de Energía (SENER) – Lourdes Melgar, Deputy Secretary of Energy for Hydrocarbons – Mexico
The Undersecretary for Hydrocarbons delivers a frank and wide ranging interview in which she discusses among other topics Pemex’s submission for Round Zero, the potential of Mexican Shale gas and the new regulatory process for awarding upstream oil and gas contracts.
Congratulations on your appointment in February as Deputy Minister of Hydrocarbons in Mexico’s Ministry of Energy. What has been keeping you most busy so far?
Well, definitely the first priority this year has been to complete the drafting and negotiations of the secondary legislation. In December 2013, our Congress approved an all-encompassing constitutional reform in the energy sector; that was only the first step, we then needed to draft the by-laws and draw up 21 secondary laws, the bulk of which are directly related to hydrocarbons.
We have also been busy analyzing Pemex’s request for Round Zero, which we received on the March 21st and have to decide upon by September 17th of this year.
One of the fundamental tasks of SENER will be to manage expectations. You yourself have admitted that it may take years for Mexico and its partners to increase reserves and production. Meanwhile one of the primary selling points of the reform for consumers – lower electricity and gas prices – will also take time to materialize. How are you going about dealing with this?
You are right about the need to manage expectations. Many people understood that, when our government committed to lower electricity and gas rates, this was going to happen overnight. From the start, we have been clear that this was not going to happen by decree, but by running a much more efficient and competitive energy sector. Thus, we needed an energy reform.
Regarding oil, we have to increase our production and the restitution of reserves. This is a major challenge. It is crucial that we make the right decisions for Round Zero in order to ensure that Pemex gets what it needs to sustain current production at around 2.5 million barrels per day. In the short term that is our target, ultimately Pemex should be in a position to surpass this figure.
In our decision-making process for Round One, we will need to strike a clear balance between bidding those oil fields where we can increase production fast and at the same time, include more complex plays that will take longer to come on-stream. The more challenging plays, such as deep-water or heavy oil fields, need to be tackled early on in order to bring them on-stream as soon as possible.
For gas, we have decided to take a two-prong strategy. On the one hand, we want to take advantage of neighboring the cheapest gas market in the world, so we are speeding up our infrastructure programs to ensure that we build the pipelines needed to import enough gas so as to reduce our reliance on imported LNG. Here we expect to see tangible results within a couple of years because infrastructure development is already well underway with CFE’s north-western pipeline and Pemex’s Los Ramones. On the other hand, we are aiming at increasing our domestic production of natural gas which includes both conventional and non-conventional resources.
How does SENER intend to persuade and incentivize private companies to begin production of shale gas in northern Mexico?
There are several challenges regarding the extraction of shale hydrocarbons, one of which has to do with fiscal considerations. We are convinced that having appropriate fiscal terms is essential to making contracts attractive to potential participants in the bidding process.
Another issue of upmost importance for the development of shale plays is generating appropriate conditions for reaching agreement between whoever wins a contract and the landowners and local communities. The hydrocarbons law contains a comprehensive mechanism to promote a scheme of negotiation and mediation aim at ensuring fair retribution and the trickle-down of benefits at the regional level.
In Mexico, unlike in the US, the hydrocarbon resources in the subsoil belong to the State. In terms of expectations, many believe that high returns from shale commonly found in Texas will be automatically replicated in Mexico. One of our roles at SENER is to bring some reality checks about what landowners should expect. We need to establish a balance in which the terms of land use are realistic, while ensuring that the tenants are never taken advantage of.
Another challenge is making the coexistence of mining and oil production work in a positive manner. In several shale areas, we already have coal deposits and concessions for other types of mining. The miners have concerns about what will happen to their rights given the fact that in Mexico oil rights outplay other rights. The legislation establishes a procedure to ensure the achievement of negotiated agreements and the coexistence of activities.
Finally, we have included a strong sustainability component in our legislation both from the social and environmental perspective. In addition to the mechanism of negotiations for retributions mentioned above and the implementation of prior consultation to indigenous populations, we have created the National Agency for Industrial Security and Environmental Protection. We are not inventing anything new; we are adopting international best practices well known by the industry. The bottom line is that companies should not expect any surprises. The aim is to make sure we are working in accordance with the highest standards of sustainability, human rights observation and environmental protection. In this regard, we are equally attentive to sustainable water use, and are in the process of developing appropriate regulation.
You have said very firmly that anticorruption safeguards will “make or break” the reform’s effectiveness. What has your ministry been doing to ensure financial transparency in every contract and bidding round?
The discussion about transparency has been on the table from the very moment we decided to launch an energy reform, so we have made sure that we establish checks and balances along every step of the way. For instance, the bidding process will not be decided by just one person or institution; the decision-making process will be shared across institutions based on a comprehensive system that will guarantee full accountability and transparency.
