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Mexico energy reforms

News / / Mexico energy reforms

Mexico is one of the top ten largest oil producers in the world and is the third largest in the Americas behind the United States and Canada. However, Mexico’s production has been in decline for the last nine consecutive years going from an output of 3.3 million barrels per day in 2004 to 2.52 million barrels per day in 2013. All this could be about to change, though, as a result of the new energy reforms that are currently being implemented in Mexico.

So what are the energy reforms?

Primary legislation & constitutional reforms

The energy reforms introduced by President Enrique Peña Nieto will end the 75 year state run monopoly of the energy sector by Pemex, which was created as the sole oil operator in Mexico after nationalisation in 1938. The oil and gas industry contributed around 13% of the country’s export earnings in 2013. More significantly, earnings from the oil sector including taxes and direct payments from Pemex accounted for roughly 32% of the total government revenues in 2013. The current decline in production, therefore, has a very real impact on the country’s fiscal health and the day-to-day lives of Mexicans.

In December 2013, following the approval of the constitutional reforms by congress, changes were made to the constitution in order to allow foreign and private investment in Mexico’s oil, gas and electricity sectors. It is anticipated that if the reforms are successful, Mexico should see increased competition in both foreign and domestic participation within three to four years, leading to greater reserves being discovered and increased oil and gas production.

Under previous legislation, contracts with private, non-Pemex entities in respect of activities and services required to develop the oil industry which involved (i) production or profit sharing, (ii) compensation in kind, or (iii) compensation in proportion to hydrocarbon production were forbidden. The reforms seek to introduce permitted contract models which can be agreed between non-Pemex companies for services, profit sharing, production sharing, licences or any combination of these.

Secondary legislation

The secondary legislation has now been put before congress. The energy reform package includes nine initiatives which will modify 13 existing laws and create eight new ones. These laws are to regulate the following:

  •  powers and functions of the regulatory bodies, including
    the Ministry of Energy, the National Hydrocarbons Commission (CNH) and the Energy Regulatory Commission (CRE);
  •  national content rules for assignments and contracts that are executed;
  •  transparency of the bidding process, contract award and assignment;
  •  regulation of the Mexican Petroleum Fund to manage and distribute resources generated for the State from the exploitation of the oil industry (excluding taxes);
  •  creation and regulation of Control Centre of Natural Gas to take over the operation of the national pipelines and storage system;
  •  creation of the National Centre for Energy Control (CENACE), now a division of the Federal Electricity Commission (CFE), as a public independent agency; and
  •  legal framework for the organisation and conversion of productive state companies.

These laws are intended to offer greater flexibility over contractual terms and take an objectively sensible approach to rates and local content requirements.

Surprising many with their expediency, the secondary laws were approved and signed into law on 11 August 2014. Many ship owners are already starting to make enquiries as to the potential OSV opportunities in Mexico. In anticipation of the reforms, Pemex has also already signed several Memoranda of Understanding with deepwater operators, including a recent agreement with Total. Pemex has primarily focussed on operators who have experience in the Gulf of Mexico.

The secondary legislation provided more substance to the framework already in place, including details of the contractual structures that will be available, applicable fines, ownership of Mexican oil and gas, additional protection for landowners, congressional influence over the appointment of Pemex board members, import rights of gasoline and diesel and local content requirements in the oil and gas sectors. In respect of the latter, local content will aim to reach a minimum of 35% industry-wide, although to facilitate deepwater development this requirement could well be much lower, even zero, for deepwater projects. In any event, 35% is relatively low and compares favourably with local content requirements in other jurisdictions such as Brazil.

Following the introduction of the secondary laws, Pemex has also commenced a corporate restructuring. It is thought that it will retain its profitable exploration and production unit, but will consolidate its less well-performing natural gas, refining and petrochemical divisions into a single unit, known as industrial transformation. There will be a further three subsidiary companies below these two units offering drilling services, logistical and transportation services and electric power generation.

Round Zero

Following the initial approval of the constitutional changes in December 2013, Pemex has been involved in “Round Zero”, a six month process, during which Pemex had been considering which of its current fields it wished to continue exploiting. These were forwarded to the CNH in March 2014 so that they could be settled before any further licensing rounds open to private companies commence. It was by no means guaranteed that Pemex would be permitted to retain all the fields on its ‘wish list’.

