Mexico Moves Toward Historic Energy Reforms

© 2013 The Texas Lawbook.

By Boyd Carano, Raul Garcia and Alan Alexander
Special Contributing Writers for The Texas Lawbook

(January 23) — On Dec. 12, 2013, the Mexican Congress approved an energy reform bill (Energy Reform Bill) that would end the State’s 75-year monopoly on the oil and gas industry and open Mexico’s energy sector to private investment and participation. The Energy Reform Bill would amend articles 25, 27, and 28 of the Mexican Constitution, allowing private parties to participate in the upstream oil and gas sectors, expand private participation in the midstream and downstream sectors, and allow for private participation in the electricity sector. The Energy Reform Bill also includes so-called “transitorios,” which are binding guidelines for the implementing legislation that Congress is to pass in 2014.

The Energy Reform Bill goes beyond the reforms called for by President Peña Nieto earlier this year, and would include not only profit-sharing and service contracts, but also production-sharing contracts and licenses which would allow parties to own hydrocarbons at the wellhead. The reforms passed by the Mexican Congress open up the Mexican oil and gas sector to private participation, including foreign investors, for the first time in over 75 years. The nature and scope of opportunities for investors, however, will not be fully known until implementing legislation and regulations are passed next year. Furthermore, the details of the reforms should also determine the role that state-owned oil company Petróleos Mexicanos (PEMEX) will play in the marketplace going forward, and whether a truly competitive marketplace will be allowed to flourish.

The key provisions of the reform are as follows:

Upstream
The amendments would open Mexico’s upstream oil and gas sector to private investment and competition. Under the Energy Reform Bill, the Mexican government would be allowed to grant oil and gas rights to both PEMEX and private parties. PEMEX would also be allowed to enter into joint ventures with private parties. The Ministry of Energy, with assistance from the National Hydrocarbon Commission, would be responsible for administering a bidding system that would award contracts for oil and gas rights. The Energy Reform Bill calls for a contractual framework that would allow profit-sharing, production-sharing, and service contracts, as well as licenses. The Energy Reform Bill would require Congress to pass secondary legislation within 120 days after its enactment detailing the terms and conditions of the contractual frameworks. The secondary legislation should include details of the proposed contract and license terms, such as the duration of contracts, fiscal terms, and pre-qualification criteria, which will be critical for determining how attractive the reforms are for private investors.

The Energy Reform Bill has addressed the issue of whether firms would be able to book reserves by allowing them to report contracts and projected earnings from such contracts for financial and accounting purposes, provided that the contracts make clear that the Mexican government owns the hydrocarbons in situ. Some commentators have stated that these measures should allow firms to book reserves under applicable financial and regulatory reporting regimes.

Midstream and Downstream
The Energy Reform Bill would also open Mexico’s midstream and downstream sectors to private investment and participation. Under the bill, the Energy Regulatory Commission would be responsible for granting permits for the storage, transportation, sale and distribution of oil, gas, oil byproducts, ethane, propane, butane, and naphtha. Secondary legislation would provide details for the above regulations. Furthermore, the Executive Branch of the Mexican government would be required to create the National Center for Control of Natural Gas within 12 months after the enactment of the bill. Importantly, the operation of Mexico’s national pipeline network would be transferred from PEMEX to the National Center for Control of Natural Gas, which would act as an independent operator of the network and administer the corresponding transportation contracts.

Electricity and Power

The Energy Reform Bill approved by the Mexican Congress would eliminate the State monopoly over the power sector currently held by the Comisión Federal de Electricidad (CFE) and would open the power generation market to more private investment and competition. The CFE’s monopoly on power generation would be terminated and the CFE would be transformed into a “productive” state-owned company whose main objective would be the creation of “economic value” for the nation. The control of the national power grid and distribution and transmission of electric energy would remain exclusive activities of the State. However, state-owned companies would now be permitted to contract with private parties for infrastructure projects including cables, towers, and substations. Furthermore, private parties would be allowed to openly produce power and sell without restriction the electricity that they produce.

The Energy Reform Bill lays out plans for the creation of the National Center of Energy Control, which would act like an independent system operator (ISO) and would control and administer the national power network and the wholesale electricity market and ensure open access to the transmission and distribution networks. The likely purpose of these reforms is to open the power generation market to more competition in hopes of lowering electricity rates.

PEMEX’s Role in the Reforms
The attractiveness of the reforms for international oil companies will be strongly affected by the role that PEMEX will play in the Mexican marketplace post-enactment. As the reforms currently stand, PEMEX would initially be given some favorable treatment, though ultimately it would be expected to compete with private firms for oil and gas contracts.

The Constitutional amendments passed by Congress would terminate PEMEX’s monopoly and transform the company into a “productive” state-owned company that would be expected to operate under best industry practices. After an initial “round zero” where PEMEX would be given the right to request assignment of blocks and areas where it will continue to operate, PEMEX would then be treated as one more operator during the bidding process for oil and gas contracts. The Ministry of Energy would have to approve PEMEX’s request for assignment of “round zero” areas, and would take into consideration PEMEX’s technical, operational, and financial capacities when making the decision. The Ministry of Energy would also be required to take into account PEMEX’s current activity in the requested areas. In areas where PEMEX has exploration activities and investments, PEMEX would be allowed to continue exploration activities for three years, with a possible extension of two years. PEMEX would be allowed to continue development in these areas if it successfully began production within the relevant time-frame. If PEMEX failed to begin production in the area within the time-frame, then the area in question would revert back to the State and would be assigned through the bidding process. PEMEX would also maintain its rights in areas where it is already producing hydrocarbons, though it would be required to deliver a development plan justifying its ability to produce the area effectively and competitively.

Another important measure introduced by the reforms would be the removal of PEMEX Union representation from PEMEX’s Board of Directors. The PEMEX Union has been perceived as a source of corruption and inefficiency within the company. This measure is intended to increase the company’s transparency, facilitate professionalism in its management, and strengthen PEMEX’s appeal as a prospective partner in joint ventures with international oil companies. Furthermore, the reform bill calls for the organizations charged with awarding upstream, midstream, and downstream contracts to be independent and impartial. Though PEMEX will be given some favorable treatment, namely through the “round zero” contract allocation, the bill’s provisions call for a full liberalization of the oil and gas sectors which would allow private firms to compete freely.

Conclusion
The Energy Reform Bill passed by Congress is expected to bring about dramatic changes to the Mexican energy industry. Although the bill still needs to be approved by a majority of state legislatures in order to be enacted, most analysts find the prospects for passage to be very favorable. The “transitorios” included in the Energy Reform Bill both provide guidance for Congress and give insight into what the implementing legislation and regulations will look like, indicating Congress’s intent to achieve far-reaching reforms to Mexico’s energy sector. However, many of the key details, including the terms and conditions of the proposed contractual frameworks, will be provided by the secondary legislation to be passed by Congress in 2014. This legislation will further reveal the likely impact of the Energy Reform Bill on Mexico’s energy sector, and the opportunities it may present for energy investors worldwide.

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