Priming the pump: Mexico ends 75-year-old oil monopoly

As Mexico ends its state monopoly on oil and gas IFLR1000’s Chris Cooper looks at the arguments for and against reform and impact on the country’s legal market

Amid much controversy and under the watchful eyes of the global markets, Mexico has reopened its energy markets to private and foreign investors.

On December 15 2013, nearly four months after its introduction, the Mexican Congress approved a historic energy bill, the first major economic reform for the country since it signed the North American Trade Agreement nearly two decades ago in 1994. President Enrique Peña Nieto’s introduced the bill in July 2013 that sweepingly overhauls the country’s energy sector and ends the 75-year monopoly on its energy resources opening it for global investors, such as ExxonMobil or Chevron, to pump crude from its reserves. The controversial move is a bold step to revamp the country’s declining oil production, which hit an 18-year low in July 2013.

The approved bill modified Articles 25, 27 and 28 of the Mexican constitution that outlines how the country uses its natural resources, who owns those resources and how to develop the country’s economy from the wealth generated by them.

The 295-page bill leaves the ownership of subsurface hydrocarbons to the Mexican state and allows the State to execute agreements with private companies regarding upstream, midstream and downstream activities for oil and gas industries. All activities related to oil and gas will cease to be state monopolies. The bill also outlines the creation of a public trust, “Mexican Oil Fund for Stabilization and Development” (Fondo Mexicano del Petróleo para la Estabilización y el Desarrollo) in conjunction with the Central Bank as trustee to receive, manage and distribute income resulting from allocations and agreements with private companies and productive state companies, such as Petróleos Mexicanos (Pemex).

On Wednesday, April 30 2014, the government released its draft legislation that includes nine new laws and 12 amendments. Congress ended its regular sessions that day but is expected to host extra sessions to pass the energy laws by the end of June 2014.

According to the proposed legislation, the Mexican energy regulatory bodies, CNH and the Energy Regulatory Commission, must make all decisions public and will have the power to issue resolutions, apply sanctions, issue permits and authorizations. The CNH will regulate exploration and production of hydrocarbons, administer tenders and oversee contracts while the Energy Regulatory Commission will control transportation, storage, compression and regasification activities and the sale to the public of gasoline, natural gas and petrochemicals, as well as power generation. Public bids will be held for contracts and production licenses with the winner being able to provide the best economic conditions for the Mexican state. The government also outlined five rules of transparency for contract bidders that includes making all rounds of bidding available in real time via the Internet and requiring companies to make public the costs incurred and payments received from the government.

Institutions that will participate in the bidding process include the Department of Energy, which will make the technical guidelines of contracts; the Ministry of Finance which will set economic and taxation; CNH that manamges bids, allocates and administers contracts; and finally, the Mexican Petroleum Fund, Trust Bank of Mexico, which will make payments for contracts and administration and management of oil revenues, excluding taxes.

The legislation has created the Coordination Council of the Energy Sector, which includes the secretary of energy and the three secretariats, the presidents of regulatory commissioners coordinated bodies: CNH and CRE and the directors of the two new decentralised public agencies that make the reform, National Center for Natural Gas (CENAGAS) and the National Energy Control Center (CENACE).

Pemex

According to Pemex itself, the company will now become “a productive state owned company with a new tax regime, with budgetary autonomy, with more competitiveness and transparency.”

The exploration, extraction, transportation, and marketing of crude oil and natural gas in Mexico have traditionally been controlled by the company, which was created in 1938 when then-president Lázaro Cárdenas closed the country’s oil markets to global participants. But, Pemex is struggling to keep pace with meeting the demands of oil production because of its lack of resources and towering debt and in February 7 2014, the company had to deal with the resignation of Exploration and Production Chief Carlos Morales.

 “With the energy reform, Pemex would stop carrying out many activities exclusively, as the private sector would be able to participate actively in the industry, investing its own resources,” says Juan Carlos Machorro of Santamarina & Steta, “thus, the reform will help Pemex to be more efficient in performing certain activities, since under the current scheme, it has become a highly inefficient entity due to the large number of tasks to be performed and the limited budget and control to which it is subject to. The reform is expected to dust-off and modernize PEMEX in order to make it more efficient, productive and competitive.”

Protests

The bill was passed after much push-back from the Party of the Democratic Revolution (PRD). "It would have been a political suicide for us to support any constitutional change in energy," said Jesús Zambrano, the president of the PRD, in an interview with the Wall Street Journal. "[It’s] better to be seen by analysts and international investors as a leftist party incapable of negotiating than to be seen by most Mexicans as traitors for not defending our oil sovereignty."

