After delaying the announcement for a week, President Peña Nieto finally unveiled his energy reform proposal at 11:00am on August 12th, 2013. In a ceremonial act that took place at Los Pinos, the current administration gave a general outline on what the energy reform document submitted to Congress contains. And while its content might not be what the international players were expecting, it is a step in the direction towards progress and efficiency, something which the energy industry has long lacked.
The act started with Energy Minister, Pedro Joaquín Coldwell, giving a summary on the diagnosis of the issues that the industry is facing. Inefficiencies have transformed Mexico from an energy giant to the figure of an old monarch resting on its laurels. Joaquín Coldwell pointed out that current imports for the country’s energy market include 2,130mcf/d in natural gas, US$21 billion in petrochemicals and 49% of gasoline’s domestic consumption. After detailing the import situation in the country, the Energy Minister described how those inefficiencies have also translated into losses for the industry. Overall, the country’s oil production has decreased from a peak 3.4 million b/d in 2004 to a current level of 2.55 million b/d. To put it into context, the amount of barrels of oil a day that Mexico has stopped producing in the past nine years exceeds Argentina’s total estimated production in 2013. Apart from this, the inability of the country to produce enough natural gas to fulfill its demand has culminated in several shortages and critical alerts, which have undermined industrial activity in the country and made a rather large dent in companies’ bottom line. Energy costs for the private sector have increased, by having to substitute natural gas for fuel oil while shortage issues got temporarily solved through import agreements.
All of these factors combined with the shift that Mexico has experienced as an oil and gas producer, and the change in the nature of the challenges for extraction has led to the necessity of a strong energy reform. Without slighting Pemex’s skillfulness to be efficient enough in keeping the industry afloat, the Energy Minister brought up the topic of lack of execution capabilities in the country, mainly blaming it on the shortage of joint experiences with technological leaders in the global market. He mentioned Pemex’s requirement for investment, technology and knowledge in order to steer the ship on course to progress, alluding to the urgency of joining forces with those who already own those attributes.
“Pemex deserves the chance to form alliances with other companies to increase its execution capacity.” – Pedro Joaquín Coldwell.
After the heavily celebrated introduction, President Enrique Peña Nieto took the stand to explain in which ways this energy reform proposal would be “able to transform and improve Mexicans’ quality of life… by recovering the best from our past to conquer the future.” In what looked like a clarification on the possible misinterpretations and distortions that his words could lead to, Peña Nieto asserted that Mexico would keep ownership of the hydrocarbons found within its geographical boundaries, trying to hush the rumors of a possible privatization of an asset that Mexicans view as “part of their inheritance.” He then proceeded to detail the five elements included in his proposal for oil production:
1. Risk/Profit Sharing Contracts
The proposal includes an amendment on the 27th Article of the Constitution, returning to the original wording by Lázaro Cárdenas. Within this plan, the country is reaffirmed as the unquestionable owner of its hydrocarbon resources and restates the impossibility of paying through hydrocarbon reserves – therefore blocking the possibility of having PSAs (production-sharing agreements) or concession type contracts.
However, the new/old drafting of the article allows Pemex to establish risk sharing agreements (or profit sharing agreements) with other companies. This means that the Mexican NOC will be finally allowed to establish partnerships in order to develop specific projects, alleviating Pemex from carrying out the mandate of doing everything by itself.
While the difference between risk-sharing agreements and production-sharing agreements might be just in the payment procedure, it could scare off IOCs anyway from bringing their operations to Mexico, since it does not allow them to book reserves. Nevertheless, as Iván Alemán Aleksei (former Chief of the Legal Unit at the Energy Ministry) addressed in his Mexico Oil & Gas Review 2013 interview, this could just be looked at as an intermediate step – with IOCs receiving payment in cash and using that money to buy hydrocarbons from Pemex. This transaction could simply be another way for Pemex to export hydrocarbons, which is currently the way the NOC has to deal with the excess oil production it has compared to its refining capacities.
2. Fiscal Reform
The proposal also includes a review on Pemex’s current tax regime, suggesting a new model based on international best practices and closer in line with corporate tax structure. This international model will help alleviate some of the budgetary concerns that the company has, allowing more freedom to invest in research and, therefore, enabling to delineate long-term plans for comprehensive progress, instead of short-term plans to fill the gaps.
By having a better structured tax regime, Pemex would be allowed more flexibility in terms of spending and more management autonomy, which is what the executives of the Mexican oil company have been claiming for in the past few years. However, as the fiscal reform proposal will only come later, the details of how the regime would change have not been specified.
3. Restructure for Pemex
As a logical next step, an internal restructure for Pemex is outlined in the document. As Fluvio Ruiz Alarcón, Professional Board Member of the NOC stated in last year’s interview for Mexico Oil & Gas Review 2013, the strategic decision to divide Pemex into divisions has lost its validity since it no longer offers an optimal platform to streamline execution across the value chain. To quote him, “the system is inefficient because it generates division in the decision-making process and creates power structures that cause conflicts of interest. It has also reduced the possibility of improving the information sharing process and the transfer of human, technological and material resources between the company’s different areas.”
The subsidiary model would then be superseded by two different branches: Pemex Exploration & Production (which would be in charge of the upstream sector – the same as today’s Pemex E&P) and Pemex Industrial Transformation (which would be in charge of the downstream sector, merging Pemex Refining, Pemex Gas and Basic Petrochemicals and Pemex Petrochemicals subsidiaries). This would eliminate some of the duplicities and internal inefficiencies that the company currently has, further enhancing an effective corporate government and opening the downstream and midstream segments.
