A Primer: Mexico Energy Reforms
Vianovo | Mar 19, 2014
Mexico’s Oil & Gas Resources
Mexico is the world’s 9th largest producer of oil and the third-largest in the Western Hemisphere (behind the U.S. and Canada and ahead of Venezuela). It has vast untapped shale oil reserves, estimated to be the 5th largest in the world, according to the U.S. Energy Information Administration.
As the third largest supplier of crude oil to the United States (after Canada and Saudi Arabia), Mexico accounts for roughly 12% of its northern neighbor’s total imports. The lion’s share of Mexico’s crude oil exports (85%) head to the U.S. – all supplied via tanker, as Mexico does not have international oil pipeline connections.
While Mexico has immense oil and natural gas supplies, it has been on a decade-long track toward becoming a net energy importer. Oil production has been steadily declining, falling by 1 million barrels per day since 2004. With limited domestic refining capability and strong demand, the country is already a net importer of refined petroleum products, such as lighter grade gasoline and diesel. And in natural gas, Mexico’s growing consumption needs (for power generation and to meet industry demand) outstrip its productive capacity, leaving the country as a net importer of the fuel. Mexico’s main supplier of natural gas is the U.S, with imports arriving both as liquefied natural gas (LNG) and via an integrated and growing network of cross-border natural gas pipelines. The below chart illustrates the strong energy relationship that Mexico has with the United States.
In December 2013, Mexico’s Congress passed far-reaching constitutional reforms to begin the process of opening the energy sector to private participation and worldwide investment. Pemex, the world’s only remaining state-owned oil monopoly that faced no competition, has for many years lacked the necessary capital, expertise and equipment to operate productively. After falling behind, Mexico is finally taking actions that will allow its energy sector to catch up to global developments, allowing private investment in every segment of the hydrocarbons sector, even while clearly affirming the Mexican State’s sole ownership of the minerals in the subsoil.
The reforms are sweeping in scope and reshape Mexico’s energy landscape. Three of the biggest changes are:
1. The energy sector is opened to private investment. The reforms allow domestic and foreign private investors to participate in activities like refining, transport, storage and distribution of oil, natural gas, fuels and other oil products. Most important, the private sector will be allowed to participate in exploration and production of oil and gas – on behalf of the Mexican state – in three new ways: licenses, profit-sharing, and production-sharing agreements (these will be clearly defined in secondary legislation, which is currently being drafted). Awards will be made through an open and transparent bidding process. The reforms also permit private sector participation in the generation of electricity.
2. A new regulatory framework is created. As shown in the below chart, a new regulatory framework will divide oversight of the oil and gas sector among a host of entities, including:
The Energy Ministry (Secretaría de Energía-SENER) remains in charge of the sector and will continue to set overall energy policy for the country. It has the new responsibility of determining the areas that can be subject to exploration and production and will assign Pemex contracts in the ‘Round Zero’ stage, which allows the company a one-time pick of what it will keep of its existing inventory.
The National Hydrocarbon Commission (Comisión Nacional de Hidrocarburos - CNH) is strengthened, made autonomous and given an enhanced role under the reforms. It will be the key player in Mexico’s oil and gas industry. CNH will oversee regulation of upstream activities and will oversee the bidding process and awards to both private companies and Pemex.
The Energy Regulatory Commission (Comisión Reguladora de Energia – CRE), also strengthened and made autonomous under the reform, will focus on mid- and downstream activities.
The Ministry of Environment and Natural Resources (Agencia Nacional de Seguridad Industrial y Medio Ambiente- SEMARNAT) will have a new National Agency of Industrial Safety and Environmental Protection under its purview, which will oversee industry safety and environmental protections.
Mexico’s Ministry of Finance and Public Credit (Secretaría de Haciena y Crédito Público-SHCP) will establish the fiscal terms applicable to each contract type, such as the relevant royalty rates, tax levels and other aspects, and will design the parameters of a new oil sovereign wealth fund, the Mexican Petroleum Fund for Stabilization and Development (Fondo Mexicano del Petróleo para la Estabilización y el Desarrollo - FoMePe), which will then be overseen by Mexico’s Central Bank.
Two new entities – the National Natural Gas Control Center (CENAGAS) and National Electricity Control Center (CENACE) – will own and operate the national pipeline systems and electricity grid, respectively.
3. Pemex and the Federal Electricity Commission (Comisión Federal de Electricidad-CFE) will transition from monopoly status to operating as state-owned productive enterprises. The reform mandates that both entities create economic value and increase revenues, in essence requiring that they act like any other actor in the sector. Each company will have a new board of directors, appointed by the President and comprised of five independent members and five members of the federal government. The Pemex union will no longer be represented on the company’s board. The Secretary of Energy will preside over both boards. Pemex is granted the advantage of being able to choose which of its existing assets it wishes to keep under a ‘Round Zero’ of tenders (its bids are due March 21). SENER will decide if Pemex may retain the acreage it selects based on whether the company proves it has the financial and technical capacity to develop them.
