Implications of the Energy Reform: a transformation for Mexico and the world

The day after the signing of the Energy Reform’s secondary laws, President Enrique Peña Nieto underscored his intention to transform the country.

“When I started my term in office, I made it very clear that my government did not come here to manage the country, we came to transform it,” he wrote in a personal message on the Presidency’s official website.

“The obstacles were of such magnitude that it was impossible to overcome them with merely a more efficient administration. The change had to be radical,” he declared.

The radical change the President advocates has become a reality in the unprecedented Energy Reform. Among other things, the new legislation will allow private capital from inside and outside Mexico to take part in this transformation, while the State retains ownership of its natural resources.

Investment opportunities: refining and natural gas

Although investments by state-owned oil company Petróleos Mexicanos (Pemex) tripled over the past 13 years, from $9 billion in 2001 to the current $28 billion, crude oil production has fallen by one-third in the past decade, according to Energy Information Administration (EIA) statistics.

The reform opens a window of opportunity for private sector companies, which have the adequate technology and know-how to develop the deep-water wells in joint ventures and partnerships ------------------------------- Sourcing oil and gas from a stable democratic country in the same region will mean for U.S. consumers and companies lower costs and more stability of hydrocarbon inflows

President Peña Nieto assures the Reform will allow Mexico to turn this situation around by attracting private investors who will not only provide financing, but will also share the costs and risks of developing new projects.
Pemex and the power utility company, Comisión Federal de Electricidad (CFE), will remain under government ownership, but will be given greater autonomy in their management. Their structure will be strengthened, transforming them into Productive State Enterprises with incentives to partner or compete with private sector companies.

The Reform also supports an increased production of natural gas, fertilizers (the latter will receive an injection of $1.15 billion), and oil refining. Currently, Mexico is a net importer of refined products, obtaining abroad about 50% of its gasoline and 65% of its petrochemicals. In 2013, Mexico’s refineries processed 1.69 million barrels per day (bpd), compared to Brazil’s 2.1 million bpd or Venezuela’s 1.86 million bpd. Nonetheless, Pemex continues to rank high in the global refining industry and is currently positioned among the top 12 companies in capacity.

With the Energy Reform, Pemex will attract new investments, transfer of technology and know-how. Pemex expects to upgrade its six refineries and enable them to process heavier grades of crude, which account for 80% of its output from the Gulf of Mexico.

While refining holds enormous potential for foreign direct investment, exploration and development of natural gas are also attractive. Growing demand, especially from Mexico’s industrial and electric power sectors, has raised consumption to 2.3 trillion cubic feet in 2013 from just 1.4 trillion in 2000. Although natural gas production in Mexico has grown by 50% since 2000, greater investment in the sector will still be needed.

Under the new legislation, private companies will be able to produce natural gas and retail it in Mexico – a huge turnaround from the traditional system. As President Peña Nieto himself has pointed out, “We did not allow private companies to take natural gas out of Mexico, but we did buy natural gas from private companies in the U.S. and elsewhere, and resell it at a higher price than if we had produced it ourselves.”

Investment opportunities: deepwater and shale oil exploration

Mexico joined the league of the world’s top 10 oil producers thanks to the underwater deposits located in the relatively shallow waters of the Gulf of Mexico, such as the Cantarell field. At its peak, in 2004, Cantarell accounted for 63% of Mexico’s total crude production, as compared to less than 20% to date, according to Pemex. However, years of productive life in some of these wells are dwindling. To meet its increased production targets (3.5 million bpd in 2025, compared to the current 2.5 million bpd), the country will have to develop its deepwater and shale oil deposits.

Mexico holds enormous reserves in both these areas. Deepwater exploration is likely to be most appealing to integrated oil companies that can handle all aspects of the process, from exploration to production and refining. These companies already account for 88% of the crude output in the U.S. territorial waters of the Gulf of Mexico. On the other hand, companies specializing in one or another area of the process will be most attracted to shale oil exploration and production, as will the major international companies.

Deepwater exploration is already underway; at present, in the Bay of Campeche, over 100 drilling platforms are in operation. There are prospects of discovering major deposits of gas or oil located below both U.S. and Mexican territorial waters. The Transboundary Hydrocarbon Agreement (signed by U.S. lawmakers in December 2013 and subsequently included in the package of enabling legislation approved by Mexico in August 2014) dictates that both countries can exploit the deposits in question through a proportional spilt: if 40% of the deposit lies on the Mexican side of the boundary, Mexico gets 40% of the net revenues, and vice versa.

Likewise, potential investors will be looking at opportunities for joint exploitation of Mexico’s “unconventional” assets – shale oil and gas. According to the EIA, Mexico has technically recoverable reserves of 545 trillion cubic feet of shale gas and 13 billion barrels of shale oil. In fact, the Mexican state of Coahuila is home to one of the world’s largest deposits of shale gas, contiguous with the Eagle Ford formation across the border in Texas.

Investment opportunities: electricity

The transformation that comes with the Energy Reform goes beyond oil and gas. The electricity sector has also undergone a fundamental change that opens a huge investment opportunity for private companies. Mexico’s Ministry of Energy estimates that electricity demand in Mexico will increase by 4.7% annually through 2026. This will require an additional 37.5 Gigawatts (GW) of generation capacity, up from the current 62 GW. The cost of this added capacity is estimated at $57 billion, with another $36 billion forecast for investments in electricity transmission and distribution. This expansion in the power sector will capitalize on Mexico’s plentiful reserves of natural gas, in order to replace its expensive and outdated fossil-fuel generation system. With various independent power producers already present in Latin America and the U.S., the electricity sector, like oil and gas, will have a lot of appeal for private partners in the near future.

