Enrique Peña Nieto announced his energy reform proposal on August 12th (Image courtesy of trbimg.com)

Enrique Peña Nieto announced his energy reform proposal on August 12th (Image courtesy of trbimg.com)

Many actors in the energy industry have aired their views about the reform since President Enrique Peña Nieto announced his proposal on it last Monday. While many explanations are still pending on the specifics for the reform to succeed, the main outline already looks promising as a step in the right direction. One of the factors on which the energy reform’s success depends is how Pemex will be affected by the fiscal reform.

The current energy reform proposal already includes a review of Pemex’s current tax regime, suggesting a new model based on international best practices and closer in line with corporate tax structures. The aim of this model is to alleviate some budgetary concerns from Pemex, giving the company enough freedom to re-invest that money in research and development programs – which could target current execution, technological and human capital issues. But in order to achieve progress in all of these areas, the government will need to obtain the amount of tax that Pemex was paying from somewhere else – let’s not forget that Pemex provides one third of the revenue that fills the government’s coffers, and acts as the federal budget used to benefit the country.

Image courtesy of hilodirecto.com.mx

Image courtesy of hilodirecto.com.mx

Currently, Pemex’s tax regime consists of 15 different types of taxes, with additional contributions hampering the NOC’s growth. With that in mind, it is clear that Mexico’s oil dependent economy has long relied on the outcome of one single company: Pemex. As any financial consultant will argue, putting all your eggs in one basket is not the savvy way to spread out risks. Portfolio diversification has been the traditional way to ensure that risks are distributed among different sources, enabling a company’s investments to yield profit even when one of the elements in it is experiencing a downturn. Mexico’s government is looking at ways to diminish volatility within each of the elements of its investment portfolio: by transferring some of the responsibilities to other sectors of the economy – or even other players within the same sectors – Mexico’s economic health can be better preserved for years to come.

One of the possible sources for the government to fill the gap in tax revenues is to transfer the burden to other players: this is where the amendments to the Constitution proposed in President Peña Nieto’s reform play their part. By allowing Pemex the freedom to partner with private companies in exploration, production, midstream and downstream projects through profit sharing contracts, the government might be planning to shift the tax burden from Pemex to private investments. Horacio M. de Uriarte Flores, Partner in charge of the Energy Division in Mijares, Angoitia, Cortés y Fuentes, anticipated this possibility in his interview for Mexico Oil & Gas Review 2014: “The government has to replace Pemex’s contributions by charging income tax to new players in the industry. With a new structure that transfers the contributions that Pemex was paying to possible private companies partnering with the NOC, the government would stop taxing itself, which is the current situation. This means that, instead of taking money from one pocket and putting it into the other, the government would allow that money to promote development in Pemex and get its fair share from private companies trying to make a profit in the oil industry.”

Complementing this idea, Manuel Tamez Zendejas, Tax Partner for the same law firm, commented on the possibility of shifting the fiscal balance to other sources of revenue. “Today, two thirds of government revenue comes from income tax and Pemex,” he said. “Any tax reform should then focus on indirect taxes, so IVA (Mexican value-added tax) has to help to release the burden on Pemex while keeping the federal revenue constant. Therefore, ideas such as charging IVA on the sale of hydrocarbons should be considered.” Luis Videgaray, Treasurer for the government, was also quoted in the media this week saying that hydrocarbon exploration and extraction activities will now be subject to income tax, confirming what tax experts were already expecting. All these changes are expected to bring Pemex closer to the way other NOCs in Latin America are governed, with Colombia’s Ecopetrol and Brazil’s Petrobrás being the clear examples.

Luis Videgaray (Image courtesy of latercera.mx)

Luis Videgaray (Image courtesy of latercera.mx)

However, news of Constitutional amendments and possible changes in the industry have created a negative buzz within Mexican socialist parties and their followers in the country. As was foreseen since the leftist energy manifesto was published last year, people are taking this proposal as the government’s effort to privatize the company and sell the country’s hydrocarbon reserves to international stakeholders. While allowing international companies to partner with Pemex might seem like a step into that direction, the reality is that Mexico is just looking at the way to gain the capabilities it is lacking in order to modernize its technological and human resources’ portfolio and better face upcoming challenges. During his interview for Mexico Oil & Gas Review 2013, Iván Alemán Aleksei, former Chief of Legal Affairs in the Mexican Energy Ministry, reassured his audience that this will not affect, in any way, the federal income: “The federal budget consists mainly of contributions made by Pemex during the extraction process and hydrocarbon export operations… Any company in the world pays some sort of contribution to its government on oil extraction operations. The money collected from those operations is what ends up in the federal budget.”

Left movements against privatization (Image courtesy of washingtonpost.com)

Left movements against privatization (Image courtesy of washingtonpost.com)

With a similar argument in favor of indirect taxes, a new social movement was formed in the past week under the name of Movimiento Nacional en Defensa del Petróleo (National Movement for Oil Protection). This movement disputes that, no matter how much Pemex contributes to the federal budget – a figure that rises up to MX$ 1.269 billion – the NOC does not need help from foreign companies. The group claims that the gap in the tax revenue can be transferred to other companies in different sectors of the economy, by contending that the largest companies in Mexico are evading some of their fiscal responsibilities due to loopholes in the ISR Law (income tax). They also defend the fact that Pemex is not in such a bad position as to say that the country has only nine years of oil reserves left and, therefore, to create a sense of urgency to bring newer technologies through foreign participation in the national industry. While their set of arguments makes sense, this could just be a complementary piece in the complexity of the fiscal puzzle that the Treasury will soon have to address.

In the end, every proposal from the three main parties in Mexico is trying to address the Pemex fiscal situation in different ways. With PRD suggesting to reduce Pemex’s hydrocarbon tax rate from 71.5% to 62.5% (nine full percentage points) and PAN approaching the issue with a transition plan in which foreign companies pay an extraction tax, the attention will now shift to the fiscal reform to address these issues.

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