Oil reforms cool in hot political climate

Mexico's Pemex is preparing this month to issue the first incentive-based contracts allowed under the country's 2008 oil reforms. Most observers agree that the reforms didn't go far enough, but will a new president in 2012 pick up the pace? Russell McCulley reports.

Among other changes, the 2008 oil sector reforms backed by Mexico's president Felipe Calderón and the ruling conservative National Action Party, or PAN, allow state-owned Pemex to issue contracts with foreign oil companies that would reward IOCs for reaching benchmarks but not grant a share of oil and gas production, which is prohibited under the country's constitution.

The first of the contracts could be issued this month and will target efforts to boost production in mature fields, Pemex E&P general director Carlos Morales Gil said in a conference call following the release of the company's 2Q 2010 results. Further contracts will address development at the Chicontepec field and in the deepwater Gulf of Mexico, where Mexico has 29 billion barrels of reserves, by Pemex's own estimates, but lacks the technical wherewithal to produce them.

The country is scrambling to increase production after several years of decline, most of it attributable to the depleting Cantarell offshore field. So far in 2010, according to Pemex statistics, daily crude output has averaged around 2.6 million b/d, down from 3.3 million b/d five years ago. With oil revenues funding more than a third of the Mexican government's operating budget, the decline has implications that go far beyond energy security.

The reforms fell short of what Calderón had asked for; the opposition Institutional Revolutionary Party, or PRI, supported the plan only after some key elements had been watered down. With two years left in the president's six-year term – and with recession and drug cartel-fueled violence dominating public discourse – few expect lawmakers to return to the reform effort any time soon.

‘I think further reform is unlikely before 2012 because Calderón's hands are full,' says Terry Hallmark, director of political risk and policy assessment for IHS. Internal politics could also interfere, he says: ‘I think PRI understands there is a problem, but they have no interest in handing Calderón a victory.'

PRI, which dominated postrevolutionary Mexican politics for 70 years until the 2000 election of president Vicente Fox, is poised to retake the presidency in 2012. The party made large gains in the 2009 midterm elections, gaining seats in the Chamber of Deputies and picking up two state governorships held by PAN. In July 2010, the PRI won nine of 12 gubernatorial races, bolstering the standing of Enrique Pena Nieto, governor of the state of Mexico, who is widely seen as PRI's likely choice in the presidential race.

The leftist Party of the Democratic Revolution, or PRD, represents a small but influential minority and opposes any efforts to partially privatize Pemex.

Calderón and PAN have little incentive to return to the energy reform debate, ‘in part because he's so preoccupied with the security situation in Mexico,' says Mark Jones, chair of the political science department at Rice University in Houston. ‘He already has one really difficult political and social front open; I don't think he wants to open another one that doesn't really provide him with any political benefit. It's too late now for PAN to get any political benefit from passing [reform] legislation, because by the time it would actually start to have a positive effect on the economy, the elections will have passed.'

Both PAN and PRI realize that some reform of Pemex is necessary, Jones says: ‘that is, the government is draining way too much tax revenue from Pemex to support government activities. As a result, Pemex is starved for investment, and the consequence of that is declining production.'

Not wanting to alienate its union allies, PRI only agreed to a weaker set of reforms in 2008.

But after its 2009 victories, Jones says: ‘PRI realized that, odds are, they're going to govern 2012-18, and they see the writing on the wall. That is, if Pemex isn't reformed now, they're going to have a continued drop in production, in revenue, which is going to make it very difficult to govern.'

With the public more focused on security and the economy, he says, further oil reforms are ‘more a debate among politicians looking at the future of government revenue. Most of the discussion is coming now from the PRI, who have done the calculations and realize if nothing changes, it will be very difficult to govern.'

Pemex has been helped by stable oil prices, says Hallmark. And recent efforts to boost production at mature fields such as Chicontepec, augmented by maximum production levels of 85,000b/d at Ku-Maloob-Zaap that are expected to hold for the next few years, will keep production relatively flat. But the downward trend is likely to continue without aggressive deepwater exploration and production, which is years away. A ‘lukewarm solution' could include a reduced government take of Pemex revenues, allowing the company to put more into investment, Jones says. ‘But what they really need is to properly exploit reserves in the Gulf of Mexico with foreign partners,' he says.

‘Probably the most optimistic, from the reform perspective, would be some type of reform that is able to pass which doesn't violate the constitution and, most likely, teams Pemex up with other state oil companies, such as Petrobras,' he says. ‘That would be the most politically viable option. It's a way to at least calm down the left a little bit, and would provide some political cover.'

In the meantime, should Pemex discover large, exploitable reserves in both shallow and deep waters, it ‘would prove to be a vindication of energy minister Georgina Kessel's claim that no new energy reform is needed in Mexico, rather that we should be patient and wait to see how the 2008 reforms play out,' says Duncan Wood, a professor of international relations at the Instituto Tecnológico Autónomo de México and senior advisor for the Mexico Institute at the Woodrow Wilson International Center for Scholars.

‘Experts and insiders agree, however, that even with the new bonus contracts that Pemex will produce in October – fully two years after they were first announced – it is unlikely that we will see a wholesale move by major oil firms into the Mexican side of the Gulf of Mexico,' Wood says.

‘The big IOCs are interested in securing reserves so as to build up their portfolios, and awarding bonuses for exceeding production targets is poor incentive to those in the sector who can really help Pemex.'

Should PRI retake the presidency in 2012 and hold on to majorities in Congress and state governorships, he says, ‘Mexico will have the political circumstances required to make meaningful change'.

Given the urgency, says Jones, PRI officials might be willing to consider further reform before the 2012 election. ‘The question is, do Calderón and PAN really want to take all of the political heat, and essentially bear the political cost of pushing this reform through, but not reap any of the benefit?' OE

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