Mexico’s Congress is now drafting the all-important secondary legislation. It has until April 20, the close of the current legislative session, to write or reform the 20 or so laws and statutes that are tied to the constitutional changes. The President’s Office will present the secondary legislation as a complete package in the next few weeks. Among the most important topics to be addressed are:
- Clarification of the contractual framework and terms for private sector participation in the sector, namely: licenses, production-sharing contracts; profit-sharing contracts; and pure service contracts.
- Issues of eminent domain.
- The applicable taxation and royalty system.
- Transparency details for operations and financial reporting by the energy sector entities.
- Functioning and interaction of the regulatory entities.
- Domestic content requirements, if and where applicable.
Areas of Opportunity
Mexico’s oil and gas opening is highly anticipated, especially in neighboring Texas, a global energy hub. Initial opportunities for private investors may appear as early as the end of this year, after Round Zero is completed in September. We recently organized a fact-finding trip to Mexico for a member of the Texas Railroad Commission, which regulates that state’s oil and gas industry. We talked extensively with key players in the legislative, policy and regulatory arenas about the process and the accelerated timeline under which it is unfolding. Based on the information we gathered and our insights into the country, we see four initial areas of opportunity:
1. Shale oil and gas. Mexico possesses substantial shale gas resources that Pemex has effectively left untouched. There are five promising, geographically disbursed basins in the country, as identified by Pemex. The two largest of these are in eastern Mexico on or near the border with Texas, as shown in the accompanying map. Shale deposits in Mexico’s northeastern region are an extension of the Eagle Ford Shale, which has been intensively developed in South Texas over the past few years. The Cuenca de Burgos (as the Eagle Ford is known in Mexico) is estimated to hold two-thirds of Mexico’s technically recoverable shale gas resources and would have significant appeal for companies familiar with the geology of the formation and the infrastructure that exists in the region. Geographical proximity also offers advantages. The Burgos Basin is largely concentrated in the border state of Tamaulipas, which has Mexico’s largest petrochemical complexes and two major ports on the Gulf of Mexico. Several states in northern Mexico including Tamaulipas, Nuevo Leon and Coahuila are already studying ways in which their states can provide qualified human capital and physical infrastructure to make their regions more attractive to investors.
2. Pipelines. Mexico has a glaring need for additional pipeline infrastructure to move natural gas, oil, oil products and petrochemicals from the point of production to refineries, industry and other consumers. With the current lack of sufficient pipelines creating inefficiencies in the sector, we believe there are significant opportunities to invest in midstream infrastructure.
3. Partnering with Pemex. The earliest opportunities for entry into Mexico’s energy sector will be through partnership with Pemex. According to the timeline specified in transitory articles of the Constitutional Reform decree, ‘Round Zero’ should be resolved in September; 180 days after Pemex has submitted its bids. Following SENER’s approval of Pemex’s ‘Round Zero’ bids, the oil company will likely look for joint venture opportunities with private investors. Then, pending approvals from CNH (for the partnership) and SHCP (for the financial terms), Pemex will be able to enter into all three models of contracts with partner companies for its fields.
4. Electricity. The energy reform also includes the opening to private investment for electricity generation. The major areas of opportunity in this field will be in the addition of power generation capacity (nuclear energy will remain solely responsibility of the Mexican government) and in the upgrading and improvement of the electricity grid.
Mexico is poised to enter a new energy era. The newly reformed constitution specifies a distinctive and investor-friendly energy model for the country, one that incorporates lessons learned from other countries as well as from Mexico’s long history as a producer. This bold reshaping of its energy landscape will require tens of billions of dollars of annual investment and open the door to major commercial opportunities. Aware of Mexico’s promising energy resource potential, investors and firms in the US and beyond will need a clearer picture of how these transformation changes will be implemented. This clarity will unfold in the coming weeks and months, allowing better assessment of the opportunities for private participation.
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About the Authors
Dr. Shannon O’Neil is Senior Fellow for Latin American Studies at the Council on Foreign Relations and a leading Mexico expert. Shannon serves as a Senior Advisor to Vianovo, and a MESA practice member. She is based in New York City.
James S. Taylor is a partner in Vianovo’s Austin office and leads the firm’s Mexico Energy Strategic Advisory (MESA) practice. James, who grew up in Tamaulipas, Mexico, is a long-time advisor to companies and policymakers in Mexico and the US.