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Mexico moves on energy reforms to reverse declines

But questions remain over whether the major changes needed to reverse declines in the oil and gas sector will be able to pass. Justin Jacobs looks at the challenges that lie ahead

President Enrique Peña Nieto came to London this summer with one message: this is Mexico's moment. "The time is right for Mexico to move forward and to transform itself." For Mexico's ailing energy sector the moment has been a long time coming. Once the Western hemisphere's oil-producing powerhouse, years of declining output now mean the country faces the prospect of becoming a net oil importer by the end of the decade. Not that the decline is inevitable. The country has vast resource potential in its undeveloped shale and deepwater fields, which could give the industry a second wind and boost Mexico's economy.

But nearly everyone now recognises that state-run Pemex, which has a monopoly over the industry, lacks the financial and technical capabilities to turn things around on its own.

Against that backdrop, Peña Nieto will start pushing for major energy sector reforms this autumn aimed at modernising Pemex and attracting new much-needed foreign investment and technology into the country. "We must strive towards the creation of an updated, modern and sustainable oil industry, to enhance our country's capacity to produce and generate energy," Peña Nieto said in a June speech at Chatham House in London. It is an effort that is being closely watched in capitals and oil company headquarters around the world.

The winds of change are blowing through Mexico City. Peña Nieto came into office in December last year, and top of his ambitious agenda was implementing structural reform of Mexico's economy. But his party, the Institutional Revolutionary Party (PRI), failed to win a majority of seats in congress as the three main parties - PRI, the National Action Party (PAN) and the Party of the Democratic Revolution (PRD) - split the vote, leaving Mexico without a dominant political force for the first time in decades. But in a deft bit of politicking, Peña Nieto embraced that plurality and brought the parties together under the banner of the Pacto por Mexico - Pact for Mexico - which outlined a series of major reforms for the Mexican economy.

Reforms

With a broad consensus and mandate for action following the election, the three main parties quickly passed substantial reforms for labour, education and the telecoms sector before the summer break.

Energy reforms, though, will be far more difficult to pass. This year many Mexicans celebrated the 75th anniversary of the nationalisation of the oil industry, which in spite of the sector's woes in recent years, remains a source of pride for the country. A recent poll from Centro de Investigación y Docencia Económicas (CIDE) found that 65% of Mexicans polled opposed opening the sector to foreign investment. Mexico's powerful unions also oppose reforms over worries that it could lead to short-term job losses.

Nevertheless, major energy reform looks more possible now than it ever has before with all three major parties backing change, at least in principle. As ever, though, the devil will be in the details.

Peña Nieto has been clear what reform will not be. "I wish to make myself clear on this point: through this reform, Pemex will neither be sold nor privatised; Pemex will be transformed, and will be modernised," he said in London. "I must insist the state will own hydrocarbons in Mexico, it will own oil. But we need to expand Pemex's capabilities. Pemex does not have enough resources to generate more infrastructure and more energy resources on its own."

While placing such strict limits on the extent of reform at the outset is probably necessary to keep the public onside, the comments raise the question over whether reforms, if passed, will go far enough to entice new foreign investors.

Hopes were raised about Mexico's oil sector in 2008, when Mexico's congress allowed Pemex for the first time to award private companies per-barrel fee contracts to help boost production at some of its mature fields. Service companies, such as Petrofac and Schlumberger, which are comfortable with the contract model have been keen.

"We must strive towards the creation of an updated, modern and sustainable oil industry, to enhance our country's capacity to produce and generate energy"

But the deep-pocketed majors such as ExxonMobil and Chevron that Mexico needs to help it unlock billions of barrels of oil in its technically challenging and expensive shale, deep-water and heavy-oil fields have shied away from the contracts. Most recently, BP and Shell dropped out of a bid round for a per-barrel fee contract to help Pemex boost output from the Cantarell field, which was Mexico's largest oilfield before a rapid decline in the mid-2000s. Pemex has struggled to crack the field's complex geology on its own.

Mexico will probably need to make changes to its constitution to allow foreign companies to share in the profits of producing oil alongside Pemex if it hopes to attract the investment it needs. Lawmakers will have to take into account changing dynamics in the global oil industry as it contemplates how far to go with its reforms. The proliferation of shale and deep-water discoveries around the world have given international companies far more options for where to invest than they had the last time Mexico was debating energy reform in 2008. That has forced resource holding states to offer companies better deals in order to attract investment.

The PRD, which has advocated for maintaining Pemex's central role in the industry, launched the first salvo in the energy reform debate. In late June the party's leader Jesus Zambrano presented a plan that would give Pemex much more operational autonomy and cut its tax burden. The plan did not touch directly on the role of private investment in the industry, but PRD officials said they would be willing to consider small changes to the constitution.

The need for change is clear. Whether this truly is Mexico's moment remains to be seen.

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