When, where and who will benefit from Mexico’s Energy Reform?

By Carlos Angulo Parra

Mexico’s energy reforms enacted this year have been lauded as extraordinary by its promoters (PAN, PRI and the Executive), and depicted as catastrophic by its detractors, mainly left-wingers. In this article, I intend to put the reform in perspective.

First, when will we start seeing results? Well, I believe we already are. For instance, under the reforms, the price of gasoline in Mexico’s border areas is pegged to U.S. prices, to allow Mexican gas stations to compete with those on the U.S. side. As we all know, competition results in better prices for consumers. PEMEX continues to control downstream and retail under the new regime until 2017 but the border areas benefit immediately from competition and the rest of the country will begin seeing the benefits starting next year as gas prices will be increased according to inflation until a complete free market system is put in place a few years later.

Like in gas prices, Mexico’s border area will likely soon benefit from lower electricity and natural gas costs. The new regime allows Comisión Federal de Electricidad (CFE) to acquire natural gas from Texas directly and without PEMEX intervention, enabling CFE to use natural gas instead of fuel oil and reducing the cost of generation by as much as two-thirds.

Unlike the rest of Mexico, which is in significant need of infrastructure, border regions have good pipeline networks that make the flow of natural gas to the border areas more efficient. Obviously, much work is needed here but the CFE has announced the bid for various pipelines on bot the U.S. and Mexican sides to meet its future natural gas needs. Also, as Los Ramones pipeline is finished, CFE will have lower costs in generating electricity for all Northern Mexico.

Ok, so who benefits? Oddly enough, the first beneficiary of the reforms is PEMEX because it will be liberated from the government burden it historically has had in its decision making process. PEMEX will no longer be regulated as a government agency, freeing it from complicated bureaucratic authorization procedures from several government agencies.

From now on, PEMEX is a State Productive Enterprise, which will have a businesslike structure, with an independent board of directors. Another positive of the reforms is that PEMEX can now freely contract with companies that, before the reforms, it was legally impeded to contract with because of constitutional and foreign investment limitations. There are some exceptions though, such as PEMEX can’t migrate “Asignaciones” (unbidden purchase orders) granted to it to Contracts without the Contractor being approved and can’t enter into Exploration and Production joint ventures except through a bidding process.

Finally, under Round Zero of the Energy Reform, PEMEX was granted almost all of its wish list by the Secretary of Energy making it a viable company with sufficient reserves to explore in the future. 

Although these are positive changes, there are still many questions. For instance, it is still not clear what being a State Productive Enterprise will mean in the short and long term for PEMEX and people doing business with it: Will Mexico’s full faith and credit still back service contracts with PEMEX or not? There are still many unknowns on how will the system work in practice, but one thing is certain, a PEMEX ran like a for-profit corporation will be more efficient and that can only benefit us all.

Similarly, current service providers to PEMEX under service agreements will continue providing services to PEMEX but may expand into more aggressive (and lucrative) business ventures, but in some instances it will continue to contain foreign investment restrictions, such as maritime shipping.

In the case of E&P (Exploration and perforation), some service providers may get the benefit of having their contracts migrate from a service agreement to another arrangement more akin to a farm-out and share in the economics with PEMEX beyond just the simple fee payable.

Another important constituency that may benefit sooner rather than later are E&P companies that PEMEX will seek to partner with for the 14 projects it has announced, particularly in deep and ultra deep water and shallow water, heavy crude plays.

Other beneficiaries of the reforms in the upstream sector will be those participants in Round One (in which PEMEX may also participate). Companies involved in the Chicontepec area, particularly in conventional fields, as well as shallow water plays may be the first to participate in Round One bids. Texas companies may be interested in getting their feet wet in the Sabinas area, in the state of Coahuila that borders with Texas. Please see accompanying exhibit chart that highlights the blocks contemplated to be bided-out in Round One.

However, when talking about upstream, the effects of crude oil prices must be considered. Shale plays, as well as on-shore conventional plays with complicated geographies may lose the interest of the type of operators that typically participate in such plays. The Executive should consider whether assistance or more advantageous economic terms should be offered up in such plays, at least temporarily, to encourage these operators to participate and begin the process of creating an industry.

Finally, almost immediate opportunities exist in midstream. Transportation, storage, and petrochemical transformation are big market niches that must be considered.

The other sector that will have an immediate impact in private enterprise opportunities, including foreign investors is the electrical sector. Under the reforms, the generation of electrical power is fully open to private investments. But the government will still control the grid and distribution, except when “qualified big consumers” are involved, to which an entity generating power may sell directly (Assuming they are able to grab one of the few that fall under the definition as a client). Private Electric generators may sell electricity to CENACE (the entity that controls the grid), and to CFE. 

In conclusion, Mexico’s energy reforms have some short term benefits but must be viewed as a long-term play.

The opening of the energy sector in Mexico came at perhaps one of the worst moments, when oil and gas prices are dropping, in a fierce competitive environment, when the United States has become or is in the process of becoming a net producer rather than an importer, and when turmoil and concern about stability in the world are at a peak.

Nevertheless, Mexico is a big market with enormous potential, and desperately needs to be an efficient producer of energy to catapult economic development and create a more competitive atmosphere for industry. It will take time, but transforming a country is not a sprint race. It’s a marathon that requires a well thought out plan. We hope the executive is up to it. We know the private sector surely is.

The Author thanks Luis Fernando Gomar, from Strasburger and Price, PC for his valuable input to this article.