Eduardo Núñez, Managing Partner, Núñez Rodríguez Abogados, Mexico
A former Chief of Staff to Pemex’s General Counsel evaluates the Peña Nieto administration’s proposal for secondary implementing legislation on energy reform and sheds light on some of the challenges ahead in constructing a regulatory state and transitioning between fiscal regimes. He also delivers insights on how the local legal landscape is shifting and the advantages of hiring specialist boutiques over full-service law firms.
From a legal perspective, what do you make of the proposed secondary implementing legislation that Peña Nieto unveiled to Congress last month? To what extent are the articles in line with what Mexico needs to achieve its latest production target of 3.5 million barrels by 2025?
The energy reforms can be understood when placed in relation to the broader context of enhanced competition sweeping across the Mexican economy. The changes taking place within the energy sector are actually part of a much wider agenda being spearheaded by the Peña Nieto administration that aims to break monopoly domination and transition the state from economic agent to regulator of free markets. The achievement of the Institutional Revolutionary Party (PRI) this time round has been to consolidate enough agreement from political forces across the political spectrum to trigger structural reforms across a whole tranche of sectors including competition, telecommunications, education and energy. We are moving forward towards a new economy for Mexico and the constitutional amendments that have been passed by congress represents the mechanism by which an open energy market will be created.
The proposed secondary articles are in line with the original constitutional amendment and contain few surprises. . As soon Peña Nieto took office, it was evident that the Mexican state would try and regulate specific aspects and activities in the energy sector. One such area is exploration and production of hydrocarbons. The government has been unambiguous about the fact that new entrants in E&P would still be acting on behalf of the Mexican state. The laws themselves are well thought out. What have yet to be properly defined are the administrative regulations that will have to be issued by bodies such as the Ministry of Energy (SENER) and Comisión Nacional de Hidrocarburos (CNH). These are the areas where more work still has to be done.
What has to happen next to complete the energy reform process?
The next step will be for the Finance Ministry (HACIENDA) to decide on the economic model of each type of energy sector contract. The hydrocarbons bill, in its existing form, doesn’t mention by name the different categories of contrIact or the level at which these matters will be regulated. It will actually be revenue laws emanating from HACIENDA that will eventually specify the rules of the game for tenders and will define the meaning of terms such as ‘profit sharing’. The last time this happened was in 2009 and I was fortunate enough to participate in the drafting process. Back then, there were 11 executive regulations to draft and I recall it was a complex and difficult task. This time round there will be more or less 26 so it’s going to take a substantial amount of effort and time. If all goes well, we are looking at January 2015 for the unveiling of model contract. I foresee that a number of different contracting regimes will operate in parallel – one regime for E&P, a second one exclusive to Pemex, and maybe a third one to address the contracts of independent oil companies.
Another essential function will be improving the capabilities and capacity of the institutional apparatus charged with regulating the energy market. CNH and theComisión Reguladora de Energía (CRE) currently comprise around 80 and 300 people respectively, and this is going to be insufficient for the several tasks ahead.Meanwhile the newly announced National Agency for Industrial Security and Environmental Protection doesn’t yet exist so has to be created from scratch. It is key to identify the right talent and know-how to work within these institutions. Building a regulatory state is an important undertaking and requires sourcing quality teams of experts well-versed in what are complex issues.
Having served as Chief of Staff to Petróleos Mexicanos’s General Counsel, could you maybe give us an insight into some of the challenges Pemex is facing as it transitions towards becoming a competitive productive entity?
The main challenge will be changing the corporate mentality within Pemex. The generations of senior engineers inside the company are used to acting as an extension of government rather like civil servants managing a bureaucracy. They will now have to learn how to become true businessmen and entrepreneurs and this transformation may take some time to happen.
There is, of course, a new generation of Pemex insiders who now occupy the top forty or so management positions and they do understand international expectations and the type of competitive National Oil Company (NOC) that Pemex will have to become. Most possess degrees from US Ivy League business schools and it is these people that will serve as the enablers of transformative change. This will surely happen, it may take some time for their methods and practices to permeate through the organization.
