Mexico energy reform seeks to make history by repeating it

September 16, 2013

A key differentiator in the proposed energy reform introduced by Mexico’s ruling party, the PRI, is its populist slant, according to a panel of speakers at a seminar hosted by law firm Mayer Brown, which explored the details of the reform.

Mexican president Enrique Peña Nieto wants to make a clean slate of the country’s current energy policies in order to return to the original ideas of the man Peña Nieto called Mexico’s “oil pope” – former president Lazaro Cardenas; Cardenas originally nationalized Mexico’s oil industry in 1938, explained Dr. Duncan Wood (pictured), director of the Mexico Institute at the Woodrow Wilson International Center for Scholars.

By presenting that rhetoric to the Mexican people, Peña Nieto is appealing to their sense of history and national identity, which Wood said is heavily associated with Petróleos Mexicanos (Pemex).  Wood continued that the Mexican people as a whole did not believe there was a problem with the energy industry’s even after what he termed a “mini-reform” in 2008.

The restrictions often foiling industry progress would be stricken from the constitution under the new reform: Like Peña Nieto said, it would be a clean slate. According to the panel, he wants Cardenas’ original words to ring anew, a tactic that conference chair and moderator Dallas Parker, of Mayer Brown, called “a stroke of genius,” saying that he thought “it will serve Mexico well.”

“The president has avoided deciding how it should take shape … what’s most important is that he doesn’t decide how it should be done,” said panelist Jose Valera of Mayer Brown.

The reform has two major components: oil and gas, and electricity. The oil and gas component focuses heavily on reshaping Pemex, seeking to allow the beleaguered company to profit-share with both national and international companies and reorganize into two divisions: exploration and production, and industrial transformation.

In his discussion of the reform's background and explanation of its cultural context, Wood explained that Pemex has previously lacked the resources and ability to modernize itself because of issues including constitutional constraints and legal matters. The government also takes an enormous portion of Pemex’s revenue, leaving it with little to invest.

“If you line up the liabilities to its investments, the company is essentially bankrupt,” Wood said.

The government’s portion of Pemex's revenue is set to radically decrease, but there’s another issue at hand: Pemex’s current inefficiency and decreased production.

“The workers aren’t working. Some are simply there collecting a paycheck,” Wood said. “It’s got one of the lowest rates of productivity, one of lowest rates of barrel production in the world," he said, explaining that production had dropped from its offshore Cantarell oilfield from 3.4 MMbo/d to below 2.5 MMbo/d. Cantarell, Mexico’s largest field, was discovered in 1976, and brought into production in 1981. The complex is located 80km off the coast of the Yucatan in the Bay of Campeche.

While Pemex has room for improvement, the panel agreed overall that the company could be turned around if it is responsive to the changes, citing that not only does it currently excel at things like oil discovery and shallow water operations, but that most people are generally excited about the reforms, especially Pemex, who has a sizable stake in them.

“Right now, it’s easier for Pemex employees to do nothing and collect a paycheck than to do something and create risk. Operators live in fear of corruption charges,” Wood said, commenting on some of the company’s hardships. “They need to trim the fat and solve the debt.”

The reform has several classifications designed to strengthen Mexico’s local industry and economy while ensuring more prominence on the international stage. While the current administration might have looked internally to revive their energy policies, they turned outward to study established energy powerhouses like Brazil and Norway to design other policies, particularly those dealing with local content rules.

Under the new reform, Pemex officials are pushing for 40-45% local content, Wood said, explaining that the government understands how the appropriate levels of local content requirements can inject life and development into local economies.

“They said the plan is to develop corporations in cities where Pemex has a presence,” Wood continued. “It would be an incubator of new oil services companies, to spur the development of these providers, to help create industry clusters, with a possible spillover to local communities.”

While the infrastructure was not in place around the time of the 2008 reform, that’s certainly changed now, explained Manuel Cervantes, of MCM Abogados. Mexican services companies were now primed and ready to provide services on such a scale.

“In 2008, there were no Mexican service companies; now, we have drilling and completions companies, deepwater…there’s a good presence five years later. We are now prepared to do that,” Cervantes said.

 Norway requires usage of 50% in-country research and development. In 2003, the Brazilian regulator architected a more flexible, variable plan: between 37-85% local goods and services in the exploration phase, and between 55-80% in the development phase. Requirements are lowered for deep water offshore blocks and increase for onshore blocks.

The Mexican government recognizes that there are many parts that have to fall in place in order for the reform to be as successful as projected, one of which is the current proposed tax reform. Another contingent issue addressed by the panel is the transboundary agreement between the United States and Mexico. Ratified by the Mexico Senate in April 2012, it is currently ensnarled in the US Congress, which needs to enact legislation authorizing the Department of Interior for its role in the agreement.

Salinas, who worked with fellow panelist Fernando Alonso of Elias-Calles y Alonso de Florida, S.C. on the agreement, explained that it was a treaty whereby Mexico and the US agreed to explore and produce transboundary reservoirs in the Gulf of Mexico. Any discovery within the area would constitute a transboundary development by both countries. The agreement was designed to promote cooperation and equitable development between Mexico and the US. It is believed that there are a great deal of discoveries lying in wait in the area, as Mexico is already finding out.

“Pemex has had around three major oil discoveries close to the [agreement’s proposed] border, but not within scope of treaty,” Salinas said.  

 Right now, Wood said, it will take a big push from President Barack Obama, who already has a host of other priorities. In the meantime, Wood has a secondary proposed solution: “Write your US Senator.”

Fellow speaker Gabriel Salinas of Mayer Brown added that, under the reform, the entire hydrocarbon chain would be open to first-hand sales, with the reform covering upstream and midstream of the value chain. Wood continued later that the interest was “across the board,” but that “the big money is in deepwater in the offshore Gulf of Mexico, especially with the majors.

“If the financial and other terms are what’s expected, deepwater is projected to be the primary interest; the government sees it as having the most potential, along with shale,” Wood said.

The panel strongly supported the reform, and felt positively about its passing.

“It is good news not just for Mexico but for the industry, when you take into consideration the resources that Mexico has,” Alonso said.

“The political stars are aligned this time as never before, so I think the odds are a lot higher than during the times of [former president Vincente] Fox and [former president Felipe] Calderon,” said Cervantes of the chances of the reform and secondary legislation passing.

If the reform and secondary legislation passes, private oil and gas contracts under the new reform could be signed as early as 2014, according to the panel.

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