The Petrochemical Industry

Introduction

Petrochemicals are one of the pillars of Mexican industry supplying a wide range of raw material. However, during the 1990s a controversy arose in Mexico about the constitutionality of the basic petrochemical industry (BPI) and the secondary petrochemical industry (SPI). This controversy intensified in July 1995 when the Mexican government began to realize the possibility of selling off various assets for the production of secondary petrochemicals located at 61 petrochemical plants distributed in 10 complexes owned by Pemex-Petrochemical.

Various sectors of the Mexican community opposed the sale and the possibility of liberalizing the petrochemical industry, including senators and representatives, unions, industrial leaders, associations, industrial chambers and certain political parties. This caused a climate of uncertainty and lack of confidence among domestic and foreign investors who wanted to invest in the petrochemical industry.

This update discusses some legal considerations about the constitutionality or otherwise of both Mexican and foreign private investors in the BPI and the SPI, and the need for private investment in this sector.

Background

The transformation of hydrocarbons through chemicals began in the first decades of the last century in the United States. However, it was not until the Second World War that the petrochemical industrial developed to an industrial scale due to the need to find substitutes for natural products and raw materials.

In Mexico this industry started in the 1950s when plants were constructed to manufacture substitutes of imported products such as formaldehyde, plastic resins and ammonia.

During the administration of President Adolfo Lopez Mateos in 1959, the development of the petrochemical industry was established as a priority. During this period the possibility of using private capital to develop the industry become apparent to the government. The then director of Petroleos Mexicanos (Pemex) Pascual Gutierrez Roldan analyzed the possibility of "associating with interested Mexican and foreign private parties for the production of polyethylene". The industry developed during the 1960s and 70s. Production in the volume of petrochemicals increased 53 times, 359 petrochemical permits were awarded between 1961 and 1983, 163 of which were delivered to companies, and investment rose to more than Ps500 billion.

The petrochemical industry boom was spurred on by the six year Basic Petrochemical Programme 1977-1982 during President Jose Lopez Portillo's administration. Under this programme the petrochemical industry was established as a priority, reflecting the government's intention to develop it to levels of international competition.

In 1986 a new programme was enacted to further developing economic petrochemical activities: the Integral Programme for Development of the Petrochemical Industry, which attempted, among other things, to convert the domestic petrochemical industry into a net generator of foreign currency.

In 1990 all companies manufacturing petrochemicals through the direct transformation of basic and secondary petrochemicals were obliged to register at the Mexican Petrochemical Commission in order for greater control to be exercised over productivity and investment in the industry.

In 1992, through the promulgation of the Organic Act of Petroleos Mexicanos and Subsidiary Entities (the Pemex Charter), Pemex-Gas and Basic Petrochemical (Pemex-G&PB) and Pemex-Petrochemical were created as decentralized bodies with their own legal status and patrimony.

The Basic and Secondary Petrochemical Industries

One of the fundamental characteristics of the petrochemical industry is its structure of long productive chains that supply other fields of economic activity, the first link of which are the primary and the secondary petrochemical products. In order for these chains to function efficiently, adequate communication is needed between the supply of raw materials and the establishment of prices culminating in various products.

Basic petrochemicals
The BPI includes:

"Products that are suitable as basic industrial raw materials and which result from the petrochemical processes founded on the first important chemical transformation that is done to products or sub-products by refining natural petroleum hydrocarbons."

Thus, the BPI is a source of supply of raw materials for the SPI.

The BPI is an economic activity exercised exclusively by the state. In practice, private companies acquire the national products of the first processes from Pemex-G&PB or from abroad, and with them create hundreds of chemicals that are transformed into articles for daily use.

Secondary petrochemicals
The SPI is defined as "the subsequent transformations of basic products to give a large diversity of intermediate petrochemical products".

In the SPI sector, secondary products may be obtained from the Mexican state and private parties of Mexican or foreign nationality.

Legal Framework

The Mexican Constitution
Pursuant to the Mexican Constitution the government has exclusive rights over the subsoil as well as the exclusive right to exploit and develop petroleum and gas. The wording of the Constitution bars private ownership of hydrocarbons and reserves ownership of petroleum and all solid, liquid, and gaseous hydrocarbons to the state. The ownership of such natural resources is a constitutional right that is inalienable and not subject to any statute of limitations. Consequently, it is impossible for the government to concede oil exploration and exploitation rights to private parties.

Further, the Constitution considers the petroleum and BPI industries as strategic areas in which all domestic hydrocarbon resources and basic petrochemicals are exclusively reserved to the state.

