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Talk of changes to Mexico's oil monopoly stirs cautious enthusiasm in US

5 July 2013
E&E EnergyWire

HOUSTON -- Is an energy revolution about to be unleashed south of the border?

With a handful of other major reforms successfully pushed through, President Enrique Peña Nieto is next moving his nation toward serious consideration of energy sector reforms, as he looks to change the way the state oil monopoly Petróleos Mexicanos (PEMEX) does business.

Many Mexico observers are skeptical, because such change has been proposed before without results. But experts believe things might be drastically different this time around, and the energy industry in this city is paying very close attention as it stands to earn billions of dollars in new contracts to help Mexico increase its oil and gas output, should the laws change.

Last month in London, Peña Nieto said he was looking to make huge changes to Mexican energy law. He and his political party, the Institutional Revolutionary Party, have been hinting at possible changes to the nation's constitution, which currently makes it impossible for outside firms to develop oil and gas reserves. Though most doubt the rules can be changed to allow private companies to own mineral resources directly, many speculate that certain profit-sharing arrangements could be introduced that would allow companies to book Mexican oil and gas assets as partly their own, as long as they are being produced.

Professor Stephen Zamora, head of the Center for U.S. and Mexican Law at the University of Houston, confirmed that change is indeed in the air. But specific policy changes have yet to be proposed, he said.

"They're still very tight-lipped about what the reforms are actually going to consist of," Zamora said. "They want to do something in order to attract foreign technology and foreign investment, and Mexico has a lot of resources."

Gabriel Salinas, a native of Mexico and associate at the international law firm Mayer Brown, laid out four possible scenarios that could play out as Peña Nieto prepares the Mexican Congress and public to seriously address the question, something expected over the latter half of this year.

One possibility is that nothing happens, Salinas said. Oil is a very touchy subject in the country, and the day the government expropriated all oil companies and reserves in 1938 is celebrated as a national holiday. The idea of greater foreign participation could prove too unpopular.

But Salinas believes it's possible that some skeptical voters and lawmakers could change their minds as they become more educated on possible reforms and what could be at stake if nothing happens. Mexico's largest oil field is in perpetual decline, and decades of underinvestment by a politically hamstrung PEMEX is leading to a steady drop in crude oil production. If the trend isn't halted or reversed, Mexico may one day find itself having to
import oil to feed its growing economy.

Another possible scenario could see the government making minimal administrative reforms to PEMEX that would free it up to act more like a private oil company. Rules could also be adjusted to permit more private companies to participate in the downstream side of the business, improving the nation's hydrocarbon transportation infrastructure, something that could make shale gas development in Mexico's portion of the Eagle Ford Shale more tenable.

However, as Salinas pointed out, Peña Nieto has promised a "transformational" change, which suggests he wants to see changes to the constitution. As a member of the political party that expropriated the industry in the first place, Peña Nieto may have the political capital to pull it off, he argued.

"The next months are really key," Salinas said. "Basically, the Mexican Congress is ready to start discussing this. They agreed to have two sessions during the summer, which is out of the regular schedule, to kind of iron out all the pending issues they need to so they can focus on the energy reform during the fall. So there seems to be a better chance than any time for constitutional reforms to be discussed."

Getting creative with profit sharing

Though no specific proposals have been made public yet, speculation in academic circles is focused on Mexico developing a type of creative profit-sharing system, as well as devising ways to let companies claim Mexican energy resources as their own, even though they wouldn't technically be so.

Current law does not allow oil and gas companies to have private ownership or claim to hydrocarbon reserves in Mexico. Both Zamora and Salinas don't think this will change anytime soon. It's a key problem, because private oil and gas companies need to be able to book certain recoverable reserve volumes as collateral to obtain financing from large banks. This is why publicly traded companies are eager to annually tout reserve replacement ratios of 100 percent or greater.

A third way needs to be devised. Salinas thinks the government could get around this problem by introducing joint ventures between PEMEX and private companies, deals that could be contracted in a way that keeps the oil as the property of the Mexican people but awards the companies a sufficient profit for helping to produce it.

"This has been heating up in the last few weeks, particularly based on President Nieto's statements and some of the top officials," Salinas noted. "They said the reforms might involve constitutional reforms and they've talked about private participation in profit-sharing agreements, joint ventures with PEMEX."

Zamora at the University of Houston predicts that Mexico could also introduce more multiservice contracts into the industry. Small changes to PEMEX contracting rules have already helped Houston-based oil field service companies win contracts for work on deepwater offshore exploration in Mexican waters.

"When the government first expropriated oil companies and created PEMEX early on, they still allowed concession contracts ... even under the same constitutional provisions as exist today," Zamora said. "Then they changed the law to make it absolutely not a question that a foreign investor would be able to have anything approaching a concession."

He also believes the government could find success winning over support for oil and gas reform by invoking the North American Free Trade Agreement. Though that treaty leaves out oil and gas, the precedent it set for the integration of several industries in Canada, the United States and Mexico may make it seem more natural to the public at large that energy production could follow.

"Integration is really good -- maybe we should think about integration in energy as well?" Zamora said.

'Like reading tea leaves'

Not all Mexico experts agree, however.

Dagobert Brito, a political economy professor at Rice University, advised the Mexican government in the late 1990s on models for pricing natural gas in its economy. He argued that constitutional change is "absolutely necessary" if Mexico hopes to increase oil and gas production, but he's very skeptical of Peña Nieto's chances of succeeding this time around.

"Reading Mexico's congressional politics is like reading tea leaves," Brito said. "I started working for the Mexican government as adviser back in '96, and back then they tried to figure out a way to cut a deal."

He also pointed out that Mexico's democracy is relatively young, and lawmakers may be too inexperienced to pull off serious constitutional amendments. Plus, Peña Nieto's party, the PRI, will have to strike a deal with the opposition National Action Party, which it just ousted from power in the most recent election. The transformation from dictatorship to democracy could make oil reform more difficult, Brito said.

"This is my opinion, but they've been talking about tricks for at least 20 years, you know, can we come up with some technicality so that [private companies] can book the reserves," he said. "I think if that were possible, it would have been done. But you never know."

But Salinas still sees some promising signs that U.S. oil and gas companies may soon be returning to Mexico to expand the current energy production renaissance to all of North America.

If so, it would be another sign of Mexico's emergence as a more advanced economic powerhouse, a development that's been overshadowed by media coverage of drug trade violence. One of Latin America's fastest-growing economies is experiencing surging manufacturing industries and a rapidly expanding middle class. Opening up the oil and gas sector would generate jobs and energy that could further fuel this transformation. The rapid pace of reforms rolled out by the new administration hints at what's possible.

"It's been pretty significant actually," Salinas said. "It's been a little more than six months of his administration, and President Nieto has already managed to push through two major constitutional reforms, one in telecommunications and the other in the education sector, and he has already proposed a comprehensive financial reform."

"He's expected to soon propose the energy reform and fiscal reform this fall," he added. "The political momentum and the timing is as best as it's ever been before."

Republished with permission. Copyright 2013 Environment & Energy Publishing, LLC

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