If we take a practical example such as service contracts, the way Pemex interacts with its suppliers in the future will need considerable modification. Service companies had to submit to Pemex’s conditions because there was nowhere else for them to take their business. All of this is changing and Pemex’s stance will have to shift accordingly. The win-lose equation will need to become a win-win situation where overall benefits are more equitably shared. Pemex’s standard procedures for contracting will have to further align with international norms.
Our understanding is that the overall fiscal burden on Pemex is to be reduced from 79 percent of profits to 65 percent by 2025. In your opinion, is this a fair proportion? And what will be the likely consequences of such a move?
Although the figures you are quoting are still at the proposal phase and have yet to receive congressional approval, this would be welcome news for Pemex. Having more fiscal autonomy will liberate the company and allow it to reinvest a greater share of its profits. This will allow Pemex to compete locally and internationally. Lack of control over its own budget has been a problem in the past and has prevented the company from fully participating in deep water and shale plays. Because of the enormity of the figures concerned, this percentage reduction in fiscal burden would make a difference to Pemex’s prospects.
The mechanics of transitioning from one tax regime to another are complicated and will entail a fair degree of what you could call economic acrobatics. The metaphor that best springs to mind is that of the “paso de la muerte”, a Mexican cultural tradition in which a rider must pass from the saddle of one moving horse to another. Because Pemex profits account of 40 percent of the federal budget, it is going to be a balancing act to ensure that the nation can maintain its current levels of expenditure while at the same time readying Pemex to compete on a level playing field against foreign multinationals. There will probably have to be some sort of transitory scheme for the next five or so years. The idea is that, over time, payments from Pemex to the treasury will diminish and the shortfall will be made up by greater tax contributions from the private sector. This, however, sounds much easier in theory that it will be in actual practice.
Núñez Rodríguez Abogados is a boutique law firm with attorneys experienced in handling the unique legal needs of elite clients in both energy and infrastructure projects. How will the energy reforms change the way you do business? Are you predicting a significant upturn in business?
Many of my clients deal in the exploration side of onshore and offshore. This can mean drilling activities or the construction of what we call naval artefacts such as jack-ups and submersibles. Since years ago, I have been representing both Mexican and foreign companies in their negotiation of contracts with Pemex. My work will for certain increase since many new entrants will need to build new alliances with Pemex and the framework of interaction will be completely overhauled.
What must be understood is that, as the result of the reforms, we are creating a new branch of public administrative law in Mexico in regard to oil & gas. This means there are no experts in Mexico in that arena. For sure, the international legal firms will try to bring in experts in administrative law from abroad, but still there is no enough knowledge within the local market, and regarding the contacts and know-how with regard to Pemex, the government and the regulatory bodies.
Núñez Rodríguez Abogados is not a full service law firm, but a specialist boutique with unparalleled expertise in negotiating service contracts with Pemex and the rest of the Mexican para-statal entities. Through our alliances with other leading specialist boutiques such as those that concentrate on Marine law, tax or litigation, we can offer a much more thorough service than any broad brush so-called full-service practice.
There is no doubt that the reforms will trigger many more work opportunities for us, but at the same time, we have resolved to remain true to our values as a niche firm. We will continue to offer the highly personalized, face-to-face, bespoke service that we have always adhered to in the past. My personal strategy going forward is to make sure we represent a leading stakeholder in each of the segments of the oil and gas value chain – one major, one independent, one service contractor etc. By keeping a finger in each pie in this way, we will maintain our levels of expertise and cover all types of contracting regime. By contrast, some other legal firms will probably try and represent more than one client in the same segment and they could well end up in a situation where there are real difficulties as a result of conflicts of interest.
What does a foreign firm need to do to succeed in the Mexican oil and gas sector?
In the future, foreign firms will find Mexico an easier market to deal with. The country is progressing along a very positive growth trajectory. The legal framework being established will provide certainty for the sorts of activities that many foreign energy companies will want to perform. Success will reside upon linking in with the real experts. It is important not to just align with the people who claim to have all the contacts. It is important to underscore those people who are ‘know how’ knowledgeable. A new market is being created with new people. The landscape is changing and it is the people who really understand the business, the locality, the sector and the framework who will be most of use in guiding new market entrants through the process of doing business in Mexico.