The Pemex Charter
Pemex was created by the Mexican Congress immediately following the expropriation of the oil and gas industry. In 1992 the Mexican government submitted a bill to Congress that restructured Pemex in order to preserve and guarantee its role in the Mexican economy and the international market. Upon the bill's approval, the Pemex Charter effectively restructured the operative sub-agencies of Pemex by creating the following subsidiaries:

• Pemex-Exploration and Production;
  
  
• Pemex-Refining;
  
  
• Pemex-G&PB; and
  
  
• Pemex-Petrochemical, which participates in the SPI together with national and foreign investors.

Each of these subsidiaries enjoys a distinct legal status and is capable of owning property. Each subsidiary is independently responsible for the functions entrusted to it. The subsidiaries are structured along integrated lines of business and operate as cost centres, which are evaluated based on their productivity. At the same time Pemex-Corporativo remains the entity primarily responsible for the oil and gas industry. Foreign participation in Pemex or in its subsidiaries is prohibited.

Gradually, Pemex has expanded its scope of activities to include a variety of economic activities that are not considered strategic areas constitutionally reserved to the Mexican government, nor the exclusive domain of the oil and gas industry in accordance with the Regulatory Law of Article 27 of the Mexican Constitution in the Petroleum Branch (the Petroleum Law), such as the SPI.

In view of the constitutional restrictions relating to the petroleum and BPI industries, it follows that the BPI is reserved to the Mexican government for its exclusive ownership, development and commercialization. As a result, Pemex and its decentralized subsidiaries, in particular Pemex-G&PB, carry out the development of this industrial sector in an exclusive manner. Thus, direct participation of foreign or Mexican private investment is not allowed in the development of the petroleum and BPI industries. However, by not forming part of a strategic area as set forth in the Mexican Constitution, public, private (either Mexican or foreign) and social sector participation is allowed in the SPI.

The Petroleum Law
In 1958 the Petroleum Law was enacted, the original version of which enlarged the scope of activities reserved for the oil and gas industry. However, in subsequent reforms approved by Congress on May 11 1995 and November 13 1996 restrictions were eased on the natural gas and petrochemical sectors. As a result of these reforms, the petroleum industry currently encompasses:

• the exploration, exploitation, refining, transportation, storage, distribution and first-hand sale of petroleum, and by-products obtained through the refining process;
  
  
• the exploration, exploitation, production, and first-hand sale of gas; and
  
  
• production, storage, transportation, distribution, and first-hand sale of by-products that can be used as basic industrial materials, as well as the following basic petrochemicals: ethane, propane, butane, pentane, hexane, heptane, naphtha, the raw material for smoke lampblack and methane when this comes from Mexican hydrocarbons.

Should the production of secondary petrochemicals also result in the generation of basic petrochemicals by private investors these may be used by the investors in their own operations or sold to Pemex or its subsidiaries. In any event, private investors must notify the Ministry of Energy of the generation of such basic petrochemical products.

The amendments to the Petroleum Law ended the classification of BPI and SPI. When Mexico changed its international economic policy by becoming a member of the Agreement on Tariffs and Trade (GATT) in 1986, it commenced with the deregulation of BPI products. In October 1986 the former Ministry of Energy reclassified petrochemical products, reducing the number of primary products. The products that remained as basic petrochemicals were: cetaldehyde, acetonitrile, acrylonitrile, alfaolefins, ammonia, benzene, cyclohexane, vinyl chloride, cumen, dictoroetano, dodecibenceno, styrene, ethane, ether metilterbulico, etilvenzene, ethylene, heptane, hexane, isopropanol, raw material for black smoke, methanol, N-paraffins, interofelins, ortoxilene, ethylene oxide, paraxilene, pentane, polyethylene AD, polyethylene BD, propylene, propylene tetramer, toluene and xylene.

Three years later, the government maintained only 20 products as basic, establishing 66 as secondary. The products removed from the basic petrochemical list were acetaldehyde, acetonitrile, acrylonitrile, alfsolefinas, cicloexano, chloride de vinyl, cumeno, dicloroetano, styrene, etilbencano, isopropanol, olefinas internas, oxide de ethylene, polietifeno AD and polyethylene BD. In 1991 ether methyl was also reclassified as a secondary product. The most recent resolution classifying basic and secondary petrochemicals was issued in 1992 establishing the following eight products as basic: ethane, propane, butane, pentane, hexane, heptane derived form natural gas, naphtha and the raw material for smoke lampblack.

