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Interview

with Hector Moreira, Professional advisor to PEMEX, PEMEX

01.09.2011 / Energyboardroom

Within the 2008 reform the creation of PEMEX’s independent professional advisers came. Why was there the need to create such a figure?

I think the need existed a long time ago, although it was not directly felt because Mexico was producing oil in large quantities and petroleum prices were doing very well.

The oil picture from 2000-2004 was very “rosy” because oil prices and production were both steadily increasing. But soon after, production started to decline because of lower output from Cantarell and oil prices came down as well.

In a way, declining production from Cantarell had a good side to it because it forced Mexico to face the reality that PEMEX needed to change. What I mean by change is that PEMEX had been seen as part of the government, no different from any ministry.
Each new president in Mexico appointed a new PEMEX general director and a different staff to implement new corporate policies based on the political party that was chosen by the electorate to lead the country.

Also, since PEMEX was part of the government, it was under the direct influence of the Secretary of Finance. So a lot of decisions in PEMEX – regarding production for example – were made according to the needs of the state budget and public finance, which does not work well for an oil company.

All was fine during times of plentiful oil and increasing production. But when production began to decline we had to realize the true nature of PEMEX as a technological company. It is still owned by the people of Mexico, but it cannot be managed with a short term view.

The whole idea was to make PEMEX more like a private company in the sense of looking for efficiencies and opportunities with long term views in mind and still being owned by the nation. That is a big difference.

A few months ago we presented our action plan to achieve this. We have to clearly present to all stakeholders our long term strategies and objectives and define the investment profile of the company over the next five years. Regardless of the fact that the current government might only have two years left in power we need a continuous plan to make the company more solid.

So we are trying to work with a lot more structure – rules, regulations, and norms. We have a new system on how to approve projects; a new system to approve contracts; and new system to appoint people to different positions. We are also trying to make sure that the technical requirements of the position are fulfilled rather than a candidate being just a political appointee. He or she can hold any political view so long as technical conditions are met.

We have spent two years organizing PEMEX so that it is more similar to any other oil company in the world in the sense of our long term view, efficiencies, and clear plans.

That entire process is our idea of reform.

How challenging was it to create this new board after 70 years of operating the company in a certain way?

It has been very challenging. People often greet certain policies and regulations with scepticism because they see a detrimental impact on production. So you have to convince them that it is to their own advantage and that PEMEX will be more efficient and that work will be clearer. Also that it is going to be easier for them to function because there will be more streamlined patterns and procedures; so everybody wins.
In the beginning it was very difficult but I think they are learning that, all things considered, we are better. The company is functioning better, is more efficient, and can move faster.

We have tried to make PEMEX more transparent. For instance, we inquire and hold the company accountable for certain commitments. If the plan says to drill “x amount” of wells, then we want it signed in writing so that people have a clear sense of what is expected from them.
We are also trying to eliminate decisions by committee. There can be an advisory committee, but somebody ultimately has to sign on the dotted line. If you assign a contract then you have to sign. You cannot say it was decided by 25 people in a committee because it loses all responsibility.

So we have tried to clarify a lot of things which may have looked suspicious in the past to many people. We are trying to make as many contracts as possible open to public bidding. Rather than giving a contract to a company based on historic reputation each new contract relies on competitive bidding and a bespoke solution for the specifics of what we are looking for.

Of course, there are many exceptions such as when repairs need to be done by the one company and sole provider of specific equipment. Although there are exceptions, we have to be clear on why we are doing it.

Also, by law we have to increase the role of Mexican suppliers to PEMEX. Buying the cheapest is not always the best. What we need to do is create a new system that allows more national service provider companies to PEMEX.

However, the problem is that I cannot give a contract to a more expensive Mexican company because that would be equivalent to issuing a subsidy. We therefore have to ask “under what conditions you can come up with a price that is similar to a foreign company?”

Conditions can range from moving to five year contracts or lines of credit to support research and technology. At that point you can have an open bidding process and they can come and compete on equal footing with foreign companies. But above all we have to create the system to encourage Mexican companies to be suppliers of PEMEX.

Does that exist today?

It did not exist before and approximately 70 percent of all purchases went to foreign companies. The question then becomes, “is this the minimum I need? How do I increase the Mexican part of the purchasing system and contractors?”

The law says that we have to increase the percentage of Mexican purchases. There is no specific time frame for it but it has to be done quickly. But it cannot be done too quickly either because the companies do not yet exist. You have to create a new set of rules and a new set of procedures to support the Mexican companies without subsides and in compliance with our international commitments.

We are obliged by free trade agreements to give American and Canadian companies the same treatment, so we have to tread very carefully. The question is how to do it? Perhaps if it is an American company we encourage that they start operations in Mexico. The task then becomes to negotiate in such a way that honors the agreements while creating more jobs in Mexico. I am sure the US government is thinking exactly the same thing.

PEMEX cannot invest in everything. What are the main priorities that the company should focus on?

The needs that PEMEX is required to fulfil for the nation demand a lot of money. We need to be able to finance so many infrastructure and programs; to build petrochemical plants; and to do more exploration and production. The requirement in investment is large.

