by Karen Boman
Rigzone Staff
Should the legislative process move forward as planned, the first profit sharing contracts under the new regime would be issued for the bidding process in the second half of 2014, said Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center for Scholars. New oil production is expected to begin flowing between three to five years from that date, Wood said.
Mexican President Enrique Pena Nieto’s proposed constitutional reform of Mexico’s energy framework – one of the most significant economic changes in Mexico in the past century, Wood noted – will clean the slate and take Mexico’s energy sector back to 1938, the year then-President Lazaro Cardenas nationalized Mexico’s energy industry.
Introduced on Aug. 12, Pena Nieto’s proposal would grant Mexican Congress broad authority in allowing for and defining the terms of exploration and production activity in Mexico. It would end state energy company Petroleos Mexicanos’ (PEMEX) monopoly on exploration and production (E&P) activities and allow private companies E&P rights either directly from the state or through an association with PEMEX. The proposal would permit private companies to own oil and gas production and fully share in economic risks and benefits.
Direct private investment would also be allowed in the midstream and downstream sectors under the proposal. Additionally, the proposal would also open the door for Mexico to become a competitive wholesale power market.
Nieto has proposed wording of Articles 27 and 28 of the Constitution that is the same as the language implemented in 1940, when Cardenas nationalized Mexico’s oil industry. By going “back to the future”, Nieto seeks to head off criticism from nationalists and traditionalists who say reform would betray the national sovereignty and Mexico’s citizens. Nieto’s appeal to history has also helped smooth things over with the Partido de la Revolucion Democratica (PRD), who are opposed to constitutional change and to private sector investment.
Nieto’s proposed change to Article 27 of Mexico’s Constitution prohibits concessions, but would allow for production and profit-sharing deals, a right that had existed from 1940 to 1960 before a constitutional amendment barred the practice. Future production sharing contracts would be enabled with a 50 percent plus one vote in both houses of Congress, Wood noted.
The Partido Accion Nacional (PAN) center-right political party announced a separate reform proposal July 31. In its proposal, PAN proposed a concessions-based system in which the private sector and foreign companies would compete with PEMEX. The state would continue to own reserves, but private firms would be able to book reserves. The Comision Nacional de Hidrocarburos (CNH) would be strengthened in its regulatory functions, and would be able to award contracts and concessions.
PAN’s proposal is modeling off legal frameworks developed in Brazil and Colombia, said Gabriel Salinas, a partner with Mayer Brown. PAN’s proposal raised the bar of expectations, helping the Partido Revolucionario Institucional’s (PRI’s) proposed amendment. Though it maintains the legal framework in place since the 1950s, the initiation of profit-sharing discussions marked a huge step forward in the energy reform debate, Salinas noted.
PRD, which opposes constitutional reform or private sector investment, has proposed change through secondary laws and the removal of PEMEX from government and union control by removing union representatives and the Minister of Finance from PEMEX’s board. PRD also has proposed lowering PEMEX’s tax obligation to the government so it can invest in exploration and production technologies and uniting PEMEX again into a single entity.
Efforts for previous presidents to reform Mexico’s energy sector stalled in Mexico’s political process; the last attempt at energy reform in 2008 resulted in only modest results. However, the message got through to all three political parties and Mexico’s citizens that the nation’s energy sector faced problems.
In shaping his proposal, Nieto looked to announcements earlier this year by the PRD and PAN to see what goal posts the government had to aim between, Wood said. Nieto’s proposal seeks to bring everyone under the same tent by not being too extreme. The PRD and PAN’s proposals showed Nieto “what would be acceptable to the middle.”
Nieto made clear that, even after reform, hydrocarbons would belong to the state, and that the government was not granting recessions. Nieto’s efforts to pacify the other political parties worked to a certain extent. PAN will likely vote in favor of the proposal, and PRD reacted less violently than expected to Nieto’s proposal. PAN will likely vote in favor of the proposal, Wood noted. This likelihood will increase if PRI is willing to negotiate over the strengthening of the CNH and reforming PEMEX’s board to reduce the union influence.
Lazaro Cardenas’ son Cuauhtemoc Cardenas threatened to lead a national campaign for a referendum on the issue of constitutional change – while PAN argued the proposal was too timid. However, protests in Mexico don’t seem to have much impact on the legislative process, and Cardenas influence has waned.
Public education efforts by the government since that time have helped convince Mexicans that their nation has an oil problem; however some polls suggest that the nation’s citizens remain somewhat resistant to private investment, equating private equipment with privatization, still considered a dirty word in Mexico.
While citizens can propose legislation, they do not have the power to recall legislation that has been passed.
Nieto and his government have an ace up their sleeve, the Pacto por Mexico, a negotiating mechanism through which Mexico’s three political parties have used – with great success – for implementing legislative reform. Given the track record of Mexico’s three political parties in successfully reforming other Mexican industries – and the fact that the PRI holds a majority of seats in the state legislatures – constitutional reform is likely to be unimpeded.
Nieto and other proponents of reform see constitutional change as necessary to reverse Mexico’s declining oil production and to help boost the nation’s economic growth. Nieto seeks to raise Mexico’s oil production to 3 million barrels of oil per day (MMbopd) in 2018 and to 3.5 MMbopd by 2025, Wood noted. In 2004, Mexico produced 3.4 MMbopd and exported over 2 MMbopd. After eight years of production declines, Mexico in 2012 produced 2.5 MMbopd, despite an increased investment to $20 billion per year from $4 billion a decade ago. Declining production from the large offshore Cantarell field was attributed for the production loss.
