David Enríquez
Partner
Goodrich Riquelme y Asociados
/
Insight

Emerging Energy Paradigm

Mon, 09/01/2014 - 14:53

The Energy Reform bill adopted by a narrow margin in December last year, which took effect on January 1, 2014, finally formalizes the most liberal regime in Mexico’s history. Framed by the Pact for Mexico, the far- reaching political agreement promoted by President Enrique Peña Nieto, the reform and its scope were established at an early stage of the president’s administration. First and foremost, hydrocarbons remain the nation’s property. Additionally, CNH’s faculties will be extended; refining, petro-chemistry and transportation will be opened up to competition; electricity production costs will be lowered through natural gas; good quality energy supply at reasonable prices will be established in the country; and, last but not least, PEMEX will be converted into a public, productive company. Secondary legislation was proposed on April 30, 2014, encompassing nine new laws and amendments to many others, and is currently being considered by Congress. The likelihood of the package passing without major changes is reasonably high. In this context, the challenge for President Peña Nieto’s administration will be the sound and timely implementation of the Energy Reform. The following paragraphs outline some of the key aspects of the Reform and the forthcoming secondary legislation.

PEMEX AS A PRODUCTIVE COMPANY

According to the bill’s transitional clauses, PEMEX is expected to progressively become a productive company, along with CFE, within two years. This transition is designed to lead PEMEX towards having greater managerial and technical autonomy, which would involve a special budget regime. This conversion will be beneficial for PEMEX, which will benefit from a whole new governance approach and a tailor-made budget, and for the federal government, which can assume an increase in expected revenue as the private sector is likely to bring more economic value to the nation. It inevitably forces PEMEX to pass its traditional power over oil and gas to the new managers of the resource, CNH and SENER. On its way to becoming a productive company, PEMEX will gain greater managerial and technical autonomy. In addition, other productive companies and even ad hoc financial vehicles may be incorporated by the federal government in order to participate in certain areas, such as trans-boundary reservoirs, where State participation will be mandatory.

INSTITUTIONAL DESIGN

The institutional design rests on a trinity driven by CNH in collaboration with a robust SHCP and SENER. Under this new structure, CNH becomes the new key player in the Mexican oil and gas industry as the new awarding authority for private companies and PEMEX. CNH will organize public biddings, assignments, contract executions, technical administration and the supervision of development plans. This collaborative scheme also includes SEMARNAT, which will act as a monitoring authority in the hydrocarbons sector via ANSIPA, a specialized agency in an environmental and industrial safety matters. The Reform also brought a substantial modification with regard to the counterparty since each contract must be signed with the federal state through CNH and no longer with PEMEX. This means that, among other consequences, the negotiation stage will be 

carried out without the participation of PEMEX’s trade union (STPRM), which was strongly weakened by the Reform as it was dismissed from PEMEX’s governing bodies. CNH’s new role considerably diminishes PEMEX decision-making power. CNH has two major duties: to identify and authorise which fields PEMEX may exploit and who may accompany the oil company in their development. Indeed, PEMEX will barely have the right to make suggestions as CNH has the last word on field assignments and partnerships when PEMEX decides to migrate its exploratory titles. In the same way, the contractual flexibility will mainly be regulated by CNH along with SENER, which will be in charge of contracts’ technical design among other matters.

The oil revenues will be placed under the control of the Bank of Mexico and invested into a Mexican oil fund. After tax, the fund will receive all revenues stemming from the exploration and extraction of hydrocarbons. A priority chain has been designed to organize the funds’ distribution, such as contractors’ payments preceding any distribution. In the order of priority, funds will go to the fixed federal budget, debt sovereign payment and long-term savings. If the net income exceeds 0.15% of the GDP, an investment programme will be triggered for developments, projects and pensions among other things.

One of the goals of this Reform is to reinstate organisms and institutions that slowly lost their purpose. Obviously, since various institutions are simultaneously being overhauled, the biggest challenge will be for all these to try to walk the same path without overlapping on each other’s duties. Many of these new institutions have little to no experience in running a bidding process or working with IOCs. Therefore, the apprehension of the private sector is understandable as many years of working with PEMEX established a mutual confidence, which will not have to be built up from scratch. The effectiveness of this transition will fully depend on the expertise of the professionals leading these institutions and their capacity to learn from foreign failures and success stories. Although the new Coordination Council for the Energy Sector seems to be an efficient way to align all related governmental organizations, its individual members will have the power to either jeopardize or foster the Reform.

CONTRACTS, TAXES AND SUPPLEMENTARY REGULATION

The new contractual modalities, as well as their relationship vis-à-vis the new hydrocarbons taxation system, will eventually be assessed by the markets on a benchmarking basis. Whether or not the fixed tax components (exploratory fees per square kilometer and royalties) as well as the variable fiscal elements (bonuses and remunerations), in addition to the respective adjustment mechanisms, are comparable to equivalent oil provinces elsewhere is still to be scrutinized by the number and quality of the participants in the forthcoming rounds. Agrarian, social and environmental regulations as per the secondary legislation will also have to be tested in real terms, as PEMEX will no longer be the primary player dealing with such sensitive sets of considerations. All in all, even the finest set of secondary legislation will not succeed, unless the right public officials are in place at every new and reshaped governmental organization. The rapid decline of production simply cannot wait any longer.