Gabriel Ruiz highlights Mexico's 2008 energy reform initiatives.
The 2008 Mexican energy reform movement is now a year old and is still waiting to start walking. The reform started as an effort by the federal government to introduce new contractual structures different than pure service contracts as a counteractive measure for the increasing decline in oil production and the lack of reserves restitution. However, the inefficiency of a political system that is the product of a young Mexican democracy, as well as the discussion over age-old taboos concerning the national oil industry, finally overshadowed and greatly limited the original objectives of the energy reform.
The result of these deliberations was a series of reforms focused mainly on Pemex. Both the Mexican government and Pemex believe the entity can significantly increase and diversify oil production by attracting technically capable private companies by way of incentive-based service contracts expected to be released towards the end of 2009. Although a 2008 reform represents the most significant change in the Mexican oil industry legal framework in recent history, its impact will likely be insufficient to provide the necessary economic and technological resources to address an ongoing lack of reserves restitution, a steady drop in production, the highly complex challenges facing drilling in deep waters and, most recently, the budgetary constraints Pemex faces in 2010 as a result of the weak public finances of the Mexican federal government. All of these elements help suggest a more comprehensive energy reform is indeed not far away, a reform that may eventually permit Mexico to develop and reach the places where the hope of its oil industry future lies.
2008 energy reform initiatives
Significant changes regarding internal structure, operation, audit procedures, budgeting and corporate governance were passed into law in November of 2008. These changes will eventually permit the government-owned Pemex to operate under a special contracting regime that allows public bid procedures and service contracts to include price negotiation phases as well as price adjustment clauses due to the introduction of new technologies and project efficiencies. The well-known prohibitions that circumscribe private participation in E&P activities in Mexico remain the same: contractors may not gain any form of title on the reserves and price compensation shall be paid strictly in cash, barring the possibility in agreeing payment by way of percentages of production, sales take or oil revenues of Pemex. Production sharing agreements, risk service and other similar agreements are now expressly prohibited by the new Pemex Law.
While the constitutional principles that have governed the Mexican oil industry remain intact, the 2008 energy reform addressed issues related with Pemex’s organization, the oil industry in general and the oil industry regulators. The newly enacted Pemex Law (Ley de Petróleos Mexicanos) is now, together with the previously existing Regulatory Law of Article 27 of the Mexican Constitution in the Oil Sector, also known as the Petroleum Law (Ley Reglamentaria del Artículo 27 Constitucional en el Ramo del Petróleo), the key laws of the Mexican oil industry. These laws obligate Pemex to operate under a new set of criteria that may help attract the level of private sector investment needed to develop an ailing Mexican oil industry. Some of the principal aspects of the new Pemex operating regime are the following:
- Contracts: Contracts related with Pemex’s core activities are subject to the rules established in the Pemex Law, its regulations and the directives issued by the Pemex Board of Directors, rather than to the general procurement framework applicable to other public entities; public bids shall include stages in which contract prices may be negotiated; contracts may include clauses that allow the amendments to such contracts in order to include price adjustments as a result of the inclusion of new technologies, variations in market prices of supplies and equipment, and the acquisition of new information that may increase project efficiencies; price clauses may establish additional compensation when the contractor saves time in the performance of the works and as a result of Pemex benefiting from better technologies or other project efficiencies.
- Financial: Pemex will now have a greater financial flexibility due in part to a differentiated fiscal regime, the autonomy to use its excess income and the introduction of the Pemex performance-based “Citizen Bonds.”
- Corporate Governance: Pemex strengthened its decision-making process by including four professional members in its Board of Directors, the creation of executive committees and having a CEO and Board of Directors with greater authority and responsibilities.
In order for the laws passed and modified to become effective, implementing rules and regulations must be enacted. Both the regulations of the Pemex law and the Petroleum law were published in September of 2009 and as of late November 2009 only the Board of Directors’ guidelines remain to be approved.
However, the implementing regulations are now facing legal challenges brought by opposing political parties who claim the regulations go beyond the permitted scope set forth in the Petroleum law. Opposers argue that the regulations overstep the boundaries of the oil and gas activities that are by law reserved to Pemex. The legal battle will be heard before the Mexican Supreme Court and will eventually be decided in the upcoming months, an event that will undoubtedly further delay the effects of the energy reform.
Notwithstanding the narrow and limited scope of the final energy reform of 2008, the new Pemex operating regime is a significant step in releasing Pemex from the straitjacket that the prior legal framework represented, greatly restricting access to the level of highly trained personnel and technology needed to substitute Cantarell and the other oil-producing fields currently undergoing their natural and expected declination. Evidently, the reform will likely benefit the local and international service companies that have been working in Mexico for decades, as Pemex’s immediate strategy to increase oil production includes a major increase in drilling activity in Mexico’s southeastern prospective oil fields, the Chicontepec region (where an initial target of 17,000 wells between 2008 and 2021 was set despite public criticism from industry experts), abandoned wells and the deep waters of the Gulf of Mexico.
Both the Mexican government and Pemex believe the entity can significantly increase and diversify oil production by attracting technically capable private companies by way of the incentive-based service contracts expected to be released towards the end of 2009. Although the 2008 reform represents the most significant change in the Mexican oil industry legal framework in recent history, its impact will likely be insufficient to provide the necessary economic and technological resources to address an ongoing lack of reserves restitution, a steady drop in production, the highly complex challenges facing drilling in deep waters and, most recently, the budgetary constraints Pemex faces in 2010 as a result of the weak public finances of the Mexican Federal Government. All of these elements help suggest a more comprehensive energy reform is indeed not far away, a reform that may eventually permit Mexico to develop and reach the places where the hope of its oil industry future lies.
Gabriel Ruiz is an attorney in the Monterrey office of Thompson & Knight, representing clients in the development of oil, gas, and energy projects. He also assists and represents national and multinational companies before governmental bodies and regulatory agencies in Mexico. He can be reached at +52.81.8215.7724 or firstname.lastname@example.org.