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Mexico cracks open the door with energy reforms

President Enrique Peña Nieto is hoping to transform the country’s energy sector

Mexico's president Enrique Peña Nieto has proposed historic reforms to his country’s energy sector aimed at luring new foreign investment and technology into the deep-water and shale fields that could reverse the declining industry’s fortunes. If passed, the package of reforms would herald the most dramatic change in the industry since it was nationalised in 1938.

The most significant, and politically difficult, aspect of the reforms calls for rewriting articles 27 and 28 of Mexico’s constitution, which codify the state’s monopoly over the oil and gas industry. Peña Nieto wants to rewrite those articles to allow the government to award concessions for new projects to private companies.

Although Peña Nieto hopes to open the sector, he has reaffirmed that Mexico will remain the sole owner of its oil and gas reserves. It has been clear that Peña Nieto saw giving up the state’s direct control over its oil and gas resources as a step too far. “I must insist the state will own hydrocarbons in Mexico, it will own oil. But we need to expand Pemex's capabilities,” he said in a speech delivered during a visit to London in July.

Offering direct ownership in Mexico’s oil and gas reserves would have left Peña Nieto open to charges from the left that he was giving away Mexico’s resource wealth, a potent line of attack in a country that takes enormous pride in the independence of its energy industry.

Reforms

Peña Nieto’s Institutional Revolutionary Party (PRI) and the right-leaning National Action Party (PAN), which supports reform, are expected to have the votes to push through constitutional reform. Polls, though, show that the government still has much work to do to win over the public. A widespread pubic backlash led by the Party of Democratic Revolution (PRD) could yet derail the proposed changes.

To avoid that, Peña Nieto has proposed a contract structure that will allow the state to retain ownership in the oil and gas reserves themselves, but gives companies a share in the profits of oil sold. That will disappoint many potential investors. The profit-sharing model has been used with little success in countries such as Ecuador and Bolivia.

But Peña Nieto’s administration appears to be aware that profit-sharing contracts on their own would probably not be enough to lure the kind of deep-pocketed foreign investors Mexico needs.

The government has said it will push for a second wave of major regulatory changes after constitutional reforms have been passed. Crucial to that effort will be structuring the contracts and Mexico’s legislative framework in a way that allows foreign companies to book reserves on their balance sheets under US stock market regulations.

“I must insist the state will own hydrocarbons in Mexico, it will own oil. But we need to expand Pemex's capabilities”


Booked reserves is a key metric that investors and financiers use to evaluate oil and gas companies. And international majors such as ExxonMobil, Shell and Chevron will want to be able to book reserves in Mexico to justify high-risk shale and deep-water projects.

Government officials say they have held talks in recent months with the US Securities and Exchange Commission (SEC), which regulates reporting for company’s that trade on US stock markets, over how to do this. “The plan is that companies will be allowed to register the economic interest of the risk-sharing contracts under SEC rules that allow converting that value into volume while the state maintains full ownership,” said deputy oil minister Enrique Ochoa.

The SEC’s rules governing reserves reporting contains many grey areas, but so long as companies take on an economic risk in exploration and development in Mexico – as opposed to receiving a set fee for oilfield services provided – they are typically able to book reserves.

Also crucial to reforming the industry will be making changes at Pemex. Peña  Nieto has ruled out a partial privatisation of the national oil company, such as that carried out by Brazil’s Petrobras and Colombia’s Ecopetrol. But he has proposed tax changes to help ease Pemex’s financial burden. The government has long treated Pemex as a cash cow. The company funds around one third of the government’s budget. That has starved Pemex of funds to re-invest in its core business, and as a result it has fallen well behind its international peers.

Peña Nieto has also proposed restructuring Pemex into separate upstream and downstream units while improving transparency and accountability. The state company has earned a reputation at home and abroad for corruption and inefficiency and turning it around will be as important as putting new legislation in place. Pemex will remain at the core of Mexico’s oil industry, and unless it improves changes at the edges will not make much of a difference.

Like all good compromises, Peña Nieto’s proposal gives neither side everything it wants. Resource nationalists will shudder at the prospect of ExxonMobil setting up shop on Mexican shores, while modernisers will claim that reforms, at Pemex in particular, do not go far enough. Yet the multi-stage reform agenda gives Mexico’s fledgling oil and gas industry a real chance at revival.

The plan pushes at the edges of what is politically possible at home while giving international oil companies just enough to make them think seriously for the first time in decades about investing in Mexico. All eyes will turn to Mexico this fall as the country debates its energy future.

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