Supporters Of Mexico's PRI Party Await Election Results

Proposed amendments to Mexico’s constitution that would open up the country’s energy sector to foreign investment stand a good chance of passing, thanks to a pressing need for revenues and a well-staged political campaign. But the follow-up legislation that sets the tone for foreign investment will be critical to the success of efforts to revitalize oil and gas production.

Mexico’s president, Enrique Peña Nieto, has proposed amending the country’s constitution to allow for foreign company participation in oil and gas exploration and production, as well as the midstream, refining and power generation sectors. All points on the oil and gas value chain in Mexico are currently controlled by state-owned Petroleos Mexicanos, or Pemex.

“The most important part of the President’s proposal is that it eliminates the Pemex monopoly on the oil and gas sector,” Dallas Parker, a partner with law firm Mayer Brown, told Breaking Energy. “It opens up the opportunity for contracts with international oil companies to participate in the Mexican energy sector.”

Parker and other Mayer Brown attorneys, including Mayer Brown partner Jose Valera and associate Gabriel Salinas, have indicated that while such reforms have popped up previously in Mexico’s political discourse, the chances of success are better this time around than at any previous point. Not only are two of Mexico’s major political parties aligned behind the need for reform, President Pena Nieto has linked his proposal to policies enacted by former President Lázaro Cárdenas, who was behind the nationalization of Mexico’s oil sector in 1938, and is still viewed with reverence by the Mexican populace, according to Parker.

“Nieto has made a smart move here,” Parker said. “In large measure, what he’s doing is taking the constitution back to where it was in 1938…Cardenas is such a revered historical figure in Mexico that it’s going to make it harder for those who would oppose reform to oppose it.”

The Devil is in the Details

A constitutional amendment, if successful, will be a significant step towards a more liberalized oil and gas sector. But it is not the only political hurdle to bringing in foreign investment. “A constitutional amendment is always in the broadest possible terms,” Parker said. “It opens the door, but they’ll have to have enabling legislation that spells out the details.”

Mexican lawmakers will have to draft and enact legislation that creates the kind of business environment in which foreign oil and gas companies will want to invest. “It will boil down to government take, opportunity for profit, and the tax regime that overlies this oil and gas structure,” Parker said.

One area that may prove non-negotiable is the booking of reserves – the inclusion of oil or gas reserves on foreign oil company balance sheets. “The enabling laws are going to have to make clear that the booking of reserves is explicitly permitted,” Parker said.

Contract type will also play a role in the degree of foreign interest in Mexico’s fields. And “Industry would prefer a production-sharing arrangement as opposed to a profit-sharing arrangement,” Parker said.

Cost recovery – the portion of costs an investor is entitled to recover before production- or profit-sharing kicks in – will also factor into international oil companies’ investment decisions, as will sector governance. “We don’t know yet if Pemex is going to make the rules, of if there’s going to be a separate national commission.”

And contracts will have to be structured in such a way that investing in Mexico is at the very least competitive with investments elsewhere around the globe, as companies are finding bigger payouts in deep and ultra-deep waters, as well as in unconventional plays. “They’re going to have to present an overall package that is attractive in light of conditions prevailing internationally,” said Parker.

What Could Go Wrong?

While momentum for reform appears strong, amending the constitution may not go as smoothly as planned.

“The main risks threatening the reform involve the constitutional reforms getting diluted in congress, or the secondary laws somehow not following the spirit of the constitutional proposals,” Salinas said

But a real need for reform – to arrest and perhaps reverse the ongoing decline in reserves, production and revenues – may argue in favor of optimism. “That in my mind is the strongest point in favor of reform,” Salinas said.

“Mexico is leaving money on the table. It’s only a matter of time before they make the necessary changes to develop its reserve potential,” said Salinas.

“There’s lots of opportunity for tripping up, but I think there’s a real understanding among Mexican politicians, at least the majority, that they’re in this unhappy position of declining production in a world that’s seeing a lot of new discoveries. In today’s oil and gas world, the big finds require deep technological expertise and very significant risk dollars,” Parker said.