The opening of the Mexican energy sector is set to resonate in positive ways north and south of the Río Grande. Sourcing oil and gas from a stable, democratic country – and a next-door neighbor – will translate into lower fuel costs and a more reliable supply for U.S. consumers. In terms of business, the transparent legal regime, a business-friendly environment, and lower energy costs will increase the interest of current and potential North American entrepreneurs active south of the border in industries such as maquiladoras and the automotive and aerospace sectors.

As President Enrique Peña Nieto has said, “Now is the time to put this Energy Reform into action,” – a Reform which will strengthen Mexico’s national identity as an emerging power and enhance the benefits for the country’s partners and its citizens.

BENEFITS

1. Mexico will retain ownership of its hydrocarbons and Pemex and CFE will continue to be state-owned companies. However, the new legal framework permits ownership of hydrocarbons by private companies at the wellhead through licenses, profit-sharing, and production-sharing contracts.
2. An estimated half a million additional jobs will be created in Mexico during the current presidential term. This will translate into increased demand for U.S. goods and services and a higher level of education for workers in the energy industry.
3. The hydrocarbons industry will strengthen its role as a driver of economic growth in Mexico, through an investment boom in new areas. This, in turn, will kick-start the development of the entire industrial sector, promoting economic growth in different regions of the country and creating multiple job opportunities.
4. The Energy Reform will lead to lower consumer prices of electricity and gas. The utility bills of families, businesses and industries will be reduced, while an increased supply of natural gas will make more fertilizer available at lower prices. Consequently, food prices will also decline.
5. The expected benefits of the Energy Reform, in terms of investment, jobs, production and technology will boost Mexico’s GDP growth by an additional 1% in 2018 and 2% through 2025. This will contribute to the sustainable growth of the power sector at all levels, since there will be new companies involved in petrochemicals, refining, transport and storage.
6. The new business in the power sector will bring an increase in revenues for the national budget and for social programs. The government’s revenue from hydrocarbons will grow as a result of greater production of oil and natural gas. All this additional wealth will be used to foster high quality schools and social programs to build hospitals and highways, and to offer water-supply services.
7. There will be transparency regarding the operations and the revenues derived from new oil and gas contracts, which will be open to public inspection by citizens at any time. In addition, there will be annual audits of all contracts in force throughout the country.
8. CFE and Pemex will be strengthened, thereby enhancing national competitiveness. The two state-owned companies will achieve greater autonomy, efficiency and will be able to reinvest their profits as they deem best. They will also be better organized, more transparent and better equipped to improve their corporate governance and work with their partners.
9. The electricity industry will be restructured so as to guarantee competitive rates to homes, industry and commerce. The performance of all activities comprised within the electricity industry will improve, while the CFE will continue as the operator of its present infrastructure.

MYTHS

1. “Pemex will be privatized”: Pemex will remain under state ownership and control. The purpose of the Reform is to turn Pemex into a productive entity that generates wealth, not only for Mexico, but also for its potential international partners.
2. “The Reform will bring only one-sided benefits”: The Reform was designed to add value to the activities of both Mexican and international companies. Among its many benefits, it is estimated that about $1.2 trillion will be invested in the Texas-Mexico border region over the next decade.
3. “Infrastructure problems will arise”: It is not true that international companies will face security and infrastructure challenges. With the National Infrastructure Plan 2014-2018, nearly $590 billion will be invested in infrastructure development, which will help ensure quality energy at competitive prices.
4. “The surge in shale gas exploration in the U.S. has created a supply surplus that puts into question whether Mexico’s shale exploration projects would attract U.S. investors”: By 2035, an estimated 60% of total natural gas production will come from shale, which is currently one of the most important sources the U.S. is exploring to satisfy its growing energy demand. Moreover, increased production could mean that one day Mexico will no longer need to import gas.
5. “The positive effects of the Reform will not be felt in U.S. for many years”: In the U.S., Mexico’s reforms will accelerate growth, helping to narrow the socio-economic disparities between Texas’ border cities and metropolitan areas such as Houston, Dallas and Austin.
6. “The financial benefits of Mexico’s modernized energy sector will not be used transparently”: One of the Energy Reform’s fundamental goals is to make the energy industry’s activities transparent. To this end, seven transparency and anti-corruption mechanisms have been established. These will comply with international best practices.
7. “Pemex does not require the help of the private sector to make needed investments”: Pemex needs to partner and collaborate with the private sector to improve efficiency. For example, in 2012, the participation of different companies in North American deep-sea projects brought in well over $20 billion in investment.
8. “Mexico’s oil reserves are being depleted”: As of January 2014, total “3P” hydrocarbon reserves in Mexico surpassed 42 billion barrels of crude oil equivalent. Experts predict that the country still has major, unexplored deep-sea and ultra-deep deposits in the Gulf of Mexico, as well as in the Gulf of Chicontepec in Veracruz and in the country’s Northeastern region. Private investment is required to fully develop all these deposits.
9. “No energy reform of this kind has been successful elsewhere”: Brazil and Colombia are two success stories. Thanks to their energy reforms, these countries have allowed private participation and investment in the oil industry. As a result, they have dramatically increased their oil production and their overall economic growth.