Momentum builds for energy policy reform in Mexico

Posted on 10 July 2013

By Katie Mazerov, contributing editor

A changing political climate in Mexico has opened up opportunities for energy policy reform that could provide more economic incentives for international oil companies (IOCs) in the hydrocarbon-rich country. The market is currently 100% controlled by national oil company PEMEX, but a bill is expected to go before Mexico’s Congress this fall. “For the first time in many years, both of Mexico’s major political parties are openly behind energy reform, as they realize that maintaining the status quo doesn’t serve the best interests of the country,” said José L. Valera, partner in the Houston office of law firm Mayer Brown. “The political odds of reform occurring are now substantially higher than they have been in the last decade.”

Mr Valera represents oil and gas companies negotiating exploration and production contracts in the US, South and Central America and other markets and has counseled various governments on energy legislative reform matters. “Today, the Mexican Constitution and law essentially prohibit IOCs from being in the oil business in the country because they cannot profit from the market value of the production they may obtain,” Mr Valera said. “The law still views development of hydrocarbon resources in Mexico as something that is exclusively the domain of PEMEX. PEMEX can enter into contracts with private-sector companies but may only compensate them on a set fee per unit of production, an arrangement that is basically like that of an operator/service contractor.”

Proponents for reform say that, by relaxing such restrictions, IOCs will gain much greater incentives to undertake exploration operations while providing the technology, expertise and resources that PEMEX needs to produce the country’s underdeveloped deepwater oil and shale gas resources, according to Mr Valera. This could have significant implications for Mexico’s economy. In addition to extensive oil reserves in the Gulf of Mexico, Mexico is estimated to have nearly 700 trillion cu ft of technically recoverable shale gas resources that remain largely untapped.

PEMEX has continued to focus on production of conventional onshore oil for export and the associated gas for domestic use. Because the company is a revenue generator for the government, the Mexican Congress has historically limited PEMEX’s investment in exploration due to the perceived risks and the low prices of natural gas. Natural gas has not been an exportable commodity due to the shale gas boom in the US. Often, only projects that are completely de-risked and generate a positive cash flow for PEMEX are approved and completed, Mr Valera noted.

“As a result, Mexico’s reserves and production are both declining at the same time demand in Mexico for refined products is increasing,” he said. “Ironically, the country is now forced to import large quantities of natural gas to supply its growing population and expanding infrastructure. The delta between crude oil export revenues and what Mexico has to pay to import natural gas and liquid fuels is shrinking, and Mexico will soon have a deficit in its hydrocarbons trade balance.”

Depending on the nature and degree of reform, a new policy will require either a change in the law by Congress, or a change in the Constitution by Congress with ratification by the Mexican states. “The Constitution has certain restrictions, but the law that regulates the Constitutional provision actually goes beyond the Constitution in terms of restricting what IOCs can do,” Mr Valera explained. “It may be necessary to only amend the law, but if Congress wants to deepen the reform, it will have to get into the Constitution.”

The most conservative approach, requiring only a statutory change, would allow IOCs to form joint ventures with PEMEX and take a greater share of the market value of production. A more advanced measure would eliminate the PEMEX monopoly by allowing IOCs to obtain oil and gas leases directly from the government; this would require a Constitutional change.

“This is a matter of legal reform. Nothing can be done to change the exploration and production business in Mexico until the law changes,” Mr Valera said. Approval of any reform hinges on large voting blocks in the Mexican Congress. Both the conservative National Action Party (PAN) and more liberal Institutional Revolutionary Party (PRI) support reform; the leftist Party of the Democratic Revolution (PRD) does not favor reform.

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