Dallas Parker, a partner with Mayer Brown, conference chair and moderate, said he believed President Nieto’s focus on higher-level constitutional reform is a brilliant move, given the daunting task that changing Mexico’s Constitution poses. A two-third majority of the two houses of Mexico’s Congress, as well as approval from 17 of Mexico’s 32 state legislatures, are required to implement constitutional change, but secondary legislation addressing energy would only require a 50 percent plus one vote from Congress to pass.
Since Nieto took office last December, Mexico’s unique political, economic and social system has undergone rapid change thanks to reforms of Mexican industries. Whether the change will generate anticipated economic growth remains to be seen, but the changes are a step in the right direction, said Wood.
The reform progress that Nieto’s government has made over the past 10 months resulted from the government’s success in negotiating. One government official has estimated that even secondary laws will be wrapped up by Christmas – an extraordinary move – but then again, the current government has surprised everyone with the progress it has made, and is clearly able to “get things done when it wants,” Wood said.
The Market Impact of Energy Reform
The announcement of Nieto’s proposal raised questions by private and international oil and gas firms over whether profit or production sharing contracts would be used, or whether foreign oil companies would be able to book reserves in Mexico.
PEMEX will be able to enter joint ventures with international and national oil companies, as well as other producers. PEMEX does not need investment to pursue shallow water or mature and conventional onshore plays, but needs partners for shale and deepwater exploration to share the technological know-how and risk.
The issue of booking reserves in Mexico, which was banned in the late 1950s, is a bit of a straw mat, as the government has already been talking with oil companies about how they can work the reform and book reserves.
“The government is not stupid,” said Wood, noting that companies need to be able to book reserves to obtain the capital needed to move forward with investment.
The regulatory law outlawing the booking of reserves by others will be made obsolete by the new laws which need to be enacted as a part of opening the industry.
“Our understanding is that it is the intention of the reforms to permit reserve booking, but the laws and contracts to be adopted after amending the Constitution will need to clarify this point either specifically or by using terminology that the industry will feel comfortable with to permit reserve booking,” Parker noted.
The government is negotiating to make it possible for production sharing contracts to take place, but how exactly production sharing contracts will play about remains to be seen. Five production sharing contracts under Cardenas’ in the 1940s had a government take of 18.5 percent, said Manuel Cervantes, an attorney with MCM Abogados in Mexico City; it remains unclear what the exact government take would be, but the 18.5 percent is viewed as a likely price floor.
The exact level of local content requirements for international and private companies also remains unclear; estimates of 10 percent to 30 percent have been discussed. Prior to 2008, no service companies existed in Mexico, but service companies now have a good presence in Mexico, and will prepared to fill the local content role if the reform is approved.
The Mexican government has been studying local content requirements of other countries to ensure that local content requirements in Mexico are set at the right level and are not too ambitious, Wood noted. PEMEX could follow the example set by Norway and the role of oil and gas in its economic development with incubators in cities where PEMEX is present to develop oil and gas service clusters, creating positive economic spillovers into the local economy.
A belief in Mexico exists that the international private sector is desperate to enter Mexico’s deepwater, Wood noted. While Mexico does have big oil, Wood said that companies won’t pursue Mexico’s deepwater unless the terms are right, adding, “The government knows it has to make the terms attractive to attract international investment.”
While investment opportunities exist across Mexico’s upstream, midstream and downstream sectors, shale and deepwater will likely attract significant interest. Allowing private companies to invest in exploring for and producing onshore and offshore natural gas also will serve the national interest as invest is needed to boost natural gas production in Mexico. For years, PEMEX has been mandated to produce oil to feed the national treasury. This move made business sense, but has resulted in Mexico becoming a gas importer, Wood noted.
Can PEMEX Survive?
Likening PEMEX to a supertanker, Wood said it would take time to turn the company around, Wood said. PEMEX can survive under a new oil regime in Mexico, but the company will pare down its large workforce and debt in order to do so. Wood noted that PEMEX has one of the lowest rates of production among oil companies on a per worker basis, making PEMEX a very expensive oil company. PEMEX executives also will need to be incentivized to make changes within the company; under the current structure, it is easier for executives to do nothing and collect and paycheck.PEMEX is not a traditional national oil and gas company, but a decentralized state agency whose growth has been handicapped by Mexico’s Constitution and politics. While other national oil companies worldwide have been able to adapt to develop deepwater and unconventional resources, PEMEX’s growth has been stifled by Mexico’s Constitution and its politics. As a result, PEMEX does not have the technology, expertise or process to go after what Duncan Wood calls “interesting oil”, or oil that companies must work harder to produce.
Under the existing system, the gains made by PEMEX’s exploration and production sector are lost through other PEMEX subsidiaries. While PEMEX generates lots of cash, the company faces high costs due to the large portion of revenues that Mexico’s government receives, leaving it no funds for technology and other investments. Generous union contracts and pensions also add to PEMEX’s costs.
PEMEX is not a bad company, Wood noted, adding that, in recent years, the company has found additional oil resources, and is particularly good at shallow water exploration. However, PEMEX has not found oil quickly enough to offset declining production from the offshore Cantarell field, and will need outside investment for deepwater exploration and development.
PEMEX officials have not had real interaction with authors of secondary legislative reform, but Parker said the lack of interaction might be good for PEMEX, leaving PEMEX to compete against other companies in a reformed Mexico exploration and production sector.
Ultimately, economics will drive Mexico energy reform as the country seeks to recoup money lost or left on the table, Salinas noted.
“PEMEX needs foreign investment, and economics will make reform happen,” Salinas noted, adding that the success of Nieto’s administration will be judged on the progress it makes with energy reform.
No comments:
Post a Comment