Foreign investment law
Since the administration of President Adolfo López Mateos in 1959, private parties have been granted the authority to participate in the SPI. This right was curtailed in 1973 when Congress passed the Law to Promote Mexican Investment and to Regulate Foreign Investment. This legislation limited foreign participation in the SPI to less than 40%. This protectionist law was repealed and replaced in 1993 by a new Foreign Investment Law, which allowed foreign investors to freely participate in the SPI without being subject to any percentage limitation. This was based on the repealation of the general standard of 49% foreign investment applicable to all economic activities not otherwise subject to a specific percentage limitation.

The Foreign Investment Law was a result of Mexico's efforts to open up its markets in order to meet the objectives of international agreements such as the North America Free Trade Agreement (NAFTA).

The p private sector may participate in the BPI and SPI provided that:

• The national BPI is the exclusive domain of Pemex and its subsidiaries.
  
  
• Pemex maintains control over the production, transportation, distribution, storage and first-hand sale of Mexican basic petrochemical products.
  
  
• Foreign and domestic private investors can participate in the SPI in terms of production, transportation, distribution, storage and commercialization.
  
  
• In the event that the production process of secondary petrochemical products results in basic petrochemical products, the investors can use such primary products in their own facilities or sell them to Pemex and its subsidiaries.
  
  
• Mexican and foreign companies can freely engage in the above-mentioned SPI activities. Significantly, investing companies are able to operate and own petrochemical plants, installations and related facilities in Mexico, with no cap as to their percentage participation. Consequently, even if the petrochemical plants of Pemex-Petrochemical remain unsold, foreign investors may continue to participate in the SPI.

NAFTA
The force and effect of NAFTA opened up one of the world's largest energy blocks. Chapter 6 of NAFTA, "Energy and Basic Petrochemicals", establishes the rules to be followed by the three signatory countries in relation to the trade of energy products and the BPI.

In NAFTA the Mexican government secured the inclusion of reservations applicable to the activities that are exclusively reserved to the Mexican state (eg, BPI). However, these activities may be gradually opened up to direct private investment with respect to (i) the development and commercialization of the same economic activity; and (ii) the sale of assets that have been dedicated to the development of the BPI. Hence, the Mexican government's assets devoted to the BPI are presently subject to foreign investment restrictions. Nevertheless, the Mexican government may sell the secondary petrochemical assets owned by Pemex-Petrochemical since such assets are not considered a strategic activity in accordance with the Constitution and the Petroleum Law.

In view of this it is evident that NAFTA only covers the strategic areas cited, including the BPI, but excluding the SPI. As a result, both the Foreign Investments Law and the Petroleum Law permit up to 100% foreign participation in companies dedicated to the SPI sector, as well as the purchase of assets forming part of the SPI.

NAFTA also establishes that where an activity was reserved to the Mexican government as of January 1 1992, but did not enjoy such reservation when the treaty came into effect, Mexico may restrict the initial sale of state-owned assets to Mexican national ownership, as defined in the Constitution. In addition, such limitation may also apply to any ownership interest in a Mexican government enterprise. Further, for a maximum period of three years from the initial sale, Mexico may permit the transfer of such assets or ownership interest solely to other enterprises with majority Mexican national ownership, as set forth in the Constitution. Upon expiration of the three-year period, the obligations of national treatment set out in Article 1102 apply.

In negotiating NAFTA Mexico established that its Constitution would not be open to negotiation, thus establishing similar respect towards the constitutions of Canada and the United States. Likewise, it established the necessity of observing domestic law on BPI matters by establishing that attention be paid to the standards adopted in Mexico. On the other hand, the Mexican negotiators, in observance of the Constitution, not only expressly established the applicable reservations for foreign investment, production, foreign trade, transportation, storage, distribution and first-hand sales of the BPI, but also reserved the other strategic areas that are prescribed for energy matters in the Constitution.

With respect to the supply of primary products and for the purpose of promoting cross-border trade of the BPI, NAFTA establishes the possibility that Pemex-G&PB, end users and suppliers of these products may negotiate supply contracts in accordance with the Mexican domestic legislation. The first-hand sale of Mexican BPI is part of Pemex's monopoly, carried out by Pemex-G&PB.

Comment

From a legal viewpoint it is evident that the aim of Article 28 of the Constitution has been to reserve the dominion, exploitation and enjoyment of the BPI only exclusively in favour of the state, not the SPI. Thus, the legislature through various laws (eg, the Petroleum Law and the Foreign Investment Law) has permitted the participation of both national and foreign private investment in the SPI.

For further information in this topic please contact Alejandro López-Velarde at Lopez Velarde, Heftye, Abogados by telephone (+52 55 50 81 1424) or by fax (+52 55 50 81 1425) or by email ([email protected]).