View of a red pipe line, which transport

Mexico is heading towards much-needed energy sector reform, and with two of the country’s three major political parties in broad alignment on energy goals, major changes to the sector look more likely than ever, according to attorneys in the energy practice of law firm Mayer Brown.

Mexico is major oil producer, and one of the top sources of US imports, according to the Energy Information Administration. The EIA’s most recent study shows Mexico’s estimated shale gas resources at 545 trillion cubic feet, ranking it 6th of 41 non-US countries.

“There is great potential in Mexico’s deep water and shale gas resources,” Mayer Brown associate Gabriel Salinas told Breaking Energy.

But Mexico’s oil production has been declining since 2004, and “the onus on arresting or reversing production declines falls squarely on the shoulders of Petróleos Mexicanos (PEMEX), the state-owned oil company, due to constitutional limits on foreign involvement in the exploration, production, and ownership of the nation’s hydrocarbon resources”, the EIA says.

“Mexico’s production has been declining sharply during the last decade. If Mexico does not start to invest more in exploration, this trend will not be reversed,” Salinas said.

Jose Valera, a partner with Mayer Brown, explained that Mexico has long prioritized spending on production at the expense of exploration. Mexico’s congress allocates the budget of state-controlled oil and gas monopoly Pemex based on expectations of income generated from the sale of petroleum products.

Income from oil exports feeds into Mexico’s treasury, which “depends, to a large extent, on export revenues to finance ordinary operating expenses”, Valera said. “To generate an exportable product is to generate revenues in US dollars.”

“Because the revenues of Pemex are so important to finance the Treasury, there has always been an inclination to allow Pemex to risk relatively little capital for exploration,” Valera said. “The priority was to maximize the US dollars that Mexico could spend, and to maximize those dollars meant to take as little risk as possible to produce something that would generate revenues for the government.”

This may all be set to change, as the government is facing declines in three respects: reserves, production, and perhaps most importantly, exports, with a direct impact on government revenues. The export decline “is more economically significant”, Valera said. “Mexico is getting squeezed, in that its production is declining while demand is increasing, so there’s a smaller and smaller delta every year for exportable volumes.”

Low on Gas

Developing Mexico’s gas resources is also critical. The country is a major importer of natural gas, despite its large resources, and consumption has continued to rise steadily. Imported volumes from the US more than doubled from 2007 to 2012, according to EIA data. “Right now, Mexico is having to ration natural gas for the volumes demanded by industry,” said Valera.

Mexico cannot rely solely on piped gas from the US to meet its needs. “Mexico has relatively poor gas transportation infrastructure, so not all the gas that can be imported from the US by pipeline can effectively reach all the demand centers in Mexico,” Valera said. The country also imports LNG. “Mexico is having to buy LNG on the spot market to bring in more gas, but at very high prices – $14, $15, even $17 per million Btu,” Valera said.

“When you add what Mexico has to pay to import fuels with what Mexico has to pay to import natural gas, it is almost what Mexico makes exporting crude oil,” said Valera. “Soon you’ll have a negative trade balance in hydrocarbons.”

“Those two elements, to me, make a convincing case that the public interest is not being served as a direct result of energy policy,” Valera said.

Two Out of Three Ain’t Bad

Mexico’s declining production and rising energy consumption have been on the reform agenda for years. But political conditions may finally be conducive to moving forward with reforms that have failed in the past, with two of the country’s three major political parties – the National Action Party (PAN) and the Institutional Revolutionary Party (PRI) – backing energy reform.

The PAN has tried to reform the energy framework in the past, with no success. But for the first time in decades, the PRI appears to be on board, as well.

The current president, Enrique Peña Nieto, is a member of the PRI, which is the party behind the initial nationalization of Mexico’s oil and gas industry. “The political party in Mexico with the most political capital to reform the energy sector in Mexico is the part that created the monopoly and nationalization in the first place,” Valera said.

“For the first time, you have the PRI openly and seriously proposing energy reform, Valera said. And the combined efforts of the PAN and the PRI could be sufficient to move reforms past the Party of the Democratic Revolution (PRD), which opposes them.

“For the first time you have two political parties with enough numbers in the Mexican Congress to make the reform happen,” Valera said. “That is why it does look different today than at any other time in the past.”

What Will Reforms Look Like?

Valera expressed some doubt that Pemex would follow the model of Brazil’s Petrobras or Colombia’s Ecopetrol via public sale of company shares. “But what could happen is a reform concerning a breakup of its monopoly that would allow private-sector companies to carry out exploration and production,” he said.

There are several possible avenues that could enable private company participation, including production-sharing agreements, direct issuance of exploration and production licences, or joint ventures with Pemex. And private sector exploration and development activities would likely focus on two areas that Pemex has neglected: the deepwater Gulf of Mexico and shale.

“The deepwater was little-explored because of the very high economic risks and costs, and very complex technology involved, said Valera. In shale, not only did Pemex have little economic incentive to explore Mexico’s resources, “shale gas necessitates certain technologies and certain know-how that is simply not available in Mexico”.

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