THE MIDEAST CRISIS: ASSESSING THE DAMAGE : Oil Shock Is Two Sided Coin for Mexico : Trading: On one hand, it may boost the price of the country’s crude. But if it triggers a recession in the United States, exports will suffer.

MEXICO CITY â€”  Mexicans should be dancing on their oil barrels at the prospect of higher petroleum prices resulting from Iraq’s invasion of Kuwait, but the local stock exchange index has dropped 3.4% since last week’s occupation.

The reaction is a gauge of how much the Mexican economy has changed since 1982, when oil accounted for three-fourths of exports. Every $1-a-barrel increase in the price of oil still brings Mexico an extra $1.2 million a day in badly needed foreign exchange, and that will ease--but not eliminate--a trade deficit projected to top $2.5 billion this year.

However, if oil prices rise enough to cause a recession in the United States, it could mean trouble for the two-thirds of Mexican exports not related to oil.

In addition, there is the question of whether Mexico has enough production capacity to increase exports--taking advantage of higher prices--without cutbacks in domestic supplies of oil products.

Mexico has cut exports by one-fifth since 1984. In July, it exported 1.23 million barrels a day. That was 190,000 barrels a day less than the quota assigned it under voluntary agreements with other producers that--like Mexico--are not members of the Organization of Petroleum Exporting Countries. Production has slipped nearly 1% a year, while domestic demand has grown at about the same rate.

As overall exports have dropped, the United States has remained a steady customer, buying 780,000 barrels a day of Mexico’s highest-grade oil. In July, two-thirds of Mexico’s exports were sold to the United States, in violation of a Mexican policy to restrict any customer’s purchases to no more than half of total exports.

Virtually all Mexican exports are sold through long-term contracts, tied to spot-market prices. However, under terms of the contracts, the country is excluded from the kind of quick profits available to those who trade directly on the spot market.

“Our first concern is to supply the domestic market,� said a spokesman for the Energy, Mining and State Industries Ministry, which sets policy for Mexico’s government-owned oil industry.

“We are taking a discreet approach,� he added, a marked contrast to the euphoria that accompanied the oil price hikes of 14 years ago. Unless prices remain more than $5 a barrel higher than they were before the invasion, economists are betting against a repeat of the 1970s. At that time, Mexico relied on oil exports to earn foreign exchange that sustained a protectionist economy with high import tariffs and few non-petroleum exports.

Since the oil bust, Mexico has lowered tariffs and cut subsidies on a variety of products, trimming the government’s role in the economy and encouraging non-oil exports and foreign investment.

Thus, fear of a recession in the United States--which buys two-thirds of Mexico’s exports and accounts for 63% of its foreign investment--explains the plunge in what had been a bull market, said economist Rogelio Ramirez de la O.

The fear behind the fear is that oil prices will rise enough--say $5 a barrel--to persuade the government to change its business-supported policy of cutting the state’s role in the economy to make the country more internationally competitive.

In an international depression, Ramirez de la O. said, “it is not popular to gear economic instruments to exports and increased capital flows. What (the government) would otherwise be doing to maintain external competitiveness would not be justified.�

However, Mexican economists and government officials said they do not expect sustained high price levels.

Mexico expects the Iraq-Kuwait conflict to be resolved as rapidly as it developed, making its impact on prices questionable, except in the extremely short term.

MEXICO’S OIL POTENTIAL

Mexico’s petroleum reserves are higher while daily production has leveled off.

Source: Oil & Gas Journal, American Petroleum Institute