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Insight

Potential for Energy Reform

Tue, 01/22/2013 - 10:20

In 2008, after a year of intense debate, political wagers, and an intense campaign both in Congress and in the media, an energy reform was passed in Mexico. The changes were published in seven decrees which modified or created 10 different laws. At the time, President Felipe Calderón Hinojosa stated: “I can say, without exaggerating, that this has been the most favorable change in Mexico’s hydrocarbons sector since 1938.”

However, four years down the road, Pemex’s production has continued to fall while bureaucratic processes within the NOC have grown. While crude oil production has fallen 9.6% since 2008, the number of corporate personnel at Pemex has risen 21%, resulting in a 15% increase in the company’s operating costs. Certainly, the reform did bring about positive changes, such as permitting Pemex to sign incentive-based service contracts with private companies, which are expected to start raising production and improve recovery rates at some of Pemex’s mature and abandoned assets this year. They have also boosted Pemex’s technical and development capacity, enabling the NOC to embark on complex development projects such as Lakach and improve its performance in challenging fields like Chicontepec.

Now, President Enrique Peña Nieto is calling for a new reform of the energy sector. During his presidential campaign, he emphasized his intention to modernize Pemex. As President, one of his first actions was the signing of the Pact for Mexico, in which he along with Mexico’s four main political parties committed to push for a reform that will substantially benefit the country’s hydrocarbon sector. In one of the seven commitments related to the oil and gas industry, the Pact for Mexico states that laws and regulations in both the energy and fiscal sectors will be modified in order to transform Pemex into a public company with business-like objectives.

So far, nothing specific has been said about the energy reform. The Pact for Mexico’s Governing Council - composed of representatives of all the signatory parties, technical experts and Peña Nieto - has announced that it is working on a reform project that will be presented to Congress during the second half of 2013. However, making Pemex a public for-profit company would entail a significant reform to Mexico’s fiscal system, which largely depends on taxes collected from the NOC. As a result, modifications to tax laws and regulations are being discussed in parallel to the energy reform. This complex situation and the political risk involved are expected to complicate the reform process.

The current administration has already tackled some of the obstacles that have served to block reform in the past, including issues regarding the discussion and ratification process of the 2008 Energy Reform. While in 2008 there was significant and visible opposition to allowing private companies to become operators of Mexican oil fields, at the moment there are no relevant political actors or interest groups pitted against a new reform of the energy sector. The notion that an energy reform requires the modification of Constitutional Article 27, which states that hydrocarbons are the property of the Mexican people, has dissipated. In fact, the first of the Pact’s seven commitments concerning oil and gas specifically states that “the property and control over Pemex and the nation’s hydrocarbons will remain in the hands of the nation.”

One of the main challenges that the current administration will face is the adverse reaction and general unrest that the imposition of new tax duties under an accompanying fiscal reform would generate. Pemex currently contributes 34.5% of the federal government’s income, and meangingful energy reform is likely to include a reduction of its tax burden. The PRI recently modified its internal rules, lifting the ban that blocked the party’s members from discussing the addition of a value added tax (VAT) to food and medicines, which is still a taboo in many circles in Mexico. This change might indicate that, among other measures that might affect a wide array of interest groups, the PRI might propose to charge the general population with this unpopular consumer tax in an effort to diversify its tax collection away from Pemex.

The President, his party and the Pact for Mexico’s Governing Council must quickly and carefully design an energy reform before the current political consensus evaporates. The pact has already faced a notable crisis, and is expected to face further strain as a result of the local elections that will take place in 14 of Mexico’s states in July 2013. Nevertheless, the potential for the approval of a comprehensive and effective energy reform has never looked better than in 2013.