Spillovers From Falling Oil Prices
Risks to Mexico and the United States
December 11, 2014
U.S. policymakers who worry about the impact of energy developments on geopolitics typically think of high oil prices as bad news and low prices as an unalloyed good. But a sustained drop in oil prices can be dangerous as well. This paper investigates Mexican vulnerability to falling oil prices—and spillovers to the United States—to show how troublesome such a development might be.
Falling oil prices have led to economic and financial crises in Mexico before and, in multiple cases, the United States has had to step in to help. While the Mexican economy has diversified away from oil, reducing its vulnerability, the Mexican government still depends on oil exports, with one-third of the federal budget funded by oil revenues accrued through the national oil company, Pemex. Mexico protects itself against falling prices through financial instruments that guarantee it a fixed price for some of its oil sales. But this protection is far from comprehensive, particularly against any price decline that is sustained for more than one year. As a result, faced with falling oil prices, the Mexican government would need to take on new debt, raise revenues, or cut spending. Each would create political and economic challenges.
Michael Levi, Shannon O'Neil, and Alexandra Mahler-Haug assess the vulnerability of the Mexican federal budget to a range of possible oil price declines and consider ways that the Mexican government might cope. Their model finds that oil prices would likely need to fall well below their level in early December 2014—roughly $70 a barrel—and stay low for several years in order to force major adjustments. If, however, the Mexican government were forced to cut back strongly on spending, there could be spillovers to the United States, including through migration and reduced ability to deal with crime. The paper analyzes potential Mexican adjustments and U.S. spillovers in detail.