The Energy Reform in Mexico is a real opportunity for economic growth

By Carlos Angulo, Congressman

Petroleum in Mexico has become the biggest National fetish that any country has ever seen. Every Mexican has in the back of his mind the figure of the serious iconoclastic face of former President Lazaro Cardenas with the background of an oil refinery and the Mexican flag with the slogan: “El Petroleo es Nuestro” (Petroleum is ours). The large oil transnational companies from England, the Netherlands and the United States were thus “defeated” by the Mexican people through “Tata Lazaro” (“Daddy Lazaro”) by nationalizing the oil industry in 1938.

In reality, the transnational oil companies defied the Mexican courts by not complying with a series of final labor judgments, and President Cardenas had to confiscate the oil company assets to pay the workers for their labor claims, then he expropriated the industry paying an indemnification to the companies. 

Some people speculate that a compromise was agreed upon, where the Mexican petroleum industry agreed to rely on the foreign companies services to move the energy industry ahead. But Petroleos Mexicanos (PEMEX), a decentralized entity of the Mexican government, would handled all matters pertaining to up stream and down stream of the hydrocarbon business chain, as a government legal monopoly.

PEMEX grew in size and importance to the Mexican economy, until it became like a drug that affected the government performance in collecting taxes and blocked the potential growth of the energy sector. With its large inefficiencies and corruption in its contracts and transactions, the Mexican government has for the past twenty years tried to defeat the taboo of the sacredness of petroleum, but only until now it was finally successful.

Since the Partido Revolucionario Institucional or “PRI” comeback, after twelve years of the Partido Acción Nacional or “PAN” federal government control, Mexico has become involved in a very bold move of changes in its fundamental political and economic structures. These changes have defied the normal political tendency of not “rocking the boat”. The principal historic problem that Mexico has had to cope with change is its broad spectrum of cultural mixture that has been fertile ground to develop ideological rhetoric that blocks an objective understanding of the issues. This helped in the development of a wide range of privileged sectors. 

However, the system, even after the year 2000 with the PAN in power, has kept many privileged groups intact, i.e. Government unions (Teachers, PEMEX, Comisión Federal de Electricidad (CFE), bureaucrats), informal economy groups, special business interests and private monopolies (Telecommunications, media, cement, transportation, agriculture, food specialties and others).

When the PAN was in power, there were a number of intents to make the required structural changes that Mexico required, but the PRI, together with the left wing parties constantly denied their votes required to make the legal and constitutional changes.

Now that the PRI has come back, a different political environment exists as a result of the profound political changes that took place after the democratic opening of Mexico in the past decade or so. Now we have a highly sophisticated electoral control system, with an open press, a three party system and with the eyes of the world set on Mexico.

In this comeback of the PRI, President Enrique Peña Nieto, developed, together with the three main political forces of Mexico, the Pacto por México (Agreement for Mexico) by which, using a unique and non-orthodox system in which a negotiating panel is established by the political parties and the government. After this panel comes to an agreement, then one or several parties or President Peña present the legislative changes as initiatives before Congress.

With the above described process, Mexico has achieved in a very short time, important structural changes, like labor law reform, antitrust and telecommunications reforms, education reform, transparency, constitutional relief reform (amparo), and criminal procedure reform, and is in the process of making a full refurbishment of the electoral system with the introduction of re-elections for legislators and municipal government members.

Notwithstanding all the important structural changes approved, the most important change that will help spark rapid economic growth on the one hand, but will affect the union groups that have been nurtured by the old PRI and new PAN systems alike, and that the left wing politicians have been after to protect their interest, is the energy sector reform.

However, this reform is so controversial, that it was processed outside the Pacto por México, because there are very different views on how to cope with the opposition generated by the left wing parties, mainly the “Partido de la Revolución Democrática”, (PRD), union groups and others that have been beneficiaries either of a socialistic view of the economy or the highly corrupt state monopolies.

At stake is the handling of oil and gas exploration, exploitation, transportation, distribution and refining activities, on the one hand, and generation, transmission, distribution of electrical power, on the other.

The first one that presented its energy reform initiative was the PAN. The main features of the initiative were the following:

•Constitutional changes where required.

•PEMEX and CFE will maintain their status of state owned enterprises, but they will lose their state monopoly status.

•A full fledge government concession system will be applied to all upstream oil and gas business. The concessions will be regulated by the National .Hydrocarbon Commission. The income derived from these activities will be deemed state owned, and after a consideration for investment, costs and a fair profit, the state will keep the remaining proceeds, by applying concession rights and taxes. PEMEX will be subject to the same treatment.

•PEMEX will have special preferences for concessions, provided that it meets the conditions specified by the National Hydrocarbon Commission.

