Energy Sector Reforms in Mexico: A Catch 22

Whatever changes Mexico’s energy sector will take, they will be radical compared to the status quo. At least this is what one might think, having followed Mexico`s energy reform debate since 2008 and president Nieto’s announcements following his ascent to power in December 2012. The wind of change to Mexico’s heavy crude is blowing.

I doubt that. A lot. And having put some thought to what the options are for Mexico`s production impasse, I finally concluded that the options are very slim. The energy industry is in a political Catch-22 situation, allowing for no substantial reform. There is such a great need for reform to revive the sector that there might be some change. But not enough to attract investment on the grand scale needed.

Since 2004 Mexico’s oil and gas industry output has nose-dived, and with it, its exports to the U.S.. Varying by grade, Mexico’s production of heavy crude oil fell by an astonishing 46 percent from 2004 to 2012 (mainly due to steep production declines of the Cantarell field). At the same time, exports to the US fell by 34 percent, decreasing Mexico’s share of total U.S. crude oil imports to 11 percent in 2012 from 16 percent in 2003.

More worrying note for Mexico, however, this decrease in production has come about with an increasing per capita consumption of energy over the last decades and some specialists estimate that Mexico’s energy demand and production will cross between 2018 and 2000, if no sector reforms happen. A dismal future taking the fact that one third of Mexico’s budget is currently financed through its oil and gas income.

No wonder that Mexico`s Congress enacted energy reform legislation which allowed foreign companies to participate in the oil sector through service contracts (Under a service contract the right to explore and take ownership of the oil once it is extracted, does not transfer to the IOC – more information on contract types here). To counter this downward trend in production, however, this is not enough.

In order to overhaul more than 60 years of state control over the energy sector, Nieto would have to amend the constitution to allow at least partial foreign ownership of Mexican oil. Articles 25, 27 and 28 are in play, of which article 27 is regarded as the most contentious one as it prohibits concession agreements.

Earlier this year he openly floated the idea of selling a minority stake in Mexico`s state-owned oil giant Pemex, a partial privatization à la Brazil’s Petrobras. But is questionable how radical his reform propositions will be in the face of immense popular opposition and possible disagreements within Congress which would need to approve constitutional level reform by a two-thirds majority.

The conservative National Action Party (PAN), the main opposition party to Nieto’s Institutional Revolutionary Party (PRI), already suggested a radical proposal including a reform of all the relevant articles of th constitution, and a proposal to make the country`s energy regulatory bodies autonomous. At the other end of the political spectrum, the leftist Party of Democratic Revolution (PRD) vows total opposition to any reform.

Mexicans generally are not happy about giving foreign companies a share of the oil pie. A new poll by the Center de Investigación y Docencia Económicas (CIDE), shows that 65 percent of Mexicans are against opening up Pemex.

In the face of this opposition room for manoeuvre is small, however much Mexico`s politicians might yearn for it. Some analysts don´t even believe that production sharing agreements will take hold. For instance Daniel Kerner stated in an interview with Reuters that the most ambitious Nieto could get are risk contracts, a tiny change from a service contract in which a third party shares risks and rewards related to results instead of receiving a flat fee. PRI’s party president, Cesar Camacho, has said in a recent interview that Nieto will propose production-sharing contracts for new exploration areas, but ruled out the idea of any concession agreements.

The dilemma is that if the government wants to attract investors, change might need to be radical. That means that even if the government implements some less radical changes, it might not be enough to bring in the investors.

What’s in it for foreign investors?

Exxon, Chevron and the Spanish oil producer Repsol SA are among the companies that have expressed interest in Mexico`s oil fields.

Yet what awaits them might not necessarily be the best operational environment. The country’s proven and probable reserves have fallen from a combined 31.5 billion barrels in 2007 to just 26 billion as of last year. The industry’s infrastructure hasn`t been updated for years, and there are still quesstions over a massive explosion that destroyed parts of Pemex`s headquarters in Mexico City in January 2013. When it comes to investment in existing and new infrastructure Pemex spent about $19 billion across its business – less than half the total amount budgeted for investment by Petrobas.

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