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Mexican President  Enrique Peña Nieto at the signing ceremony for the energy reform August 11, 2014. (Photo: Mexico's Presidency) 
Wednesday, August 13, 2014

Mexico Energy: Historic Milestone

President Peña Nieto has succeeded in achieving the most progressive economic reforms for Mexico since the adoption of NAFTA.

Inter-American Dialogue 


Mexican lawmakers last week gave final approval  to secondary legislation needed to complete reform of the country's energy sector, including a hydrocarbons law and bills setting up an electricity market as well administrative and transparency measures for state companies Pemex and CFE. What are the key measures adopted in the reforms, and were there any surprises? Do they go as far as investors hoped? 

Ixchel Castro, macro energy analyst at Wood Mackenzie: 
The key feature of the reform is providing private investors access to oil, gas and power assets that remained under the exclusive control of the government. The aim is to revitalize the sector and develop Mexico's hydrocarbon potential without being funded by the public budget. More than just breaking the state monopoly in the sector, this reform means the beginning of a new market-oriented rationale. Energy policy will be the framework, but not the only driving force in the sector. The reform has provided elements addressing investors' concerns in terms of flexible contracts, independent regulators and booking of reserves. Markets had an initial positive reaction, but the real assessment will be done during the next two years following three key aspects: Pemex's and CFE's restructuring process; the first oil and gas licensing round; and the start-up of the wholesale power market. Up until now, the reform has fulfilled the market's expectations, so the next step is providing results. As the reform is implemented, investors will pay special attention to the management of the licensing rounds by the National Hydrocarbons Commission and the involvement of the Finance Ministry in the supervision of investments. For the power sector, the consolidation of the National Center of Power Control as an independent dispatcher will be key to ensuring new participants of the neutrality of the wholesale market. 

James R. Jones, member of the Advisor board and co-chair of Manatt Jones Global Strategies: With passage of the implementing legislation to give form and substance to the historic energy constitutional reforms, President Peña Nieto has succeeded in achieving the most progressive economic reforms for Mexico since the adoption of NAFTA. Given the political difficulty of opening up Mexico's hydrocarbons sector to global competition, the reforms are remarkable. That is not to say that economic rewards will flow immediately. Further fine tuning through regulations and legislation will undoubtedly be needed. But the totality of all of the reforms tells the world that Mexico is leaving behind old myths and moving ahead to be a global economic competitor. The reforms invite private investors to develop the declining oil and gas reserves along with unshackling Pemex to be run as a real energy company. It establishes a framework for leases, profit and production sharing to entice the most modern producers. It creates ANSIPA, which is a one-stop shop for environmental matters related to hydrocarbons activities. It sets up rules for land-use rights that balance the interests of landowners and producers so that both can benefit and designates the National Hydrocarbons Commission to referee. It will encourage fracking and the development of shale oil and gas by taking away jurisdiction over extraction methods from the states. It sets lofty goals for clean energy and encourages renewable energy production by such things as requiring electricity generation and supply companies to purchase Clean Energy Certificates. Some things remain to be done, probably in the regular fall session of Congress beginning in September. The environmental legislation will address the regulation of water use for fracking, for example. But Pemex, CFE, and Mexican and foreign investors will find real opportunities in the energy sector this time. The winners will be Mexico and North America.

John D. Padilla, managing director of IPD Latin America: Key modifications to the secondary laws include: 1) 25 percent national content will be required in 2015, increasing to 35 percent by 2025 (excluding deepwater); 2) landowners will be entitled to benefit from production, much like those with mineral rights in the United States; 3) regulators will be further strengthened and more autonomous; 4) more money will flow directly to oil and gas producing states and municipalities with funds established for infrastructure needs; 5) generalized subsidies will be replaced by more focused ones; 6) gasoline imports and gas stations are likely to open up to competition sooner than originally proposed; and 7) the government will assume a portion of pension liabilities if the Pemex union agrees to move to a defined contribution system with auditing oversight. All of these changes are positive, or, at least, not deal breakers. The PRI and PAN demonstrated a healthy give-and-take to achieve agreement and pass these laws. Their ability to reach across the aisle stands as testament to the parties' commitment to achieving reform. The secondary legislation provides important details on the institutional framework and other issues that will matter to the private sector. Much of it looks very promising. But many of the details that will determine whether companies come in droves or dribbles will depend on the specifics to be contained in each contract to be bid out. Additionally, the government's ability to overhaul, staff up (not just bodies but the requisite skill sets) and implement the institutional framework necessary to deal with bids and multiparty dynamics will be key to coping with the challenges ahead. Mexico has achieved another major, historic milestone, which should be applauded. But more work lies ahead. 

David Shields, independent energy consultant based in Mexico City and editor of Energía a DebateConstitutional energy reforms and enabling laws have now been approved in Mexico. The magic remains intact. The expectation is that massive investments will flow into a real, open energy market full of opportunities. But the reality will be much more complex, as is the dense, often inscrutable bunch of laws that have wound their way through Congress. These laws still have to be regulated (more complexity) and turned into major, feasible projects. For now, they bring up many more questions than answers. Since they establish tax rules aimed at conventional oil, can unconventionals make headway in Mexico? Can fracking thrive, if legal and regulatory conditions are so different from those in the United States? Can deepwater drilling move forward, if the law says companies' liabilities could be 'unlimited'? Can Pemex be a productive, efficient, competitive company if it remains 100 percent state-owned and under political and bureaucratic control? Why do the laws give the president total control over appointments in Pemex, CFE and the regulators? There are major concerns about transparency all through the laws. How will Pemex pick its partners? Can this be totally discretional in a state-owned firm? To what degree will the regulator intervene--and if so, why should a regulator pick partners for a company? Will there be no controls (and thus no accountability) over Pemex 'special purpose' affiliate companies? Ultimately, we must ask: can this reform be successful? Probably yes, to the degree that Mexicans--and investors--work hard on it over the next 10 to 20 years. 

Carlos Petersen, associate at the Eurasia Group's Latin America practice: Two main takeaways can be drawn from the energy-sector reform process that is about to conclude. First, the market-friendliness promised throughout the reform process remained, and, second, the government still has questions to answer and results to deliver in order to fulfill the expectations. Regarding the first point, from the legal perspective the supporters of the reform should not feel disappointed. The Mexican energy reform has a very market-friendly sentiment, embedded in the constitutional amendments made last December and embraced by the secondary legislations recently approved by Congress. The secondary laws not only defined the rules of how the hydrocarbon and power sectors will be opened to private participation, but also granted Pemex and CFE more autonomy and healthier finances, which should be a positive sign to firms that want to partner with them and for Mexicans that will benefit from more competitive and efficient state-owned firms. On the second point, the government still has to follow through with the sector transformation. The implementation process will face many challenges in the short and long term. On the one hand, the complexity in the adaptation and creation of new rules and institutions, and, on the other, solving and navigating structural issues that Mexico has, like corruption, political polarization and insecurity, will be crucial. These key uncertainties will be relevant indicators to follow in order to anticipate if the reform's promises of boosting production, attracting investment and giving new opportunities of growth, and improving conditions for all Mexicans, will be fulfilled.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

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