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Aug 9, 2013 | 10:12 GMT

7 mins read

Mexico: On the Brink of Major Energy Reform

Mexico: On the Brink of Major Energy Reform
Ronaldo Schemidt/AFP/Getty Images
Summary

Mexican President Enrique Pena Nieto is expected to submit his party's landmark proposal for energy reform to Mexico's Congress in the coming week, culminating nearly a year of speculation and intrigue. Despite the controversy over the reforms, which proved troublesome for many previous administrations, Pena Nieto and the Institutional Revolutionary Party will enact measures capable of revolutionizing Mexico's energy sector. Unlike previous attempts, this energy reform package has the support of Mexico's largest opposition group, the National Action Party. The second-largest opposition group, the Democratic Revolutionary Party, is too weak to seriously hinder the bill's passage. While lawmakers will debate the finer points of the reforms, as well as any subsequent pieces of legislation, Mexico will soon see the most transformative adjustment to its energy sector in more than half a century — even as it sees some public unrest in response to the bill.

In December 2012, Mexico's three major parties agreed in the Pact for Mexico to reform the energy sector. But the promise was intentionally vague, leaving ample space for tri-partisan cooperation. Now, eight months later, Mexico's ruling party is poised to announce its proposal for reforming the country's struggling energy sector. 

On one end of the spectrum, the leftist Democratic Revolutionary Party supports the most limited energy reform, focusing solely on improving Petroleos Mexicanos, commonly known as Pemex, from within. It does not advocate changing the constitution's Article 27, which prohibits concessions in the energy sector. This kind of reform would make the company more profitable but would not address the country's most pressing issue: the need to expand hydrocarbon exploration and production from the comparatively easy and inexpensive Bay of Campeche into the more difficult, more capital-intensive deep-water plays in the Gulf of Mexico and in the shale deposits in the northeastern basins.

Mexico's Main Oil and Natural Gas Regions

Mexico's Main Oil and Natural Gas Regions

On the other end of the spectrum, the right-of-center National Action Party previously has supported more comprehensive proposals, including the idea of partially privatizing Pemex. Given the nationalist fervor surrounding Mexico's oil — a fervor whose roots can be found in the post-Mexican Revolution period — this proposal is highly controversial and stands little chance of acceptance. While there is a broad consensus on the need to allow more private partnerships and promote competition, a consensus has yet to be reached on privatizing Pemex or on allowing private firms to own the oil itself.

In the middle of these two extremes lies the proposal the ruling party is likely to put forth. The Institutional Revolutionary Party has suggested numerous times that it is interested in a transformative, structural reform, but one that stops short of privatizing Pemex. This is widely understood to mean improving Pemex operationally, introducing more attractive contracting models and perhaps even breaking Pemex's and the Federal Electricity Commission's monopolies. How the ruling party will go about doing this is still unknown. In theory it could implement tax reform, pension reform or subsidy reform. Otherwise it could require Pemex to have a certain stake in any offshore project, or it could give Pemex certain lucrative areas for exploration. But essentially, this middle-ground proposal allows the country to address declining hydrocarbon production without ceding control over its most lucrative natural resource and associated state-owned enterprise.

Obstacles to Reform

Pushing through the desired reforms likely will require a constitutional amendment — many reforms passed under the current administration have. But to amend the constitution, the Institutional Revolutionary Party would have to partner with another party to secure the two-thirds majority in the federal legislature and a simple majority of all state legislatures. The National Action Party is the most logical choice because it has been trying for 12 years to reform the energy sector. Its proposal is transformative, while the Democratic Revolutionary Party's ideas are essentially more of the same.

