Energy Reform Moves Forward in Mexican Senate, but Obstacles Remain for Big Oil

On Monday, three committees in Mexico’s senate — constitutional issues, energy and legislative studies — voted to bring an energy reform bill to the chamber’s floor for debate. The legislation would provide international oil companies the opportunity to participate in profit-sharing contracts and concession-like licenses for energy operations in Mexico, and it is expected to become law by the end of the legislative session Dec. 15.

The bill marks a seismic shift not only in Mexican energy policy, but also in the country’s history. Petróleos Mexicanos (Pemex) and the state have been bedfellows since 1938, when President Lázaro Cárdenas expropriated Mexico’s oil resources. In the following decades, a strong narrative developed surrounding the popular ownership of the country’s oil, and many Mexicans view the nationalized oil as an important part of their personal and collective heritage. Schoolchildren learn about the expropriation as a tale of national strength and courage in which their ancestors fought off the likes of Standard Oil of California and Royal Dutch Shell, which exploited Mexico’s precious resource for the benefit of foreigners. Today, 34 percent of Mexico’s annual federal budget comes from Pemex, and oil thus remains a national symbol of power and wealth.

With most of its easy oil drying up, however, Mexico’s production has been in decline since 2004, and the country risks becoming a net-importer of oil by 2020. Pemex lacks the expertise and technology to develop its vast deep-water and shale resources, so politicians from the centrist Party of the Institutional Revolution (PRI) and center-right National Action Party (PAN) have called for more private investment in the energy sector. In August, President Enrique Peña Nieto announced plans for reform but stuck to the conservative idea of profit-sharing to compensate international companies doing business in Mexico’s energy sector.

In recent weeks, however, the leftist Party of the Democratic Revolution (PRD) backed out of energy reform negotiations, yielding more influence to the PAN and its pro-business constituency. The resulting legislation revealed over the weekend reflects that shift and outlines cash-based contracts for service companies in addition to three plans for private exploration and production investment: profit-sharing paid in cash, production-sharing paid in oil and licenses with post-extraction fees and taxes. Instead of going directly to Pemex or the federal government, Mexico will place revenues from these contracts in a new petroleum fund administered by the central bank with better returns for social welfare programs, education and technology.

That being said, big oil is not quite ready to break open the top-shelf tequila, and rightly so.

Mexico has a highly bureaucratic energy market in which modern day foreign exploration and production companies have never operated. Although the pending reforms will ease constraints, details remain blurry. How will these big picture constitutional reforms trickle down to everyday policies? That is a question for the secondary laws, expected in spring 2014, which will hash out the particulars of the reform’s regulatory framework and legal processes for implementation.

The big picture plan for the licenses would not allow companies to book reserves because the amended constitution will maintain that oil in the ground belongs to the state. As “concession” is a politically loaded term in Mexico, privileges to the oil are explicitly out of the question; however, the specifics of how such licenses will be implemented remain unknown, and further pressure from the PAN could make licensing details less risky to foreign investment. But even if the licenses appease accounting concerns, the government has yet to specify under what circumstances licenses will be allowed over less favorable production-sharing or profit-sharing arrangements.

Beyond the contracts, other issues for the petroleum industry loom in Mexico.

Organized crime controls areas of the country, particularly in the North, where shale deposits could provide a major resource boom as they have in the United States. While characterizing and developing Mexico’s shale resources would take at least a decade, today’s security concerns are real hindrances to investment. Oil companies do not want to risk the safety of their employees or equipment. Water scarcity also remains a huge problem for shale production in the arid north, as production utilizes millions of gallons of the precious resource per well.

Also on Monday, the PRD presented over 1.7 million signatures before the Senate to solicit a popular referendum on energy reform, and anti-reform demonstrations have clogged Mexico City’s main thoroughfares. It is likely that the PRD’s opposition to the energy reform will grow stronger once Congress approves the constitutional changes. Over the weekend, a group of protesters encircled the barricaded Senate building. Since leaving the Pact for Mexico — Mr. Peña Nieto’s originally tri-partisan effort to fast track policy reforms — last month, the left is able to take a more vocal stance against the reform and translate public resentment into mobilization on the streets. The extent of the pending protests remains unclear, but prolonged unrest could turn some more traditional PRI legislators against the reform.

With oil being such a politically charged issue in Mexico, investors will be vigilant. Even if the constitutional changes are in place this week, the exact policies surrounding Mexico’s energy reform will be uncertain well into 2014 and, perhaps more importantly, controversial for years to come.

Dylan McNally is the research assistant for the Mexico Center at Rice University’s Baker Institute. He earned a bachelor’s degree from Rice University in political science and Hispanic studies. He has held internships at the Embassy of Mexico in Washington, D.C., and the National Institute of Migration in Mexico City. His areas of interest include migration, energy, trade and education in North America.

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