Although it was expected that the Energy Ministry would take until 17 September 2014 to consider Pemex’s Round Zero wish list and rule on what assets would be available to be included in the subsequent first bidding round, Round Zero actually completed on 13 August 2014. Pemex was granted the vast majority of the acreage it requested, including all of its requested probable and proven reserves, such reserves amounting to approximately 83% of the country’s supply. Of the prospective reserves it requested, though, it was only awarded 67%. Pemex has also released roughly 50% of its exploratory acreage, which has been divided into blocks of 20,000 square kilometres and will be auctioned in at least 10 licensing rounds.

As part of the first bidding round, Pemex has indicated that it intends to offer partnerships or farm-outs in 10 priority areas on prime deep water finds in the Perdido area. The precise details of the blocks that will be included in the round will be finalised by the end of November 2014 and it is expected that contracts will be awarded as early as May 2015.

Regulatory infrastructure

If the reforms are going to work as intended, significant efforts will need to be made to bolster the current regulatory regime. The CNH, CRE and the Federal Ministry of Energy will have regulatory authority over the oil and gas sectors. The creation of a new National Agency of Industrial Safety and Environmental Protection is also underway.

The CNH will have responsibility for the licensing process, with the Ministry of Energy providing technical support. Together, they will be central to the process of granting contracts and licences. The reforms will call for the Ministry of Energy to determine which geographical areas are open to exploration and extraction, and will authorise the CNH to organise the bidding process, select the winners, subscribe to the contracts and provide technical support. The detail of how these bodies will coordinate and divide the work between them has been clarified in the secondary legislation, specifically the law for Coordinated Energy Regulatory Agencies.

The CRE will be responsible for the regulation and granting of permits for the storage, transportation and distribution of petroleum products, natural gas and basic petrochemicals. It will also regulate third party access to pipeline transportation and storage, and will regulate the sale of these products.

The National Agency of Industrial Safety and Environmental Protection will set industry standards for safe operations and will also be responsible for regulating any environmental issues, such as potential pollution impacts. It is worth noting in respect of pollution that Mexico also passed the Federal Law of Environmental Responsibility in July 2013. This law was inspired by the European Environmental Impact Assessment Directives and by the Spanish Law of Environmental Responsibility. The key principle of this law is “polluter pays” which aims to oblige the polluter to restore the environment to its pre-pollution state; this principle is based on Article 4 of the Mexican Constitution which provides “...all persons have the right to a healthy environment for their development and welfare.” This obligation is separate from a polluter’s obligation to also compensate affected third parties. The possible consequences of pollution in Mexico are, therefore, not inconsiderable for the liable party.

Issues to be aware of

Overall, the reforms in Mexico are gathering pace and exceeding expectations in terms of progress. The passing of the secondary legislation into law now means that actual concrete steps can be taken, both by the Mexican government and also international players who wish to participate in the oil and gas industry in Mexico. There still remains a lot of work to be done, however, and all eyes will be on Mexico as it seeks to make good on its commitments. There remain a number of potential concerns that international parties entering the Mexican market should be aware of.

There is a general concern that the overall package of reforms in Mexico may trigger an economic reaction similar to the “Tequila Crisis” of the mid-1990s, when the peso devalued rapidly following the introduction of banking reforms.
The obvious location for shore bases to support offshore operations is the state of Tamaulipas, in the north east of Mexico. Tamaulipas has seen an escalation of violent crime recently, so security is an obvious concern for entrants to the oil and gas sector. Tamaulipas has received particular attention in terms of the State’s efforts to deal with Mexico’s drug gangs, but it remains to be seen how successful those efforts are.

Mexico’s plans for regulation are encouraging in terms of the framework and ability of the CNH and CRE to take control of their operations. There is a concern, however, over experience. The Energy Ministry is not used to dealing with private investment. Nor is it clear that there are enough qualified people to man the agencies in charge of regulation, or that they would want to fulfil that role rather than take up tempting offers to join the private sector.
Finally, there is the issue of corruption. Mexico ranks at only 106 on Transparency International’s index of nations and the recent, high profile case of Oceanografia has only highlighted practices which do not improve that perception. There is a call for proper transparency within the Mexican oil and gas sector and the government does appear to be acting on those calls. As part of the reforms, anti-bribery legislation in line with the OECD anti-bribery convention has been introduced and assurances have been made that bidding information as well as payments to/from the government will be published.

Summary

To the surprise of many, change is happening rapidly in Mexico. Outwardly, the signs are encouraging that a sensible framework is being put in place to attract investment from the heavyweight international players. There are concerns and risks, but nothing that has not arisen in other jurisdictions. How they might be resolved may, to a large extent, depend on the contract model that international companies are permitted to negotiate. One other race to keep an eye on, though, may be between the relative attractiveness of exploration in Mexico under its reforms and the burgeoning deepwater market offshore Colombia.

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