Energy Reform in Mexico

Mexico is involved in a very bold move of changes in its fundamental political and economic structures. The main historic problem that Mexico has had is to cope with its broad spectrum of cultural mixture and ideology that blocks an adequate understanding of the issues. This helped the development of a broad range of privileged sectors that flourished during the ruling of the Partido Revolucionario Institucional "PRI", as a single party system, that finally encountered defeat in 2000.

However, during the 2012 Presidential election, the PRI has come back, but in a different environment that includes: A highly sophisticated electoral control system, an open and free press, a three party system and with the eyes of the world set on Mexico.

However, the system, even after the year 2000 under the ruling of the Partido Accion Nacional "PAN", kept all these privileged groups intact, i.e. government unions (teachers, Petroleos Mexicanos "PEMEX", Comision Federal de Electricidad "CFE", bureaucrats), informal economy groups, special business interests and private monopolies (telecommunications, media, cement, transportation, agriculture, food specialties and others).

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). This political strategy is a unique and non-orthodox system in which a negotiating panel is established by the political parties and the government, not-necessarily with the participation of legislators, but by persons that have been deeply involved in the political issues for the last twelve years.

Once this panel comes to an agreement, then one or several parties or President Peña presents the legislative initiative to Congress. Then, these initiatives are subject to changes during the ordinary legislative processes.

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 procedures reform.

Notwithstanding all the important structural changes approved, now we will be entering changes that 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 interests.

The changes that will detonate this opposition are education evaluation and energy reform. The first change has already stirred radical groups from the teacher´s union of southern Mexico to block all accesses to Congress, forcing legislators out of their premises to session at the Banamex Conference Center.

Exceptionally, some of the energy reform proposals have been processed outside the Pacto por México. Why are these initiatives not handled by using the procedure that has been so highly successful? Because there are very different views on how to cope with the opposition that will be generated by the union groups and others that have been beneficiaries of the highly corrupt state monopolies that handle oil and gas (exploration, exploitation, transportation, distribution and refining activities) and electrical power (generation, transmission and distribution).

In this modified field, the first one that presented an energy reform initiative was the PAN. The main features of the initiative are the following:

• Constitutional changes will take place.
• 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 businesses. 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 have special preferences for concessions during a limited time period, provided that it meets the conditions specified by the National Hydrocarbons Commission.
• All petrochemical refining and downstream business will be open to the private sector, without excluding the public sector, through agile permitting processes, administered by the National Energy Commission.
• 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, and that will administer the oil 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 businesses that will be transferred to a state owned entity, with the mandate of selling these businesses to private investors, but in the meantime it 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 slimmer energy reform initiative. The main feature of the proposal is to open PEMEX to enter into contracts with "shared profits" with the private sector. This provision is embedded in the constitution, capturing the original wording of the constitutional changes made by President Lazaro Cardenas in 1940, upon the oil industry expropriation.

It seems that President Peña decided to go "soft" with his proposal, catering to the interest of the left-wingers, that prefer to have the PEMEX monopoly intact, but with private investment in its production chains, both upstream and downstream.

The administration´s initiative has not exited the prospective foreign investors, because it is not well defined; it contains a couple of short paragraphs from sections of the Mexican Constitution, but there is not 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.

Finally, the left wing announced that they will present an energy reform initiative that basically keeps 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.

In conclusion, we believe that the Peña administration will have to choose between keeping a closed energy sector system or open part of the same. Probably, after the congressional process, a mix system will come about, keeping PEMEX the monopoly on certain energy market portions, such as the traditional wells that PEMEX has been exploiting for decades. But in areas such as shale oil and gas, and deep water drilling, the Peña administration will have to go to a concession base system to be successful in attracting capital investments that would help detonate the Mexican economy.

Time will tell how effective the new energy reform will be.