Middle Ground for Public and Private Sectors, to Mexico’s BenefitBy Cas Biekmann | Tue, 09/22/2020 - 11:45
Q: What is the importance of Mexico’s energy sector in the firm’s global portfolio?
A: Energy is one of the most important industries for Norton Rose Fulbright in Mexico. We are one of the biggest energy firms worldwide in terms of several metrics, including volume deals, clients, headcount, panel firms and others. Since the opening of our Mexico City office, the energy sector has been seen as crucial and it has allowed us to cover most areas of expertise around it. Infrastructure projects require all sorts of expertise, from corporate matters to transactional, real estate, labor, agrarian, environmental and finance law, all of which require an important level of depth. We have grown a number of practices in our Mexico City office, most of which are designed to support our infrastructure and energy-related projects. Infrastructure projects in the energy sector is probably our most important area of expertise, covering everything from project development, to regulatory, financing and secondary market transactions.
Q: How does the firm assess the influence of the pandemic and regulatory changes in the energy sectors?
A: I think we are all struggling with the sector’s current crisis. The pandemic has introduced many problems worldwide. Demand for energy and prices have dropped dramatically, affecting the industry. The slowdown the energy sector is experiencing has no recent precedent. Similar to the 2008 financial crisis, we are expecting to see an increase in the restructuring, refinancing and mergers and acquisitions work because of distressed assets for projects that current stakeholders cannot continue to own.
In addition to these worldwide trends, it is publicly known that the Mexican government’s policy is going in a different direction from the past administrations. I am not going to judge and say if the direction of the current administration is good or bad, but the proposed changes and new public policies also allow us to see what could have been done better in the past. When it comes to investments, what matters is the credibility of one’s word in honoring contracts and a few recent examples may jeopardize such credibility. For example, even though the original Mexico City airport project was canceled, as promised in the presidential campaigns, and even though investors were paid, it did not send the best message to private investment. The same thing is happening in the power and oil and gas sectors where the government is issuing regulation and public policy which is not only addressed to future projects but is also changing the rules upon which those projects were conceived. The government is addressing the sector in a different manner. That is fine– the government won with over 50 percent of the vote after all and it has delivered on many of its campaign promises. But I do think it is of upmost importance to respect contracts agreed in the past and the rules upon which those contracts and those projects were awarded because regardless of whether they pose concerns vis a vis the new public policy, it is extremely important to send the right message that Mexico is a country that respects investments.
The government’s argument that CFE and PEMEX are at a disadvantage in their competition against private companies holds some truth. For example, they claim that private companies have an advantage when it comes to renewables, and they are right in terms of certain specific benefits that especially legacy pre-energy reform contracts have. For example, the renewably energy transmission fees private companies pay to get to the infrastructure in those pre-energy reform contracts are incredibly low. However, this was arranged almost a decade ago, when these measures were necessary to promote renewables in Mexico and to reach the 2025 climate goals. It was difficult to imagine that prices in the renewable energy industry would have decreased as importantly as they did over the last decade but, part of the reason of that is the increase in the offer of those products and services that come as a result of those supportive measures. The market offer in the renewable sector was increased as a result of the benefits that some of those projects were given a decade ago. The government’s argument about unfair competition for the state-owned companies, therefore, makes sense but that does not mean that you can change the rules upon which those investments were made. The government should also try to understand why these incentives occurred and honor them.
A similar situation is occurring in the oil and gas industry. For example, people are wondering why PEMEX ever thought about entering the Etileno XXI petrochemical project, which is turning out to be bad business. But again, it made sense considering not only the natural gas and ethane prices and its access but also Pemex’s business plan at that time. PEMEX’s plan was to continue to produce ethane and natural gas and that plan changed dramatically. And, of course, now it does not seem like a good business but no one is blaming PEMEX’s business plan change, which in my opinion is what is rendering this project as expensive. That does not necessarily mean that there was corruption, even though this possibility cannot be ruled out completely in any sector of the economy in Mexico, unfortunately. The oil and gas contracts from the bidding rounds and the long-term energy auction contracts occurred without any scandals, on the contrary they have been seen as an example of transparency and competition. Yet, antitrust concerns among competitors and away from any government’s control can never be ignored but that is a different story. I mean, if the world’s most sophisticated financial institutions could still have found a way to try and manipulate prices in the reference interest rates (i.e. Libor) despite stringent regulations, that can happen anywhere in any industry, especially in the energy sector, which is capital intensive that, by design, aim at creating natural monopolies. Nonetheless, the purpose of the Energy Reform to fully open most of its sectors to receive private investment and to have the state-owned companies competing with private entities as a means to enhance the offer and reduce prices should not be questioned as it continues to be a valid objective.
Q: How do you assess the government’s broader plans for Mexico’s energy infrastructure with a stronger focus on national resources?
