Mexico moves to relax decades-old grip on oil

A shifting political landscape, sagging oil production and growing global competition are pushing Mexico toward constitutional changes that would open its energy sector to international investors for the first time in decades.

This week, Mexican President Enrique Peña Nieto is set to send lawmakers proposed constitutional amendments that would allow international players to share potential profits — as well as risks — of Mexico’s oil projects with the state-owned monopoly Petróleos Mexicanos, or Pemex.

The proposal comes after years of declining oil production and could breathe fresh life into Mexico’s economy through an energy renaissance similar to the one taking place in its neighbor to the north.

“The energy reform process is crucial for Mexico — it is the mother of all reforms,” said Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center in Washington. “So much hangs on the success of Mexico’s energy reform — economic growth, the competitiveness of the country, potentially massive job creation, fuel prices and the historical legacy of the Peña Nieto administration.”

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But it would be a profound change for a nation that essentially has barred foreigners from ownership in crude oil projects since the 1950s and has defined much of its national identity on control of its natural resources.

Peña Nieto has identified opening up of the energy sector to international investment as a key goal for his presidency.

Mexico’s two major opposition political parties — the conservative National Action Party, or PAN, and leftist Democratic Revolution Party, or PRD— have acknowledged the need for change. The day after Peña Nieto took office in December, the three major parties jointly formed the Pact for Mexico, a broad set of social and economic principles, including a commitment to retain control of the nation’s energy resources.

The parties are not in agreement, however, on the details of attaining that goal.

Peña Nieto’s model seems to have the support of his Institutional Revolutionary Party, or PRI, and the National Action Party, enough to provide the two-thirds legislative vote required for constitutional amendments.

“President Peña Nieto is going to get a reform passed because the PRI and the PAN have both endorsed fairly similar proposals,” Bill Richardson, a former New Mexico governor and U.S. energy secretary, said in an interview last week.

“I think that is going to be an enormous job generator and energy generator, not just for Mexico but for the hemisphere, and it is going to open up the possibility of partnerships with states like Texas in renewables and offshore and natural gas.”

Resisting big changes

The Democratic Revolution Party favors more limited changes and has said it will fight amending the constitution, suggesting it could lead to privatization of Pemex.

Earlier this summer, the party led widespread protests of Peña Nieto’s proposals. Andrés Manuel López Obrador, the party’s candidate who lost to Peña Nieto in last year’s presidential election, is planning more protests in early September.

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Supporters of amending the constitution say it wouldn’t lead to foreign control of the national oil company, but that allowing foreign companies to invest directly in projects with Pemex could give it access to the international players’ advanced technology and know-how.

“Pemex currently has its hands in a straitjacket,” said Gabriel Salinas, a Mexican attorney with Mayer Brown based in Mexico City. “They have not have had the operational and administrative and financial flexibility to be a successful company because of legal restrictions.”

These restrictions specify the kinds of contracts Pemex can establish, and often lead to project decisions driven by domestic politics rather than industry economics.

“Pemex does not control its profits,” Salinas said, “so they cannot use freely their profits for exploration, which is a basic activity for the oil and gas company.”

That hammerlock on oil profits — which finance 35 percent of the Mexican government budget — has been a roadblock to overhauling the nation’s energy sector.

Production sinking

Pemex’s drop in production, and the resulting lost tax revenue, has been one driver for reform.

Since 2004, the country has suffered a 23 percent overall drop in crude output. And production from its once-muscular Cantarell field in the Bay of Campeche has fallen 75 percent, to less than 500,000 barrels a day.

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One of the debates between the Democratic Revolution Party and its more conservative rivals is whether reforming Pemex requires a change to Mexico’s constitution, or just revisions in a 1958 law that forbids production sharing with international oil companies.

“It is a common misperception that the Mexican Constitution prevents production sharing contracts that allow companies to be able to share in oil and gas,” said Steve Otillar, an attorney with Akin Gump who specializes in the Mexican energy sector. “Many constitutions have similar language that says minerals are owned solely by the country — that is not unusual. What is unusual is that once you have captured it out of the ground, most countries will allow you to share it.”

Colliding interests

The debate over exactly how to open up Mexico’s oil sector brings into play a tangle of legal, political and international relations issues, Otillar said.

Central to the debate is the long-term confidence of big companies that might want to invest, with a time horizon that could span decades. A constitutional amendment is more likely to survive shifting political winds, supporters reason, than a statutory revision.

“As soon as you have any kind of law or movement where a foreign company could own any part of the oil, the lawsuits will come out of the woodwork,” Otillar said. “A constitutional change would send a clear message to the world that Mexico is open to the oil and gas business.”

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Sentiment against foreign energy investment has been central to Mexican identity since 1938, when President Lázaro Cárdenas nationalized the oil industry and ousted foreign owners.

“Since the expropriations 75 years ago, our history textbooks have cranked into our DNA how the oil industry belongs to the Mexican nation,” Salinas said. “The word privatization has a negative connotation in Mexico, which is why you see some parties on the left using the word privatization to describe the change, even though that is not what is being proposed right now.”

Mexico has attempted modest reforms in the past, most recently in 2008, when it let Pemex enter into some fee-based contracts with oil field services companies.

But those contracts don’t involve a cut of ownership or profits, and companies other than Pemex aren’t permitted to book reserves — to list Mexican oil in the ground among their assets in financial accounting.

Must book reserves

International upstream operators say they can’t make exploration and production projects economically viable or attract investors unless they can book reserves to show their ownership of access to the crude.

“So far, Mexico has limited most of the engagement to what I would call service contracts, which really don’t fit into the portfolios of international companies, or the independent E&Ps,” said Lee Tillman, CEO of Houston-based independent Marathon Oil Corp. “Some of the metrics that we would like to have — booking reserves, sharing price risk and those types of elements that make for good opportunities for our shareholders — today they just don’t exist in Mexico.”

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As Mexico debates reform, Marathon and its rivals are watching closely, eyeing the resources of reservoirs like Cantarell.

“The industry as a whole has always sought to define a role in Mexico,” Tillman said. “It is a tremendous hydrocarbon province. Should we see reform, just like any hydrocarbon resource, there will be ready suitors there to take a hard look at Mexico as an opportunity.”

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