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The Mexican energy reform – what we know so far

In December 2013, Mexico’s Congress, urged on by President Peña Nieto and a team of radical reformers inside the federal cabinet, unexpectedly passed bold constitutional changes that kick-started a process of opening the Mexican energy sector to market forces, private participation and global investment. Without doubt, the most eye-catching element of the reform was an amendment to the federal constitution that, in a single stroke, removed the state’s exclusive rights to production. Hitherto private sector entities, though not prohibited from interacting with the Mexican market, were restricted to engaging in service contracts with the state monopoly Petróleos Mexicanos (Pemex) in which they could neither share in profits nor production. Hailed by many as a game-changer for the country’s growth prospects, the energy reforms have been forecast to trigger multiple benefits, including a reversal of declines in oil production, reduced dependency on natural gas feedstock for manufacturing, bulging state coffers, cluster development and job creation.

However, contrary to many assertions in the media, Mexico’s energy future was not definitively settled by the constitutional amendment alone. Instead, much of the nitty-gritty concerning process and content has been delegated to Congress, where it will be debated under much less public scrutiny in the guise of secondary legislation. As always, the devil will be in the detail and the potential for backsliding will be high. As Monica Santoyo of Santamarina y Steta Legal Solutions bluntly puts it: “The constitution informs us of our desired destination, but it is the secondary laws that govern how we get there, or if we get there at all!”

Congress now has until April 20th, which represents the close of the current legislative session, to write or reform the 21 transitory articles that are tied to the constitutional changes. Some of the building blocks of the forthcoming energy framework are now beginning to fall into place, but many critical questions remain unanswered. Here’s what we know so far.

Organizational shake-up

Three government ministries will have a hand in molding the new energy landscape. The Energy Ministry (Secretaría de Energía or SENER) remains the dominant force within the sector – retaining overall responsibility for the setting of energy policy, while assuming additional responsibility for selecting the areas that will be opened up to E&P activities under each bidding round. SENER has been further tasked with adjudicating which assets and contracts Pemex will be allowed to keep out of its existing inventory during the much awaited ‘Round Zero’ phase. Meanwhile, the Ministry of the Environment (Agencia Nacional de Seguridad Industrial y Medio Ambiente or SEMARNAT) is to acquire a new directorate mandated with overseeing industrial safety and environmental protection across the energy sector. Finally, the Finance Ministry (Secretaría de Haciena y Crédito Público or SHCP) has been charged with defining the fiscal terms applicable to the various energy contract types and with designing the parameters of a brand new sovereign wealth fund to be financed exclusively from oil revenues.

Independent regulators

Significantly, both the Hydrocarbon Regulator (Comisión Nacional de Hidrocarburos or CNH) and Energy Regulatory Commission (Comisión Reguladora de Energia – CRE) have been granted autonomy and had their functions boosted. The CNH will oversee regulation of upstream activities which will entail the technical management of the bidding process and supervision of compliance with production requirements laid out in the licenses. Meanwhile, the CRE will regulate midstream and downstream activities by awarding and monitoring permits for the storage, transport and sale of petrochemicals.

Operators unleashed

Pemex and the Federal Electricity Commission (Comisión Federal de Electricidad or CFE) must transition from monopoly status to productive enterprises. Neither has been privatized, so each will continue to be publically owned, but both will be exposed to competitive market forces and obliged to create economic value in the same way as classic private sector actors. Two new entities – the National Natural Gas Control Center (CENAGAS) and National Electricity Control Center (CENACE) – will own and operate the national pipeline system and electricity grid, respectively.

Many of these developments will, of course, be welcomed by multinationals contemplating market entry, but it is the issues that have not been resolved upon that continue to give cause for concern.

Ownership

Peña Nieto’s Institutional Revolutionary Party (PRI) has already been accused of back-peddling in the face of adverse public opinion polls in which some 65 percent of respondents came out against proposals to enable foreign entities to own Mexican energy resources. The PRI now suggests that the state will maintain inalienable rights over solid, liquid and gaseous hydrocarbons in the subsoil, and that private firms will be prohibited from being sole concessionaires and thus obliged to form partnership vehicles with Pemex. This leaves only the opposition National Action Party (PAN) pushing for private sector concessions in exploration, exploitation, refining and conversion of hydrocarbons. As astutely observed by The Economist, “the difference between profit- and production-sharing may merely be semantic, especially if the profits are based on the price of a barrel of oil and can count as reserves,” but then again it might not. Prospective entrants such as Statoil have made it explicitly clear that they will only participate if they are allowed to share in the risks and rewards of exploration. In the words of one Exxon Mobil vice president, “We’re in the risk business, not any old fixed-margin service contract firm!”

Seismic Data

E&P companies will also require access to Mexico’s seismic data – or a way to gain their own data – before they can consolidate their investment decisions. So far there has been little indication of how or what data will be released. According to Statoil Vice President Bill Maloney, “Pemex is sitting on what could be termed as a treasure trove of data” and the extent to which that data is shared will be fundamental in evaluating whether or not to commence operations. It has been mooted that the newly empowered CNH could allow seismic companies to shoot and sell data immediately prior to the proposed 2015 bidding rounds, but whether these terms would be deemed acceptable enough to the majority of potential new entrants is, as yet, unknown.

Soft landing

Congress will also be called upon to strike a delicate balance between cushioning Pemex’s exposure to the rigours of the free(r) market, and ensuring a level enough playing field that will attract outside and indigenous investment. Missteps either way would have unfortunate consequences for both state revenues and the healthy functioning of the new sector. Speculation is rife that the three of Pemex’s four operating subsidies that are chronically loss-making will be bundled into a single bad entity with the profitable exploration unit being spun off. Associated issues such as the extent of local content requirements that may or may not be applied have still to be resolved.

Mexico’s energy sector is, without doubt, on the cusp of transformational change, but not all the cards have yet been played. Numerous pathways still present themselves and future energy trajectory of world’s 10th biggest crude producer remains unsettlingly undetermined. From now until the 20th April, all eyes will be on Congress and the willingness and abilities of the deputies to drag this reform over the finishing line.

Article by Louis Haynes

To read more articles and interviews from Mexico, and to download EnergyBoardroom’s latest free report on the country, click here.

 

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