Mexico Opens its Energy Markets
The Mexican Congress has until the end of April to pass implementing legislation after amending the Constitution on December 20 to allow sweeping changes in the oil and gas and power sectors.
The Constitution has been amended to allow private-sector participation in activities that, since the 1960s, were deemed the exclusive preserve of the Mexican state. Private companies should now be allowed to participate in oil exploration, production, refining, processing, storage, transportation and first-hand sale of oil, gas, basic petrochemicals and refined products and to participate in the competitive generation and sale of electricity.
Oil and Gas
Until now, all hydrocarbons (either in solid, liquid or gas form) have belonged to the Mexican state. The Mexican state also has had the exclusive right and authority to undertake all upstream activities, that is, the exploration, production and development of hydrocarbons, with an express prohibition on the granting of contracts and concessions. Other midstream and downstream activities, including refining, processing, transportation, storage and first-hand sales of oil have also been reserved to the Mexican state, with the private sector only permitted to participate in limited activities, such as transportation, distribution and storage of natural gas and the provision of services through service contracts.
With the energy reforms, ownership of all underground hydrocarbons will remain with the Mexican state, but the private sector will now be permitted to participate, in addition to service contracts, through profit-sharing agreements, production-sharing agreements and licenses in the following activities: exploration, production, refining, processing, transportation, storage and first-hand sales of hydrocarbons, oil, gas, basic petrochemicals and refined products.
The inclusion of licenses in the reform is a well-received development. While the authors of the amendments (including the President and his advisors) were reluctant to use the word “concession,” the licenses will act in many ways as such, where the private companies will be able to control oil and pay royalties and taxes to the government. This could be the vehicle used by the government to tap Mexico’s vast shale gas reserves.
Another significant development is that the reforms will allow private companies to book reserves for accounting and financial purposes, while noting that the reserves, as long as they remain underground, continue to be the property of the Mexican state and thus cannot be traded.
While the power sector reforms are not as expansive and detailed as the oil and gas sector reforms, they do expand the activities in which the private sector can participate.
Until now, the private sector has only been allowed to participate in the generation and transmission of electricity that is not intended for sale at retail or through select generation schemes for which permits must be obtained from the Energy Regulatory Commission (Comisión Reguladora de Energía or CRE): independent power producer, self-supply (autoabastecimiento), cogeneration, small production (under 30 megawatts), import for self-consumption and export. All wheeling and distribution activities has been reserved until now exclusively for the Mexican state through the Comisión Federal de Electricidad (CFE).
The reforms allow broader private-sector participation in the generation and sale of electricity, but reserve operation of the national grid, as well as transmission and distribution activities, for the Mexican state, but allowing the state to hire private entities to construct and operate transmission and distribution facilities. The reforms direct the Mexican Congress to determine through implementing legislation the contract types available to the private sector for financing, installation, maintenance, management, operation and expansion of the infrastructure necessary for transmission and distribution of retail electricity.
In addition, with respect to the generation and sale of energy, the expected amendments to the existing secondary laws that regulate the power sector will provide the types of schemes and contracts that private companies will be allowed to enter into, but it will not be until their enactment that we will be able to find out the real meat of the reforms.
The Constitutional reforms also include a series of additional provisions affecting the government agencies and entities in charge of the oil and gas and power sectors or that are active participants in these sectors. The state oil company, Petróleos Mexicanos or PEMEX, and the CFE will remain key players. However, they will become “state productive enterprises” that will compete head-to-head with the private sector.
Once the implementing legislation has been enacted, PEMEX will be able to decide which projects it wishes to keep and which others will be opened to private investment. With respect to the latter, the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos) will run the bidding processes for projects it has decided to open to private investment, with PEMEX allowed to bid.
The CRE will remain the agency in charge of granting permits for storage, transportation and distribution of petroleum products, natural gas and basic petrochemicals, as well as regulating access to pipeline transportation and storage of hydrocarbons, as well as first-hand sales.
Finally, the reforms require the executive branch to create two new independent entities ― the National Energy Control Center to manage the national grid (a task that is currently performed by CFE) and the National Natural Gas Control Center to manage operation of the national gas pipeline and storage system ― within 12 months after Congress enacts implementing legislation to put the new reforms in place.
The reforms are a major development and, if properly implemented, they should dramatically boost oil and gas production, including from Mexico’s shale gas reserves, significantly decrease power tariffs over time and spark a new wave of multi-billion dollar investments in infrastructure to modernize facilities and expand Mexico’s power grid and pipeline system. But there is work to be done and, as always, the devil is in the detail. It will be in the implementing legislation that we will be able to appreciate fully the extent of the reforms and their true implications for investors and for Mexico’s growth.