Mexico takes economic gamble to keep fuel cheap

By Michael O'Boyle and Noel Randewich - Analysis

MEXICO CITY (Reuters) - A $19 billion fuel subsidy, meant to shield Mexicans from spiraling world oil prices, could swallow a chunk of Mexico's precious crude oil export windfall revenue this year, and may only delay an inflation spike.

The subsidy, which means Mexicans are paying $1.40 less for a gallon of gasoline than U.S. motorists, was trumpeted by President Felipe Calderon this week as one of a package of measures to curb surging inflation.

The Mexican government has long subsidized gasoline, along with diesel and cooking gas, but this year the program could cost four times as much as in 2007, after a leap in the cost of the gasoline Mexico imports to cover a refining shortfall.

Mexico, via state monopoly Pemex, is the world's No. 6 oil producer and a top supplier of crude oil to the United States.

But critics say the government is squandering profits from high crude prices just when it should be spending them on projects like roads, schools, refineries and oil platforms -- all things that would boost economic growth.

The money earmarked for fuel subsidies this year is more than what Mexico spends annually on education.

Wall Street analysts would also like to see Mexico reinvest more of its oil profits in exploration to reverse a decline in oil reserves and bolster sagging production. A dip in Mexico's oil exports is already putting pressure on the federal budget.

"The consumer's happiness today will come at the extraordinary price of lower proven oil reserves and lower oil production and fiscal income in the future," Goldman Sachs economist Paulo Leme wrote in a report this week.

The government's years-old practice of subsidizing gasoline has left Mexicans cushioned from surging prices. Drivers in the United States are paying nearly $4 a gallon for gasoline, compared to $2.61 a gallon in Mexico.

"I've been filling my tank here in Mexico for the past three weeks. I save a few dollars," said Texas resident Joel Lopez, standing by his pickup truck at a Pemex service station in Nuevo Laredo, just across from the U.S. border.

Mexican motorists may be happy, but the ballooning fuel subsidy will only be effective at controlling inflation if the current spike in oil prices proves temporary, said BBVA economist Fernando Gonzalez.

"If international prices don't come down, we'll have to seriously evaluate this policy," Gonzalez said.

UNSUSTAINABLE SUBSIDY

Mexico, which imports 40 percent of its gasoline, has for years subsidized prices at the pump by paying Pemex the difference between pump prices and what it pays for imports.

At the same time, the government typically fixes an unrealistically low oil export price in its budget, then sinks most above-forecast revenues into infrastructure. It set an oil price of $49 per barrel for 2008, but Mexican oil is now selling at a heady $110, implying a fat windfall.