4. Additional Transparency and Accountability
An additional chapter on the energy reform proposal talks about the need to increase auditing practices and transparency in works, acquisitions and procurement. This way, people in charge of contracting would be submitted to closer control systems to allow the public eye to be aware of the company’s transactions.
While the 2008 Energy Reform made the contracting process more transparent by requiring authorization at four to five different instances, it made it longer and threw in additional bureaucracy, dragging the time between the requirement and the delivery. This specific objective could address the inefficiency that the current contracting process holds. One solution could be the centralization of all procurement activities in Mexico, discussed by Arturo Henríquez Autrey, President and CEO of Integrated Trade Systems (Pemex’s procurement arm) in Mexico Oil & Gas Review 2013 (pg.18): “The procurement process is currently fragmented, since each division has its own procurement activities. This creates several inefficiencies… The solution to further streamline the process is to centralize procurement activities and standardize the procedure. Once centralized, we will better understand the bigger picture and negotiate more intelligently under the Pemex umbrella… Most of the large oil and gas companies have a variation on this type of model.” Addressing the procurement issues would give the public an easier access to information on the companies’ responsibilities and the hydrocarbon reserves and production.
5. Local Content Requirements
The final element addressed in the reform proposal is the inclusion of local content rules in procurement and infrastructure projects, with the understanding that Pemex will finally be compelled to enforce it. While there are requirements by law to include a certain percentage of Mexican content in Mexican operations, companies have traditionally been exempt from complying with it when the position requires specific qualifications – under the pretext of not finding the Mexican profile or technology to fulfill it.
This time around, the proposal focuses on the necessity to develop talent, technologies, engineering skills and innovation within the country, in order to fulfill the industry demands with local resources. Under this section, President Peña Nieto mentioned the responsibility of UNAM, IPN, Conacyt, the IMP, and other associations and institutions in charge of research and education, as well as public and private businessmen in rejuvenating of the national oil industry.
President Peña Nieto concluded his speech on this part of the proposal by enumerating the targets that these five elements would help to achieve. The targets include the maintenance of a 100% reserve replacement rate and the increase of oil production from 2.5 million b/d to 3 million b/d by 2018, and a further increase to 3.5 million b/d by 2025, which would represent an historic record. He also mentioned that, in order to achieve gas production targets of 8 bcf/d by 2018 and 10.4 bcf/d by 2025, the reform includes five changes on the power generation sector:
- Additional amendments to Article 27th of the Constitution to allow private participation in power generation and a fairer distribution over the country at lower costs.
- Guaranteed access to transmission and distribution networks to all suppliers.
- Strengthening of the CFE through bigger operational and structural flexibility.
- Larger planning and rectory faculties for CRE and the Energy Ministry (Sener).
- A green reform, with higher investment in the technological development of solar power, wind power and gas.
President Enrique Peña Nieto expects this to be the first step to modernize the sector and he called for an open, democratic and exhaustive debate on how to transform and modernize the country. However, international reactions have not been as favorable as he would have expected. The economic market has not reacted well to the news, dropping petrochemical companies’ stock and further pushing the Mexican peso slide against the US dollar. This might be due to the fact that the global audience expected Mexico to open up to contracts that would allow booking of reserves, which would drive the interest of the companies that own the technological prowess in the market – companies such as Shell, BP, Chevron, ExxonMobil, Petrobrás, Statoil, Total, etc.
The political stability that the country has, as well as its high production potential has long made Mexico an interesting market for companies from abroad. However, they have all been waiting for Pemex to open up its strict, outdated contracting schemes. Within this partial reform – from an international perspective – the eradication of current inefficiencies might not be enough to attract IOCs into the market. As Energy Minister Pedro Joaquín Coldwell put it, the Mexican oil and gas industry lacks the investment, technology and knowledge to continue progressing. If Mexico is not able to attract the companies that own these attributes, the reform could be considered a failure, bigger than the one in 2008 due to the current timing and context.
On the other hand, the energy reform proposed by the government should be seen as a first step towards progress – a first step that could be coming five years too late. The expectation of having a full-blown energy reform was unrealistic, at best, since there are several obstacles in the way that had not been addressed until this point. The perceived importance of oil resources for Mexican people and the myths that circulate around it could be the first one, leaving this energy reform to fight a war on two fronts: the first one to align all different opinions within the decision-makers on how to modernize the Mexican energy industry towards progress, and the second one being a marketing and educational battle to appease the Mexican audience’s perceptions about privatization and national inheritance and explain to them how the current proposals will lead to economic development in the country.
While the strategy to obtain consensus on the first front has been through the political clout that President Peña Nieto has won and its reflection on the Pact for Mexico, a more rigorous approach will be needed to finally achieve unanimity on the other front. A full-blown reform and, thus, additional progress will not be achieved until myths and biases are cleared in favor of the country’s economic benefit.
 To read the original draft of Article 27th in Lázaro Cárdenas time, go to: http://presidencia.gob.mx/reformaenergetica/assets/descargas/reforma-cardenas/dof_1940_constitucion.pdf  To know more about the financial market reaction, don’t miss out on Forbes’ “Investors Unimpressed With Mexican President Peña Nieto’s Energy Reform” and Reuters’ “Mexican stocks fall on cautious energy reform proposal”  To know more about the peso reaction, don’t miss out on MenaFN’s “Mexican peso slides more as energy reform underwhelms”  To better understand the cultural importance of oil resources and its perception as a Mexican inheritance, you just need to take a look at the festivities that take place all across the country to remember the day Lázaro Cárdenas embarked on the expropriation of all oil resources and facilities by the state.  If you want to know more about the educational efforts that the government is undergoing to teach about the reform, go to: http://presidencia.gob.mx/reformaenergetica/#!los-mitos