Mexico Opens Up Its Energy Industry: The Liberalization of Mexico’s Energy Sector May Lead to New Opportunities for Investors

by Dechert LLP

Mexico’s president, Enrique Peña Nieto, introduced a reform in August 2013, according to which the Mexican state will give up absolute control over the supply of oil, gas and electricity. The relevant bill changing the Mexican constitution came into effect on December 21, 2013, following ratification by the requisite number of state legislatures and leaving the way open for the relevant implementing legislation to be passed.

In Mexico, deposits of oil and gas have long been a nationalized commodity. Before the reform, the constitution stipulated that all underground resources located within Mexican territory belonged entirely to the state, and concessions or private shares were prohibited. Through its monopoly of the rich oil reserves in the Gulf of Mexico, state corporation Pemex (Petróleos Mexicanos) has evolved into a major economic power: its profits comprise nearly a third of Mexico’s national budget, and, with 150,000 employees, Pemex plays an important role in Mexican social politics. The state’s complete control of prices for oil and gas has also enabled it to subsidize the Mexican population to a certain degree.

However, Pemex has not been able to take full advantage of modern technologies that would have allowed it to develop the oil deposits in the deepwater areas of the Gulf of Mexico. As a result, the number of newly tapped oil wells has dropped dramatically, and the output of oil has decreased by almost one third over the past 10 years. Moreover, the country lacks sufficient capacity to refine its oil, meaning that Mexico’s imports of refined oil now exceed its exports of crude oil. The same applies to its gas deposits: due to its lack of the latest technology, Mexico currently needs to import a significant amount of natural gas from the United States.

The energy reform will allow Mexico to tap hitherto undeveloped oil and gas deposits, including deepwater oil deposits and shale gas. The government will rely on private equity and foreign technology to access these deposits. Nevertheless, the constitution has only been amended to permit private sector players to have a participating economic interest, as opposed to a legal interest, in the deposits.

Once the energy reform is fully enacted, Pemex will continue to operate the oil and gas fields that it is currently developing. However, the reform will facilitate the outsourcing of existing deposits to special-purpose vehicles with foreign private stakeholders, and unexplored deposits will be put out to tender, in which both local and foreign corporations can take part. Under the government plans, Pemex will also be able to partner with private entities that constitute appropriate technology partners.

The bill assumes that implementing legislation will set out to the required level of detail provisions allowing for profit-sharing agreements, production-sharing agreements and licenses. For the reform to succeed, it is vital that private oil companies concluding oil and gas production- or profit-sharing agreements with the Mexican Department of Energy and financing the exploration and production of the oil and gas may book the relevant reserves on their own balance sheets. Only if this right is enshrined by the implementing legislation will investors have sufficient economic incentive to finance Mexico’s oil and gas industry.

In addition to liberalizing the exploration and production of oil and gas, the reform will also liberalize the production of electricity in Mexico. In a break with tradition, private providers will be permitted to sell electricity to third parties. Private competition with the former monopolist Comisión Federal de Electricidad (CFE; English: Federal Electricity Commission) is explicitly encouraged in order to enhance the CFE’s efficiency.

The law implementing the energy reform has to be passed in the first quarter of 2014 and the first profit- or production-sharing agreement may be signed shortly thereafter. Then it will be clearer how attractive the regime will be to foreign investors.

This update was authored by Sven Schulte-Hillen and Dr. Markus J. Friedl. It is based on a German language article that originally appeared in Energie & Management Powernews on November 25, 2013.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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