•All petrochemical refining and downstream business will be open to the private sector, without excluding the public sector, through agile permitting process, administered by the National Energy Commission.

•The state owned property of all hydrocarbon resources will continue to be state owned. However, with the concession system, the beneficiaries thereof will have to pay concession rights to a special Petroleum Fund that will be formed, that will administer the petroleum income of Mexico (similar to the Norwegian system).

•PEMEX will be restructured in its corporate governance to make it a world class player, and will be liberated from its special tax treatment that has been chocking its growth and performance.

•In the electrical energy sector, this will be open to all private and public investments, this includes, generation, transmission and sales of electrical power. The only part that will remain under state control is the administration of the main power grid.

•Because CFE is predominant in the power transmission and distribution markets, it will have to break out such business that will be transferred to a state owned entity, with the mandate of selling these businesses to private investors, but in the meantime will be bound to provide access to generators for transmission and delivery of power to the final consumers.

•There are no restrictions for foreign investors to participate in the energy sector, outside of the electrical grid, provided that they form Mexican entities for their investments.

A few weeks after the PAN’s initiative, President Peña presented a very slim energy reform initiative. The main feature of the proposal was to open PEMEX to enter into contracts with “shared profits” with the private sector. This provision was embedded in the constitution, capturing the original wording of the constitutional changes promoted by President Lazaro Cardenas in 1940.

It seems that President Peña originally decided to go soft with its proposal, catering to the conservative interest of the left-wingers. However, the administration’s initiative did not excite the prospective foreign investors, because is was not well defined; it did not provide a clear definition to the energy law changes that would grant certainty to private foreign and Mexican investors to risk their capital in a monopolistic controlled environment.

On its side, the PRD presented an “energy reform” initiative that basically kept PEMEX and CFE as state owned monopolies, liberating PEMEX from its tax burdens and the Mexican Finance Department intervention, granting PEMEX full corporate autonomy, including an exclusion of its union from the board of directors (just as the PAN’s initiative).

After a severe clash that the Peña administration had with the PAN over a very left wing anti-business approach in its tax reform initiative presented by the President with the backing of almost all the left, the government came back to the PAN to heal the wounds accepting many of PAN’s proposal on political/electoral reform, and move its energy initiative towards the PAN’s view established in its proposal.

In summary, the PRI changed President Peña energy initiative, opening up all options for the government to offer to private investors (including foreign investors) that desire to exploit the oil and gas Mexican resources, to services, profit sharing and production sharing contracts, and establishing a licensing system that in reality is a system of concessions, but with a different name, to avoid the negative psychological impact that the word “concessions” generates in many Mexicans.

Also, all the down-stream system is opened for private investors, without limiting to foreign investors, in oil refining, including the total spectrum of petrochemicals, oil and gas ducts, storage and distribution of hydrocarbons and their derivatives.

There will be independent regulators appointed by the Senate with qualified majority, to dictate which areas will be open to private investment exploration and exploitation, and the applicable mode (either contract or license).

A Banco de Mexico (Mexico’s central bank) special Petroleum Fund, was established as a special trust, to capture the proceeds generated by contracts and licenses, that will be collected directly from the special duties or fees deriving from the contracts and licenses, with a pre-established allocation of such funds directed to the country’s growth and welfare, separated from the proceeds derived from taxes. This will secure that the opening of the energy sector will be properly managed.

The electrical sector fell short on what is required, that was proposed by PAN. The basic change was to recognize at the constitutional level the right of private investors to sell electrical power directly to consumers, thus, eliminating the monopoly of power generation of the Comisión Federal de Electricidad or “CFE”. However, CFE keeps its monopoly in all transmission and distribution of electricity, without any mandate to breakdown the monopoly.

However, an important change in this field is to liberate CFE from the burden of having the Mexican Treasury Department fix its rates and acquisition policies. Both PEMEX and CFE will be transformed form Federal Government decentralized agencies to “Productive State Owned Enterprises”, having a private business like structure that will help them free themselves from the burden of government agencies, granting the entities with the necessary change to make them survive in the new open environment of the energy sector.

With this opening of the energy sector, private investors and CFE will not have to buy petroleum and gas from PEMEX, thus, it is expected that energy costs will come down quickly, benefiting both the industrial consumers and the common people, by the new production of oil and gas by private companies, and the importation of them outside the PEMEX monopoly.

Mexico hopes to gain with this reform an economical growth opportunity that has been denied because of ideological taboos and political bigotry. There have been calculations that new private investment, domestic and foreign may be of fifty billion dollars a year in this new field that was closed to private investors.

But still the left wingers plan to promote a negative referendum to cancel the reform. We believe that the requirements will not be met, and there is no legal way to defeat a constitutional amendment via a referendum under Mexican law.