Q&A: “The old rules don’t apply” in Mexico energy sector

On Dec. 20, Mexican President Enrique Pena Nieto signed constitutional reforms into law to open Mexico’s energy sector to private investment.

The reforms will allow international companies for the first time in decades to share in the risks and rewards of oil and gas production. Mexican lawmakers hope the reforms will attract much needed capital investment. FuelFix.com asked Houston-based attorney, Carlos Sole, a partner at Baker Botts, about what the reforms mean. Edited excerpts follow.

Q: What part of the energy do your clients think is the most important?

A: There are two fundamental elements of the reform that capture the interests of exploration and production companies. The first is allowing companies to book the reserves for the value of the contracts for accounting purposes. The other fundamental reform is allowing companies to enter into contracts and agreements and to get paid in the actual production produced. This is important because you can take that production and you can trade it, you can sell it, and you control its ultimate destination and the ultimate price, versus having the production, and worrying about the price that Pemex is going to pay you.

Q: Which countries are Mexican leaders looking to in trying to open up Mexico’s industry?

A: Mexican government officials have cited the experience of Brazil, Colombia and Norway, which have all had state control of their resources and have liberalized them while still retaining state participation. What is unique about Mexico is how unique it was in being so closed off. For deep-water plays, the geology is very similar to what you see on the U.S. side of the Gulf of Mexico. Technical experts say it has the same geological characteristics as the U.S. side of the shale for onshore plays. But while there are several thousand wells on the U.S. side of the Gulf, there are currently only a dozen or so on the Mexican side.
Pemex has put out statistics that to fully capture their reserves, they will need about $60 billion of investment, while their own budget is $27 billion.

Q: What will be the biggest challenges for the next system?

A: Up until now, Pemex?has been the monopoly and dictated the rules. But with? the new legislation, you are stepping into a new environment and the old rules don’t apply. The Ministry of Financial will be responsible for economic terms. The National Hydrocarbon Agency will?be responsible for the actual bidding processes. The Ministry of Energy is the entity that will provide the technical support. These are three distinct agency that will need to be coordinated.

Q: What will the reforms mean for Houston?

A: For Houston companies in the oil and gas sector — be they upstream, midstream or downstream — there is going to be a new market next door and it is going to create economic opportunities. The technological advances that Houston has developed — its expertise on how and where to look for oil and natural gas plays — can now be used in Mexico.

Q: How will safety concerns affect decisions on whether to invest in Mexico?

A: Safety is a risk factor in northern Mexico, and the violence that folks see is in places along the border. For the shale plays in northern Mexico, there is a recognition that you need the appropriate safety. Some companies may look at some of the security risks and say, no thank you. But the situation is not as dramatic as it was a few years ago and all the folks we are advising are folks who are interested in the space. For companies that don’t shy away, there are plenty of opportunities. It is the cost of doing business in some of these places where the energy industry operates — in Colombia, Nigeria, Iraq, and other parts of Africa that have safety issues. There are certain emerging markets where that is a factor, and folks have developed their strategies accordingly.

Q:The reform also includes opening up the power sector to private investment, allowing private generation to compete for the first and for private retailers. This has been called one of the most fundamental changes of the Mexican energy reform. What challenges do you foresee here?

The Federal Electricity Commission has been state owned but will now be thrown into the open market. They plan to create of an independent system operator, but there is the potential for a very chaotic landscape, where lots of changes are going on, but no one knows for sure whether they will be. They have conceptualized what they want to do but there is little in terms of the actual details, explaining how you get from A to B. Some are expressing skepticism about their ability to pull this off smoothly, to create a new wholesale power generation market, because it could be difficult to make so many fundamental changes in such a short period of time.