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Oil of Olé: Mexico’s Energy Reforms

Is it possible that there will come a time when schoolchildren in Mexico will study December 20, 2013, as the day that their country started down a new road toward greater wealth and independence by changing the way they manage their oil and gas industry? That is the date when President Enrique Peña Nieto signed historic reforms to the Mexican constitution relating to the rules for developing the country’s oil and gas reserves, reversing 75 years of practice that had been premised on prohibiting all foreign involvement and vesting exclusive authority with the national oil company, Pemex (Petróleos Mexicano).

Reverting 75 years of any national government policy is historic in and of itself; but overturning Mexico’s long-standing, insular energy policy was borderline revolutionary — and, fortunately, without any of the violence that almost necessarily accompanies any revolution. On March 18, 1938, Mexican President Lázaro Cárdenas abruptly signed into law the declaration that all domestic oil and gas assets now belonged to the Mexican government, meaning that vast operations throughout the country that had been developed by American, British and Dutch companies were lost with the stroke of Cárdenas’ pen. There was widespread celebration in the streets by Mexican citizens who felt that foreign companies had been exploiting Mexico’s natural resources, paying slave wages to Mexican workers and exporting Mexico’s oil to other countries.

The foreign companies whose operations and assets had been expropriated were not of the same mind, and there were hard feelings for many years to follow; with even the uncomfortable consequence of our neighbor to the south selling its oil to Nazi Germany for a brief period of time.

The sense of national pride and vindication felt within Mexico after these events was so deep that schoolchildren have, in fact, been taught about the importance of March 18, 1938 — the day of “Expropiación Petrolera” (Oil Expropriation) for all of these years. My former boss at ARCO attended grade school in Mexico City in the 1960s and remembers being taught about these events, much like Texas schoolchildren learn about the Alamo. So let’s just say that Mexico has felt strongly about nationalizing its oil industry for a very long time.

Something else happened, however, along the way — the economic realities of the marketplace. Decades without competition or accountability eventually resulted in inefficiencies, waste, fraud, abuse and corruption. More money was being spent with increasingly less to show for it. Despite the national pride that Mexicans felt in having complete control over their oil, more and more of the country’s leaders — in both major political parties — had to confront the realization that something needed to change.

President Peña Nieto was elected in 2012 on a platform that included making radical changes to how the country had been running its oil industry. He delivered on December 20, 2013. The Mexican Senate agreed by a vote of 95 to 28, and the Mexican House of Representatives agreed by a vote of 345 to 134. Mexico’s political leaders were finally ready to change.

These dramatic reforms include: 1) allowing foreign companies to take ownership of the oil once extracted; 2) creating four types of contracts with foreign companies for exploration and production of oil — service contracts, profit-sharing contracts, production-sharing contracts and licenses; 3) opening refining, transportation, storage, processing and petrochemicals to private investment; and 4) ending Pemex’s monopoly on retail gasoline and diesel sales this year.

Mexico began accepting bids on properties in three rounds of auctioning during 2015 with varying degrees of success, primarily due to the collapse in crude prices. Although the fourth auction of deepwater properties in the Gulf of Mexico has been delayed in 2016 because of continuing depressed crude prices, President Peña Nieto has made it clear that he intends to move forward. Price fluctuations are cyclical, but these reforms are for the long term.

And, after all, it is perfectly understandable that he and all of Mexico are intent on making these reforms a success. As recently as 1995, Mexico was the world’s sixth-largest producer of crude oil. In North and South America, only the U.S. produced more oil than Mexico. But the economic handwriting was already on the wall. Starting in 1998, Pemex was so top-heavy and inefficient that it operated at a loss and has continued to do so every year since then.

Mexico’s domestic refining capacity has remained so limited that, although it is an exporter of crude oil, it is an importer of refined products, including almost 25 percent of its gasoline. Mexico’s oil production has steadily decreased since 2005. Crude oil production in 2014 was at its lowest level since 1986. Despite having both substantial conventional and unconventional natural gas reserves, Mexico continues to be a net importer of natural gas because Pemex has been unable to muster the talent and resources to develop these domestic reserves.

Just passing reforms, however, does not magically rescue a country from decades of policies destined for failure. Much more will be required before Mexico is able to realize the economic health and success that it should enjoy, given its substantial natural resources. Just like every other oil and gas company, Pemex must confront the current down market in prices. Pemex’s Director General, José Antonio González Anaya, announced in February that the company will be cutting $5.52 billion from its budget to adjust to the significant decline in its revenue. More than likely, these reforms will lead to even more streamlining within Pemex.

If Mexico really wants meaningful participation by foreign companies, its leaders will finally have to deal with the rampant crime problem. Thieves drilled almost 2,500 illegal taps into state-owned pipelines and stole some 7.5 million barrels in 2014 alone; and then there are the kidnappings, murders, etc. Foreign company personnel might still be a little reluctant to sign up.
Mexico’s political leaders have taken a dramatic first step that most believed would never occur. What happens next could go a long way toward bringing about North American energy independence — or just another mañana.

SHALE Magazine Bill Keffer TexasAbout the author: Bill Keffer is a contributing columnist to SHALE Magazine. He teaches at the Texas Tech University School of Law and continues to consult. He served in the Texas Legislature from 2003 to 2007.

Photo credit: lagardie/bigstock.com

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