Mexico’s Energy Reform Bill: The Aperatura
Mexico’s government has taken the initial bold step to open up its energy sector to private investment. While the Energy Reform Bill was signed into law by Mexico’s President Enrique Peña Nieto on December 21st, following approval by both houses of Congress and a majority of Mexico’s 31 states, secondary legislation is needed to implement the constitutional amendments in 2014. This will not be an easy task, as the details of the proposed contractual frameworks and the future role of Petroleos Mexicanos (PEMEX) still need to be defined.
For someone who was a consultant to PEMEX’s upstream arm in 1990 and tried to develop business in Mexico for Amoco with its chairman in the mid-’90s, this has been a long time coming. In fact, the comprehensive and thorough nature of the Reform Bill leads me to believe the international management consulting firm for whom I worked in 1990 had a role in advising the President and the Congress in this sweeping legislation and amendments to Articles 25, 27, and 28 of the Mexican Constitution. When I worked in Mexico, we referred to this highly anticipated reform as the aperatura, or opening of Mexico’s energy sector to private participation.
First, we should applaud the move by Mexico’s leadership as a way to improve the livelihood of its populace and thus enhance the stability of the nation. Our country’s leadership has passed sweeping legislation, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Affordable Care Act, both of which have had difficult and extended implementation processes. Realize that neither of these involved amendments to our Constitution. Also appreciate that oil is the patrimony to the Mexican people, handed down from their beloved forefathers, who nationalized the oil and gas sector in 1938 from the foreign oil companies. Consider that energy reform in Mexico is a more dramatic change than rescinding the Endangered Species Act in the United States would be, and perhaps as large as revoking Americans’ rights to bear arms.
The principal elements of Mexico’s Energy Reform Bill follow.
Opens Mexico to private investment and competition for oil and natural gas exploration and production. The contractual frameworks for private participation include profit-sharing, production-sharing (common in the Middle East and allows booking of reserves), and service contracts. The Mexican government will continue to own and control the minerals, and rights will be offered for bid and administered by the Ministry of Energy. PEMEX will have the first call (“round zero”) on continuing to operate existing fields, and can enter into joint ventures with private firms. In areas where PEMEX has existing exploration activities, it will have three years, with a possible extension of two years, to develop the hydrocarbon resources if it initiates production during the contract term.
Midstream and Downstream
Opens Mexico’s midstream and downstream sectors to private investment and participation. The Energy Regulatory Commission will grant permits for the storage, transportation, sale, and distribution of oil, gas, oil byproducts, and natural gas liquids. The Reform Bill requires the executive branch establish the National Center for Control of Natural Gas within 12 months, and that entity will operate Mexico’s national pipeline network and administer transportation contracts. This is important to private investors, as PEMEX’s continued control of the gas pipeline system could compromise movement of private natural gas to markets. I hope the same neutral control will occur for oil pipelines.
Opens the power generation market to private investment and generation that is now the exclusive domain of the Comisión Federal de Electricidad (CFE). While the control of the national power grid and the distribution and transmission of power would remain with the state, state-owned companies would be permitted to contract with private parties for cables, towers, and substations. The Bill requires the creation of the National Center of Energy Control, which will act as the Independent System Operator (ISO), controlling the national power grid and the wholesale electricity market, ensuring open access to the transmission and distribution networks for private generators and CFE. The goal is to reduce electricity rates and improve reliability in Mexico.
The Energy Reform Bill is indeed sweeping, but as in the United States, reforms take years to implement and will be fraught with some pain and uncertainty. The contractual framework and transparent implementation will be critical to success. The need for private investment is evidenced by the decline in Mexico’s oil and condensate production from a peak of approximately 3.55 million barrels per day (MMBpd) in 2004 to an estimated 2.5 MMBpd in 2013. Importantly for Mexico’s trade balance, net oil exports declined from 1.9 MMBpd in 2004 to 837,000 Bpd in 2012. Mexico is a net natural gas and NGL importer from the United States. Mexico’s oil and natural gas resource potential, when including its deep water resources, far exceeds that of the Permian Basin. Further, Mexico needs capital, a fact attested to by PEMEX’ conservative estimate that more than $60 billion per year of additional investment is needed to restore production to peak levels. PEMEX is allowed to invest only a minority of its cash flow back into oil and natural gas exploration and development, the balance of which supports the Mexican fiscal budget, including essential social programs. Every independent U.S. oil company I know (excluding MLPs) reinvests all of its cash flow, if not more through borrowings and equity issuance, to maintain and grow its production. Mexico also needs technical and operational expertise and best practices to develop its deep water and unconventional resources. Look for international companies with deep water operations like Exxon Mobil, BP, BHP, Chevron, Petrobras, Statoil, and Shell to be players in Mexico’s deep water Gulf of Mexico bid rounds. There are unconventional resources like the Chicontepec Field in Central Mexico that remind me of the Spraberry Trend—thick layers of tight, oil-rich rock that require multi-stage hydraulic fracturing. Companies such as Apache, Pioneer Natural Resources, and Concho Resources have expertise that would apply to this multi-billion barrel resource. Finally, trends—including the Eagle Ford and Lobo—don’t stop at the Texas border and could be developed by U.S. companies with expertise and infrastructure across the border.
This leads to the natural question: will Mexico’s opening its upstream lead to reduced investment in the United States? I don’t think so, as investments offering good returns always manage to find capital to fund them. Whether the Mexican energy contractual framework and competitive dynamic allows for competitive returns will not be known for years to come, and it will take big balance sheets, specific expertise, and patient investors to enter the hydrocarbon resource development business south of the border. The next question is: will increasing Mexican oil and gas production negatively impact U.S. prices? Maybe, but Mexican energy consumption is increasing with its growing population, and with increased economic activity generated by the opening of the energy sector, gasoline, diesel, natural gas, and electricity consumption should accelerate.
Let’s not forget that Mexico’s Energy Reform Bill opens the sectors described above to private participation, which means Mexican companies will be bidding against foreign companies. One of the best ways to gain early entry and perhaps success will be partnering with Mexican businessmen who have relationships in the government and with contractors that can enable success. We in the Permian Basin have a lot of expertise that is relevant to Mexico’s hydrocarbon resource development opportunity set. I will be watching patiently, along with you, the aperatura, or opening of Mexico’s energy sector, over the years to come. The aperatura will create a massive amount of new, well-paying jobs in Mexico. This will benefit the border states, including Texas, as new jobs in Mexico will reduce illegal immigration and strains on our social services infrastructure. The global oilfield service companies will be the immediate beneficiaries of the aperatura, as their expertise is what converts engineers and geologists’ ideas into production and cash flow. Where else but in Texas can one find the relevant oilfield services expertise in such close proximity to the opportunity? This could put more pressure on wages in the oilfield in the Permian Basin as availability of labor could decline. Like everything else, we’ll deal with that issue if and when the time comes.