the year 2000 Mexico subsidized electricity consumers with U.S. $4.2 billion dollars for CFE customers and U.S. $1.9 billion for Luz y Fuerza del Centro (LFC) consumers.[25] While residential users paid 39% of their real electricity consumption, agricultural users paid only 26%. The Mexican government pays for 31% of the country’s electricity bills.[26] 

Mexico’s antiquated electricity policies and equipment have resulted in distortions and inefficiencies that in the end have resulted in a 24% electricity price increase in Mexico during the 1990’s while prices in the US increased only by 4.71%.[27]  The Mexican government has faced major economic crises since the mid nineteen seventies; this economic turmoil generated a systematic lack of investment in electric infrastructure.[28] Due to the growing demand for electricity services and a very tight national budget these subsidies are unsustainable, electricity prices will continue to increase and consumers will soon have to pay the bill on their own. 

Significant private investment has resulted in guaranteed electricity supply up to the year 2005.[29] However, failure to continue making substantial investments in generation capacity and infrastructure could adversely affect the international competitiveness of key northern industrial regions.[30]         

In the (1999-2020) time-period, electricity demand is expected to grow at the exponential rate of 6.6% per year. Historically the growth of the electricity sector has been tied to economic growth and is absolutely necessary for development. From the years 1999 to 2009, electricity sales are expected to increase by 77% growing from 145 TWh to 257 TWh per annum.[31]  

The growth rate of electricity generated by self-suppliers and co-generating parties is expected to grow at a 13.6% per year going from 10.9 TWh in 1999 to 39.1 TWh by 2009.[32] In order to meet this growing demand Mexico will need to install new infrastructure capable of generating 26,281 MW. Less than half of the necessary infrastructure (12054 MW) is already under construction or in the bidding process to private parties.[33] 

3. Legal Framework of the Electricity Sector in Mexico

There are many obstacles in the road to solving the Mexican energy crisis. It is ironic that one of the toughest obstacles to surmount is the reforming of a legal framework that is supposed to be in place to serve the interests of Mexican citizens. Under the Mexican Constitution, oil production and much of electricity production are reserved for government monopolies – Pemex and the Federal Electric Commission (CFE) respectively-. Politicians and the general public jealously defend the two giants as symbols of Mexican sovereignty.  Because the government forces them to subsidize consumers, however, the firms are perpetually short of capital to invest in new facilities, equipment and technology.[34]

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