I’VE GOT THE POWER

Mexico 2014 | ENERGY | FOCUS: MEXICO ENERGY REFORMS

Key sector reforms have addressed Mexico's inability to best exploit its natural reserves, ultimately opening up the field to new players.

The sudden absence of oil drilling platforms south of the US-Mexico border is a striking visual reminder of the importance of the energy reforms signed into law by Mexico's President, Enrique Peña Nieto in August 2014. Despite estimates by industry analysts of 60 billion to 120 billion barrels of oil in the deep-water Gulf, shale, and other land deposits in Mexico, most reserves have gone undeveloped. While having some of the largest unexploited oil reserves in the world, Mexican production has actually declined sharply in recent years because PEMEX, Mexico's state-owned petroleum company lacks the technical expertise and investment to access deep-water reserves. President Nieto's reforms aim to correct this paucity by breaking PEMEX's monopoly on the industry and opening up Mexican reserves to foreign companies. This process is proving a challenge however, since PEMEX's status is enshrined in the constitution, and change will need to happen incrementally. Meanwhile, uncertainty remains as to how the reforms will play out.

One major component of the legal reforms is simplified taxation and financial obligations. Changes to the fiscal rules governing international oil companies are designed to attract participation and investment, where previously, rigid regulations gave exclusive access to PEMEX. Sliding scale royalties have been established that vary based on the nature of the field, its production, and fluctuations in oil prices. The exact terms will vary by contract, which will be established when the deals are inked. Corporate taxes will also be set at a standard 30%. This will let oil companies make significant investments without worrying that global price trends will undercut profits.

Mexico's legislature has also introduced three new types of contracts that will increase opportunities for foreign investment in the sector. Profit-sharing contracts will entitle companies to a set share of the profits resulting from oil and gas development. Even though companies will not own the resources being developed, they would be allowed to exclude the revenue from their estimated future profits. Meanwhile, production-sharing contracts will allow companies to hold titles to a percentage of resource volumes as they are produced. A final licensing agreement will allow companies to be paid in oil and natural gas extracted from each project.

Turning their sights on PEMEX, legislature has simplified the state-owned company's complicated financial regime by reducing its 11 different taxes to four (including income tax). Like its expected foreign competitors, PEMEX will also be subjected to a sliding tax-scale, ensuring that the state run company is not overwhelmed by private entries in the new market. PEMEX's cost deductions are also now capped at $6.5 per-barrel, and new deductions are not permitted. These changes should allow PEMEX to remain competitive with international oil companies, while taxes and royalty payments should decrease notably in the coming years.

Beyond purely legislative changes, the reforms are expected to change the environmental dynamics of Mexico's oil production industry. Energy reform mandates the use of clean compounds and reductions in GHGs. A combination of high-tech investment and state incentives is expected to bring about a transition from polluting fuel oil plants, to power generation that uses cleaner fuels such as natural gas. New laws also promote reforms in the following areas: energy efficiency, reduction in the generation of greenhouse gases, lowering waste generation and emissions, and the reduction of the industry's carbon footprint. In August 2014, legislation was passed establishing the Industrial Safety and Environmental Protection for the Hydrocarbon's Sector body (ANSIPAH), which was tasked with regulating exploration, oil and liquid petroleum treatment, refining, transfer, marketing, transportation, and storage activities. With broad industry oversight, and the ability to impose hefty fines for violations, ANSIPAH will ensure that the expansion of the energy sector does not come at a high environmental cost.

Mexico is now the world's 10th-largest oil producer, and 6th in terms of recoverable shale oil. With much of the reform agenda wrapped up, Mexico is set to take advantage of its resources sustainably, while protecting the basic principles of sovereignty. Reforms will ensure that the energy sector becomes an engine of economic growth, guaranteeing the supply of oil, gas, and electricity at competitive prices.