We only have two choices. One is to abandon areas and the other is to get more money. There are only two ways to get more money: either you change the tax laws or you get different models to access private money.

This is not new. The same thing happened for electricity. Mexico‘s electricity needs could not be fulfilled with the government’s budget for investment so private companies were allowed to produce electricity. They cannot sell it to the public but instead they sell it to the government at a certain rate that gives them a profit and a return on investment. Investment is done by a private company but the national electricity board sells, distributes and manages the electricity.

Maybe something like that can be proposed for refineries. Maybe we should have a refinery built with private money that sells to PEMEX and not to the public. We need to decide exactly where we are going to move with public/private partnerships. This, as I said, is no different than the electricity industry.

When we talk to people in the industry they say that PEMEX as a company has improved, but the pace at which it has moved is extremely slow. For example, incentive contracts that were passed in 2008 did not get executed until three years later. Why was this the case and how can the board accelerate implementation?

The law passed in November 2008 and we were appointed in May 2009. Nothing happened between November and May so we lost nearly seven months.

The problem is that we have a disputed law. What I mean is that there are people that do not think certain contracts should be allowed. We had to make sure that contracts are as attractive as possible and on very solid legal grounds, which takes time. The last thing we wanted was to produce a contract that was later declared invalid by the Supreme Court.

I agree that we were too slow, but there are many people involved. There is the finance ministry, the supply companies, and the courts, to name a few. I would say we have to learn how to work better. I think we have learned how to work efficiently and very well with the administration of PEMEX, but that took time as well.

When you start working a lot of things are difficult such as defining policy. And to get a company working a different way after 70 years is not easy.

A criticism I have is that certain procedures were too discretionary. There were unclear policies for many things, such as debt. Let me give you an example. We sell in dollars and our debt is issued in dollars. If you accrue debt in Yen or Swiss Francs for example, you have to buy a financial mechanism that will convert the debt into dollars otherwise you could end up with a huge difference – plus or minus. If you have debt in dollars at a certain rate, you know exactly where you stand.

So we had a new regulation allowing debt to be issued in any solid currency but required a financial mechanism to convert debt into dollars.
Previously the policy was for debt to be issued “in the interests of PEMEX.” But what does that mean? Now policies are very clear and there are no two ways about it. Can I have a debt in yen? Yes, but you have to have a mechanism to convert it to dollars. Clarifying policies takes time.

Currently the company is facing a very interesting period where different strategies such as incentive contracts and deep water will be put in place to create value for the monopoly. However we see that the company’s financial status is not very healthy and even ended 2010 with 27.5% less revenue than the previous year. Can we blame it on the post-Cantarell period, the poor fiscal reform, or the taxes that the company has to pay the government? Do you believe that there is room for improvement in the company’s financial situation?

The focus has to be in the tax law. If you analyse PEMEX‘s financial numbers, roughly 70% of our revenues gets paid in taxes. We have to be incredibly profitable to pay that amount on sales; not on profits, but on sales. If you calculate how much of profit we paid as taxes, it is over 100%. The tax situation is difficult indeed. What can change? Well we need a new tax law.

But the problem is that PEMEX contributes a third of the nation’s taxes. So if we cut our taxes in half, who is going to pay for the rest? It is not easy. I understand if the minister of finance says “You are right but what can I do?”

The national budget is three trillion pesos which is equivalent to $240 billion. We need a tax reform but it is not going to be very popular and it will raise a host of questions: how to raise taxes? Who to tax more? All those people who are likely to be taxed will surely fight tooth-and-nail against it.

So it really needs a national agreement. We need a political consensus because of the difficulties that come with increasing taxes or cutting budgets.

People say the members of the board each have their own political preference. Is this bad for PEMEX?

The board members are supposed to be independent and they are supposed to be professional people. Board member selection was intended to give each party a voice. Although that was the way they were selected, none of us were politicians in the sense of running for public office. We see ourselves as technical people.

Also, the political parties have been very respectful. I have never received a phone call from a party leader telling me to push for an idea; demanding that someone be appointed; or asking me to follow a party line. They have really been hands-off. You can say that we think differently because we have our own political ideas, but when we started we made a gentleman’s agreement that we were not going to allow politics to interfere in the decisions. I would say everything has been quite politically free.

You have been involved in the energy sector for a considerable time as sub-secretary of hydrocarbons form 2004 to 2006, through various academic positions at Tec de Monterrey, and now as an independent advisor for PEMEX. What does it means for you to have this new job and work for a company that represents Mexico‘s national interest?

It is a big challenge. This is the biggest company in Mexico and is a company that has a lot of opportunities. If we can make PEMEX a motor for the creation of new jobs, new companies, and new areas in Mexico then we would have contributed a lot to this country.

I think PEMEX has to be repositioned, redesigned, and reconsidered to different roles than it had in the past.

It is interesting that I see myself as an academic who tends to be very square and organized which I think that helps. Also, I am originally a chemical engineer so I am really a technical person rather than an economist. I believe that this is very good because PEMEX needs more from the technological point of view and more people that understand technology. I was vice president of research for Tec so a lot of my past has to do with the administration of technology or the way technology is created.

And although I was in the government, I was still part of the technical side of government as undersecretary for energy planning. But you can never get away from politics in the government.

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