In late July, the National Action Party proposed a reform that would change articles 25, 27 and 28 of the constitution. In Article 25, the party introduces environmentally friendly qualifiers, likely to curry favor with Mexico's Green Party and satisfy the Pact for Mexico promise to make Pemex a central force in the fight against climate change. In Article 27, it proposes scrapping the prohibition of concessions, thereby creating the opportunity for increased foreign investment. In Article 28, it proposes breaking the monopolies in the energy and electricity sectors, thus allowing private firms to compete all along the production chain: exploration and production, distribution, refining and retail. This would relieve some of the burden on Pemex to operate certain sections of the supply chain at a loss and enable the firm to focus on its more profitable activities in the upstream sections.

The proposal also calls for the creation of a Mexican Petroleum Fund to manage petroleum proceeds. Moreover, it would allow the National Hydrocarbon Commission and the Energy Regulatory Commission to grant concessions to the private sector in the upstream and the downstream/electricity sectors, respectively. The National Action Party also proposes keeping Pemex and the Federal Electricity Commission as state-owned companies but removing them from the federal budget and granting them operational autonomy, as well as a 10-year plan to reduce the federal government's dependence on Pemex for tax revenues. This ensures a soft landing and gives the government time to develop other sources of fiscal revenue.

None of this directly contradicts the broad outline of what the ruling party is expected to propose. It addresses the need to make Pemex more efficient, and it grants the government the ability to form new contracting models — effectively breaking Pemex's and the Federal Electricity Commission's monopolies. There is no privatization of Pemex, and there is nothing to suggest that the oil will cease being the property of the Mexican nation. Details are still scarce, but recent reports suggest that the government will find a way to give foreign firms the juridical certainty and the profit margins needed to incentivize risky, capital-intensive endeavors without transferring ownership of the resource itself. So while the Institutional Revolutionary Party's proposal will differ from the National Action Party's, those differences likely will be surmountable.

Growing Support for Pena Nieto's Plan

Pena Nieto has used the past eight months to consolidate support for the reform from within his party. In the last week of July, the Mexican government came to a wage increase agreement with the powerful oil workers union and had talks with some 18 Institutional Revolutionary Party governors whose support will be critical for passage of the constitutional reform. Unlike the National Action Party before it, the Institutional Revolutionary Party has been bringing all of the major interest groups on board before releasing the proposal, suggesting that once it is released it will be debated and approved relatively quickly, possibly by year's end. Recent delays in releasing the proposal suggest the government is addressing disagreements pre-emptively rather than waiting until later on to address internal concerns.

With few major disagreements between the National Action Party and the ruling party on the proposal, and with the major pillars of the ruling party apparently in favor of the reforms, Pena Nieto's efforts now are more of a public relations campaign than anything else. The opposition Democratic Revolutionary Party is trying to characterize the reform as a brazen and undemocratic privatization. By contrast, the Institutional Revolutionary Party has vociferously denied that the reforms will privatize Pemex and change the ownership status of the country's oil reserves.

Privatization is a highly ambiguous term in the context of Mexico's energy sector reforms. The Democratic Revolutionary Party equates privatization to allowing foreign and private firms to gain concessions, and the other two major parties equate privatization to allowing private investment in Pemex. Ultimately, the task for the Mexican government is to forge a proposal that significantly addresses problems facing the energy sector while convincingly arguing that the reform is not tantamount to privatization.

The Democratic Revolutionary Party has announced that it will hold a non-binding national referendum in half of Mexico's states on Aug. 25 and in the other half on Sept. 1. (The referendum coincides with the start of Congress's regular session.) The party also has planned a national demonstration on Sept. 8. These measures portend a fractious September, though the Democratic Revolutionary Party's ability to impede the passage of the bill is doubtful. Andres Manuel Lopez Obrador, a former presidential candidate for the party, managed to bring some 30,000 people out to protest an energy reform in 2008, but the Democratic Revolutionary Party's popularity has since waned, as has the popularity of Lopez Obrador, who has left his former party.

The Democratic Revolutionary Party can protest the bill but only at the risk of appearing obstructionist. In the meantime, the Institutional Revolutionary Party and National Action Party will go on to pass one of Mexico's most transformative reforms in decades.  

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