The Ministry of Energy will determine which areas are going to be included in the bidding process and on the technical terms, meanwhile the Ministry of Finance will be responsible for the fiscal terms. In the next step the National Hydrocarbons Commission will conduct a bidding process which will be performed in the public eye. Everyone will be able to watch the opening of the sealed envelopes on the internet, and the terms and conditions will also be posted on line for anyone to see. Once the exploration gets underway, there will be several institutions that will be following how production is moving along and there will be external audits. Here again we are not inventing anything new, but merely taking what has become international best practice and is considered by the oil industry to be standard practice, and applying it to the Mexican context.
Is there not a risk that too many weights and counter-weights will result in bureaucratic gridlock and dysfunctional-ism rather than the desired transparency?
We’re not really viewing it that way. We think that the system that we have put in place is going to flow because we have set up a full timetable with strict deadlines. This is going to be especially important in the implementation phase. Lessons learned from past failures demonstrate that, when you have institutions that don’t talk to each other, gridlock ensues. We have been able to build harmonious working relationships and engage in constant communication, so the risks of gridlock have diminished greatly.
Pemex is obviously undergoing a massive transition as it moves from a monopoly toward a productive state entity. To what extent is SENER going to protect the national champion during its most vulnerable phase as it competes for the first time on an open market?
We are trying to strike a difficult balance. At the Energy Ministry we are working on a strategy for E&P which guarantees that Pemex acquires in Round Zero what it needs to maintain current levels of production. For us, the priority is that Pemex consolidates its capacities and is able to grow as a leading oil company. We don’t intend to help it out in the sense of giving it protective privileges; instead we need to make sure that Pemex will be exposed to competitive conditions with all the necessary tools and resources to be a strong competitor. Pemex didn’t arrive on the scene just yesterday, for decades it has been a major player in the oil industry and just needs to have removed some of the hurdles that have been keeping it back, so that it can flourish and realize its full potential.
The facts that Pemex will be able to migrate its entitlements to contracts, enter into joint ventures, and acquire new technologies are all significant developments that will foster change for the better. Since the 1990s, Pemex established an effective association with Shellat the Deer Park refinery in Texas, which ranks as the most productive refinery in its portfolio. Unfortunately, until now, Pemex has been prevented from setting up similar partnerships within Mexico, and that has come at a cost for our country as we import half the gasoline we consume.
As a monopoly producer of natural gas, PEMEX dominated the gas market. Due to the lack of competition and corresponding incentives, the country ended up with a significant shortage of natural gas and related infrastructure, which had a negative impact on the economy and society. Now PEMEX will have the opportunity to compete in the natural gas market, both as a producer and as a trader. With the creation of the Centro Nacional de Control del Gas Natural, the independent system operator for the gas market, the levelling playing field will be ensured to all participants in the benefit of consumers.
What other steps has SENER taken to ensure Pemex’s eventual ability to compete?
Many people believe that when we speak about the NOC becoming a productive entity, we are simply renaming the same Pemex and casting it adrift in the open market. This is actually far from the case. Fiscal terms have been modified to give Pemex a break and allow it to make its own choices on budget allocation. It will have to comply only with two budgetary ceilings: a limit on indebtedness, and a limit on personnel and salaries. Furthermore, Pemex’s board, which will now operate according to best corporate practices, will be empowered to take all major decisions. We are also changing the pension structures to place Pemex on a healthier financial footing, as it heads towards competition.
You’ve spoken very eloquently about the importance of maintaining production levels at 2.5m barrels a day mark and giving Pemex everything it needs to be able to do that. Pemex’s CEO has set a target of 4m barrels per day by 2025. Is that something that the Ministry endorses and thinks is realistic?
Mexico needs to reverse current trends and increase levels of oil production. Looking at current levels of production and reserve restitution, along with the configuration of producing fields, the target of 4 million barrels seems rather ambitious. Mexico needs to increase production in a sustainable manner. Meeting the government´s goal of 3 million barrels a day by the end of this Administration will require an effort from Pemex as well as first barrels from new players by 2018.
In terms of corporate governance, we understand that half of Pemex‘s ten board members will be independent non-executives, not necessarily linked to the oil industry. Choosing them, however, remains a bone of contention between the executive and Congress. Can you please explain why?
During the negotiation process, our position was that independent board members should not be confirmed by Congress, as we feared that the process would result in a similar situation to the one we experienced post-2008, when political parties ended up appointing representatives to Pemex board instead of experienced businesspeople. Our aim has been to follow international best practice, yet the appointment process turned out to be a sensitive political issue.
What final message would you like give to our international readership on behalf of SENER?
With this all-encompassing energy reform, Mexico´s hydrocarbons sector will become highly dynamic. From an investment perspective, Mexico is maturing into an excellent place to do business. We are a stable democracy, with new and solid institutional arrangements; possess qualified and skilled human capital; enjoy a growing manufacturing sector, as well as improving social conditions. These combined factors should make us an attractive destination for participants in the hydrocarbon industry interested in long-term mutually beneficial relationships.