A: The government is putting together its wish list regarding energy infrastructure. Nevertheless, there is a gap between those wishes and what is possible, especially because some of those wishes overlap with the industry’s previously acquired rights under the energy reform. Any new government can try to change any industry from a public policy stand point but you cannot put the country’s credibility at risk, you cannot change the rules retroactively for what has been already done. And if they do the country will end up paying, because Mexico will lose those battles in court / international arbitration boards. I think the government will realize soon that it will not only be inefficient but nearly impossible to try and be energy independent, at least I hope they do that when is not too late. Because that is probably the ultimate goal of the current administration and it is rooted in historical context considering Mexico’s identity rather than economics. I think at this point of our globalized economy no country can have a complete energy independence, and the goal should be to try to maximize natural resources and foster the creation of competitive markets to benefit the population rather than taking ideology-based decisions. There was a time when foreign companies indeed possessed Mexico’s resources and took advantage of it but we have since moved closer to the other extreme. Seven years ago, Mexico and North Korea were the only countries that still had a complete energy monopoly. Pemex had approximately 75 years where it was the only player in the industry, and the numbers speak for themselves. Billions of dollars were drained in bureaucracy and Pemex administrative burden. There has to be more of a middle ground. Considering our current globalized economy, nobody can truly be energy independent anymore. If your goal is to have sufficient energy at a relatively low cost, and still have certain degree of control of the industry, which I think is necessary, this can be achieved through more competition, more power auctions, more oil and gas rounds, not by putting the burden in the close-to-bankruptcy governmental entities to develop the projects, which, by the way, do not have the technology to fully compete. The do-it-yourself through government-owned projects with private investment participating only as contractors, costs much more and those resources could be invested in many much more needed industries that are not as attractive to private investment.
Full independence therefore is not going to happen, is not economically possible and that is a fact. However, full liberalization has its own risks as well. Other sectors of the Mexican economy have been privatized in the past where the outcome has been basically to transition from a public to a private monopoly, like the telecom industry where every player is dependent on the dominant player in order to get access to the grid, we can find a similar situation in the railroad industry and there are many other examples. For this reason, it would be good to find the best balance between the state and the private sector and we already have the legal framework for it to happen. I believe certain infrastructure should remain in the hands of the government for the latter to have certain control over the industry. Through the energy reform, the government continues to own key infrastructure and is able to control the sector to an extent, which was a very good idea in my opinion. This is different than energy independence, however. Is more about having control over the industry in certain scenarios rather than “owning” the industry.
It is merely a matter of time before the government realizes the best way to lower prices is through competition, through private sector involvement. However, my concern is whether it will be too late by the time the government realizes that. the problem is that there is a lot of ideology involved, and not a lot of industry knowledge or strategy, let alone economics. In the short to medium term, we might not see a great deal of new projects. If the government wants to sponsor its own projects, it might have to raise taxes to be able to do so; otherwise there is just no money. Proof of that is a recent cancellation by CFE of 5 combined cycle projects intended to be owned and financed by the Government. To me the most important ideological change introduced by the energy reform was to grant the state-owned entities the mandate to be profitable. Thus, the problem that people like myself have with such big government-sponsored energy projects, including the Dos Bocas refinery, is simply that they are not profitable from an economic standpoint and there are many other sectors in urgent need of public resources while the energy sector can be very profitable and productive for all involved parties, including the Mexican state, through a balanced combination of private and public investment.
Q: Which services have been most in demand for the firm and how will these evolve?
A: Since 2017, when we formally started operations in Mexico, we have been very active in the clean energy auctions, which have now been cancelled. Nonetheless, we are still seeing activity derived from those awarded. When these projects are done, there will continue to be related activity because we also think there will be a lot of refinancing, restructures and M&A in a secondary market for energy assets. There have been changes in the existing rules that include higher transmission fees and a different order in economic dispatching for power plants introduced by the government. These decisions are currently in court. Injunctions have been granted in favor of many private projects but there is still uncertainty in the sector and that is not good for new investments. While is not the kind of work we like, we are also seeing increased activity in our firm derived from these decisions.
In the oil and gas sector, there will be a great deal of work regarding the 100-plus E&P contracts awarded by CNH in the oil and gas rounds. Our firm is benefiting on this front. We have a great oil and gas team and we have dramatically increased our oil and gas capabilities in the last 2 years. We are active in the most relevant transactions in the market, from reserve-based lending to unitization, storage matters, joint ventures and alliances and regulatory affairs, along with advice related to the existing exploration and extraction contracts. In the oil and gas and energy sectors, we expect to continue to be one of the most involved firms nationwide.
Q: What goals would the firm like to achieve this year?
A: We are still in an expansion mode in Mexico. The idea is to become a full-service firm as soon as possible, even though there has been a slowdown this year for obvious reasons given the pandemic and public policy by the new federal administration, especially in the energy sector. We might be able to add some practice areas that can complement our core areas this year. If not, then next year for sure. It could be areas like investigations, or enhance our M&A capabilities, capital markets, tax, environmental law or dispute resolution. All this will depend on market opportunities but we always have our eyes open to bring new talent. We believe our network is one of the strongest in the market worldwide.
Norton Rose Fulbright is a global law firm that provides corporations and financial institutions a full business law service. It has more than 4,000 specialized professionals based in Europe, North and South America, Asia, Australia, the Middle East and Africa.