What Mexico’s “Pemex Reform” Really Means

Bottom Line: Mexico’s Senate on 11 December—after a 19-hour session—approved legislation to modernize the energy sector and open it up to private investment, though some of the bill’s points are still being debated due to ongoing opposition by leftist politicians.

Analysis: The Senate approved the legislation with 95 votes in favor (PRI, PAN, Partido Verde) and 28 against (PRD, PT, Movimiento Ciudadan).

The legislation will amend the Mexican Constitution and change the status of Pemex and CFE (Federal Electric Commission) from public utilities to state-owned businesses. As companies, these enterprises would have autonomy to issue contracts to meet their principal goal of providing Mexico with its long-term energy needs and turning a profit.

Under current law, Pemex is permitted to issue particular service contracts for a set payment with outside providers, an unappealing arrangement for service providers. Oil production today is 25% lower than at its peak a decade ago, and in order to prevent Mexico’s becoming a net energy importer Pemex officials estimate they need to more than double annual capital investment of $25 billion. The only way to draw billions in capital is to permit private investment in the sector.

President Enrique Peña Nieto’s PRI party set out a much more moderate plan on 12 August 2013, which limited contracts to profit-sharing without any share in oil. That proposal was ill-received by potential investors, who insist that if Mexico is to pass reforms, it should make more drastic changes. (On the other hand, the conservative PAN party floated their ideal outcome, including outright concession issuance and permission to book oil reserves, in July 2013 to the outrage of Mexican centrists.)

Among the companies that have expressed interest in partnering with Pemex to explore untapped deep-water reserves in the Gulf of Mexico are Shell, Exxon, Repsol and Petrobras. The language of the bill they are considering now allows for “risk contracts” in which the “owner of the resources [Mexico] transfers the economic risk of exploiting those resources to a third party without lessening its ownership.” The third party, called a “contractor” or “operator” receives compensation tied to their success in exploiting said resource, though the state would retain the majority. Companies will not be permitted to count unproduced reserves on their ledgers, although they can list final contracts and projected profits.

In addition, the proposed reform would establish a sovereign wealth fund to manage and invest Pemex’s profits. As far as the impact on electrical distribution and transmission, the reforms leave CFE as a monopoly, though it opens the door to contracts for electric generation by outside parties, though “concessions” are explicitly prohibited.

The current text, worked out in closed-door sessions this week by the PRI and PAN parties, contemplates both profit-sharing and production-sharing agreements. Although there is no question that the PRD will voice loud dissent (and try to mobilize popular protests), the bill appears likely to pass this month, with the support of the PAN, PRI and Green Party legislators.

The over-arching Pacto por Mexico, a pledge by the three main parties (PAN, PRI and PRD) to cooperate for the good of the nation to enact 95 initiatives, large and small, fell apart on 28 November 2013 when the PRD exited over the issue of energy reform. Ironically, their withdrawal paved the way for the current PAN/PRI compromise since there was no longer any incentive to moderate the bill in the hope of appeasing the PRD. The PRD’s opposition is in synch with popular opposition to opening up Pemex; many Mexicans believe current reforms are just the beginning of a process that will end up stripping them of oil and gas resources. Though rhetoric by leftist leaders such as Andrés Manuel López Obrador contributes to popular skepticism of liberal reforms, the current generation of Mexicans also witnessed the telecom privatization of 1990 legislation that lead to comparatively poor and expensive phone service for the masses while enriching a few, such as billionaire Carlos Slim.

Yet under the status quo, Pemex affords thousands of unproductive, but unionized, workers paychecks and pensions at a cost that has become unsustainable. Proponents of the current plan to open the sector must focus on the potential for GDP growth and broad prosperity that should accompany a successful energy sector.

Recommendation: Prepare for this bill to go all the way through to the end. The energy reform bill is now under consideration by the House of Representatives, where it is also likely to pass. Once final, state oil company Pemex is expected to submit to the Secretary of Energy (SENER) the blocks where it would like to issue contracts within 60 days. Then SENER has 180 days to approve or reject those requests, resulting in "Round Zero" of gas and oil contracts in Mexico. Significantly for foreign investors, the STPRM - Sindicato de Trabajadores Petroleros de la República Mexicana or Mexican Oil Workers' Union - will be dislodged from the Pemex board. Previously they held 5 of 15 seats -- now there will be ten seats, evenly divided between government officials and independent counsel.