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    What are we to believe about reform in Mexico?

    Don Stowers  

    Lately we've been hearing a lot about energy reform in Mexico. The comments I've heard range from, "It's about time!" to "I'll believe it when I see it." What are we to make of all the talk from south of the Rio Grande about amending the Mexican constitution and rehabilitating the oil industry? Will Mexico finally allow foreign oil companies, other than oil service companies, to operate in its upstream sector?

    First, a bit of history. Mexico's oil patch has been off limits to outside oil companies since the government of President Lázaro Cárdenas seized the assets of foreign oil companies in 1938. Cárdenas founded Pemex, Mexico's national oil company, shortly after the expropriation. By the time Cárdenas left office two years later, he had changed the Mexican constitution to ban concessions to foreign oil companies, although the government continued to encourage private investment through contracts, including profit sharing agreements. It wasn't until 1960 that Mexico went a step further and nationalized the electricity industry as well. As a result, Mexico has some of the most restrictive energy laws in the world, particularly with respect to oil exploration and production.

    The expulsion of the large American and British oil companies from Mexico has had a negative effect on development of the petroleum industry in Mexico. However, the chance discovery of the giant Cantarell field in the Bay of Campeche in 1976 brought about a resurgence in Mexican oil production. It quickly became a cash cow for Mexico, although reinvestment in infrastructure and R&D lagged as profits were allegedly siphoned off into the general treasury to pay for things unrelated to oil and gas development.

    Today, Cantarell's output is shrinking and the Mexican oil and gas industry is at a crossroads. Its oil output has fallen from 3.5 million barrels per day in 2004 to about 2.6 million bbl/d in 2012. Current domestic oil consumption is around 2.1 million bbl/d. The US Department of Energy says that if current trends and policies are left unchanged, Mexico's oil production will decline by an additional 600,000 bbl/d by 2020. If this occurs, Mexico will have the distinction of having gone from the world's second-largest exporter of oil into a net importer. The consequences would be devastating for Mexico's economy.

    Fortunately for Mexico, the nation's voters chose a realist in its current president, Enrique Peña Nieto, who recognizes the need and the urgency to open up the oil sector to outside investment. Peña Nieto, who took office in December 2012, has declared that changing Pemex will be his "signature issue."

    Although Pemex has taken steps to slow the declining production by increasing investment in two newer fields, enhanced recovery techniques for both onshore and offshore fields may take years to have an effect. Moreover, some people in Mexico and outside the country doubt that the Mexican political leadership has the will and the ability to achieve long-term goals.

    In addition to the need to reform the oil and gas industry in Mexico, potential legal issues are a concern. Attorneys say that doing business in Mexico is complicated because of its outdated legal system. Writing arbitration into contracts is critical, said one energy lawyer. Mexico's laws aren't based on common-law practices like those in the US and much of the Western world. Instead, a case that would be treated in the US as a civil dispute could be prosecuted as a criminal act in Mexico.

    Peña Nieto has been trying to build a consensus in order to achieve his ambitious plan to reform the Mexican oil sector. Burdened by high unemployment and low wages, he has gone to the press and workers' unions to promote his agenda, saying that more outside investment in energy will bring more jobs and higher pay.

    The main provisions of his proposal to the Mexican Congress are:

    • Allow profit-sharing contracts with Mexican and international private companies for the exploration and production of oil and gas or other similar contracts granting exploration and production rights or incentives, and
    • Allow private investment participation in the midstream and downstream markets, including petrochemicals, refining, transportation, storage, and distribution.

    Granting this would require amending the constitution, the legal basis for the country's oil nationalism. However, it stops short of privatizing or recapitalizing Pemex. This measured approach might just get a majority vote in the legislative body.

    Mexico ranks seventh among world oil producers, ahead of Norway, the United Kingdom, Venezuela, Iraq, and Brazil. It is a stable representative democracy with free trade agreements with all major economies. Its oil and gas sector contributes to more than a third of the national government's budget and accounts for 15% of its exports.

    Opening up its shale assets and the deepwater Gulf of Mexico to international investment is crucial to Mexico's future. Soon, that nation's Congress will decide which path to take at the current crossroads.

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