In 2015, when gubernatorial and national congress elections take place, the PRD plans to hold a referendum to overturn the measures because the reforms are of enormous national importance. The party said it has the signatures of two million people of different political affiliations, class and religions.

“This reform, which did not receive the affirmative vote of the legislators and the PRD, disrupts the essential foundations of our republican coexistence and jeopardises our national sovereignty,” the party said in a declaration posted on its website.

The party says that while it is aware that the country needs a deep reform of its energy sector, oil and other hydrocarbons are and should remain Mexican-owned, Pemex should be the main oil producer and any reform should incorporate mechanisms for transparency, accountability and fighting corruption in all processes.

“These reforms must be subject to a popular consultation so that it is the citizens who decide with their majority vote if these constitutional amendments are abrogated or remain in firm,” the party said.

“Speaking about energy reform has always been a controversial topic,” Machorro says. “Besides being an economic and legal issue, it is a political problem, due to the fact that, for Mexicans, hydrocarbons are summarized in one word, Pemex. This is the reason that the previous intent of reforming the energy sector in the last decade have failed. Political alignments are not completely clear but are stronger than in the past. The energy oil and gas sector has always been a difficult topic in Mexico. The parties in the power have constantly tried to carry out a deep energy reform, with unfortunate results, like the 2008 attempt.”

Energy reform

Despite the opposition there are many in the country, particularly and not surprisingly in the private sector, who believe that reform of the oil and gas industry is a step Mexico has to take.

Carlos de Maria y Campos, a partner at Galicia Abogados in Mexico City, says that the decision to denationalise the country’s energy industry after seven-and-a-half decades is vital.

“Oil is just a natural resource that is worth nothing underneath the earth and we need to look for ways to transform it into ways to benefit the people,” he says. “This brings a lot of benefits.  The time has come for it to be resolved and we’re wasting time while the Americans are exploring fields shared by the two countries and - by the time we are ready - it will probably be dry and debating will bring no benefits and the parties have taken notice.”

Experts say the reform is expected to increase oil production from the current 2.5 million barrels per day to 3 million in 2018 and 3.5 million in 2025; increase natural gas production from the 5,700 million cubic feet per day currently produced, to 8,000 million by 2018 and to 10,400 million in 2025.

The reform of the energy sector is expected to encourage increased investment in technology and the adoption of cheaper, less polluting sources of energy such as solar and wind and also the use of gas. The president also hopes that his proposition will guarantee sufficient electricity supply and lower the cost of lighting bills for homes and small companies.

Derek Woodhouse, a partner at Woodhouse Lorente Ludlow, agrees and says that the reform is a concerning issue and the future of Mexico depends on this move.

“We have been waiting for this for almost 20 years,” he says, “previous attempts have resulted in partial reforms that took us nowhere. It seems to me that Mexico is sitting on top of a large source of wealth and due to ignorance we have not been able to access that wealth. In my view there have been stakeholders, mainly the oil industry union, that fear that this denationalisation will affect them negatively. The irony is that this is not even true. They are so powerful that they have been able to stop singlehanded any serious attempt to pass a reform that would allow private sector investment.”

Legal framework

Given the huge interest there is likely to be from oil and gas investors, it is not surprising that law firms are expecting an increase in work from the opening up the market. In addition the reform will create the need to develop a new regulatory framework.

“This would involve various elements, such as a new regime of permits, the emergence of new contractual schemes, shared profit contracts, and the creating of new relationships and dealings with the relevant regulatory bodies such as the Energy Regulatory Commission and the National Hydrocarbons Commission, among others,” Machorro says. “With the new scheme, the private sector demand for participation in the energy industry would increase significantly, and therefore, the need for legal advice and services to carry out the above activities would also increase.”

Michell Nader, an energy and infrastructure projects partner at Nader Hayaux & Goebel says the legal market will experience wide ranging change.

“There are very few energy experts in Mexico and that’s because there hasn’t been a market for them,” Nader said. “For the last nine months, some of our infrastructure and project finance lawyers have been training themselves learning about the industry and traveling to several countries to become more familiar with standards in other countries. We expect also to do a significant number of structured finance and joint venture works. Many of the domestic players that are coming will need technical support and will have to join forces with international investors. There will be a lot of joint ventures, financing and M&A.”

Nader also added that he expects most of the new entrants in the industry to go through organic growth because there few industry specialists in the current market. As a result, law firms will have to help clients from the inception to get financing and hire new employee.

Conclusion

Whether you agree with the reforms or not it is hard to deny that the Mexican oil and gas market and the associated market in legal services is undergoing a huge change. Who the winners and losers are in this situation is yet to be determined but it will be interesting to see which law firms seize the opportunity to make a reputation for themselves in this new environment.