When the Mexican Government expropriated foreign-owned oil and gas companies on 18 March 1938, and subsequently established the national oil company Petróleos Mexicanos (Pemex), it not only cemented exclusive government control over oil and gas activities in the country, as required by Article 27 of the 1917 Mexican Constitution, but also established a perpetual hope on the part of private industry participants that some opening of the sector to private investment would be just around the corner.
In 2007 and 2008, the Calderón administration raised such hopes significantly when it sought to liberalise the Mexican oil and gas regime, but the consensus in the industry is that although the 2008 Calderón energy reforms were a movement in the right direction, they nonetheless came up short. The election of Mexican President Enrique Peña Nieto in July 2012, and events following his assumption of office in December have, however, caused many in the industry to believe again that Mexico is on the verge of making opportunities in the oil and gas sector not only available but also attractive.
In March, President Peña Nieto’s Institutional Revolutionary Party (the PRI) added to this belief when it changed its platform to delete language that had opposed private money in the oil and gas sector. This change was not only practically significant, given the PRI’s role as a major party that now holds the presidency, it also holds huge symbolic importance. This is because the PRI dominated Mexican politics and controlled the presidency for most of the 20th century and is commonly regarded as the “old guard” of Mexican politics. In early 2013, the president also proposed a National Energy Strategy 2013–2027 that, although lacking specifics in many respects, reinforced the belief that greater competition in the overall energy sector is a key goal of the administration. Such events have spurred intense debate—and even protests—so it is difficult to predict the eventual form of any changes President Peña will be able to implement.
Hopes are high, however, that forces on all sides in Mexico will soon come to an agreement on some form of change that will allow and attract greater private participation in the sector, largely because the Mexican federal budget may depend on it. The financial reality in Mexico is that the government relies on the oil revenues of Pemex Exploration and Production (PEP) to fund around a third of the federal budget. Although Mexico is still a huge oil producer, crude output is on the decline and many Mexicans find it increasingly frustrating that new technologies are yielding gains in production in other countries. Although technology has always been important in the industry, PEP’s current requirements for technology that is currently in use in other jurisdictions is particularly acute now because of its need to use enhanced oil recovery techniques in plays where output is declining, its desire to exploit new areas in the deepwater Gulf of Mexico and its hopes to take advantage in new plays of unconventional drilling techniques that have created a boom just north of the border in the United States. Allowing greater private participation in Mexican exploration and production would, if done properly, give PEP access to both the technologies and the cash currently available to private players in the sector.
Given these forces, it is important to understand what changes private oil and gas companies—particularly the major international oil companies—have hoped for in Mexico up to this point. Although it is difficult to predict the final form of any changes currently being considered, any package that successfully attracts greater private, particularly foreign, participation would seem to require at least some of the elements discussed below. While some of these changes would require constitutional reform, others could be accomplished relatively simply by changing the terms of the model integrated services contract that was developed by PEP as a result of the 2008 Calderón reforms.
In the eyes of most private oil and gas companies, the Holy Grail of Mexican energy reform would be a change that allows private companies to participate in exploration and development in Mexico in a way that allows them to “book reserves”. This basically means they could then treat reserves in the ground to which they have rights as assets of their companies for accounting purposes. This would greatly expand their ability to obtain both debt and equity financing, given the resulting greater asset base. The fundamental problem with instituting any change in Mexico that would allow such accounting treatment, however, is that Article 27 of the Mexican Constitution grants direct ownership and exclusive rights of exploration and development of hydrocarbons to the Mexican state. Furthermore, the Petroleum Law of 1958 prohibits payments to operators based on a percentage of production, participation or the results of exploration.
These restrictions have required PEP to use service contracts where contractors receive a cash fee and, if applicable, bonuses. They have prevented PEP from being able to offer concessions, production sharing contracts or similar structures used elsewhere in the world that offer private companies the opportunity to book reserves. Although Mexico has amended its constitution hundreds of times, the prospects for constitutional reform on this issue seem remote as the Mexican state’s constitutional monopoly on ownership of petroleum in the ground has become an important part of Mexican culture and identity. Never say never, but making changes that would allow booking of reserves seems, at least, to be the biggest challenge on the menu of possible reforms.
Perhaps the second biggest challenge on the international oil company wish list would be removal from PEP contracts of the protection of the “Calvo Clause” of Article 27 of the Mexican Constitution and other, similar protections. This concept is currently reflected in the PEP model contract through a requirement that the contractor must waive its rights to file claims through diplomatic channels. Although, as with allowing parties to book their reserves, any change to this provision would arguably require a constitutional amendment, such a change might be less politically volatile than the change needed to allow booking of reserves. It would also seem that there are procedural protections that could be guaranteed to contractors that would mitigate the possibly draconian effect of losing recourse to diplomatic channels.
Although these constitutional amendments would be tough obstacles for the Mexican Government to overcome, there are a number of improvements that could be made to the PEP model contract itself that seem more achievable in the near future. If implemented, these would be almost certain to increase the interest of private companies in participating in such contracts—and therefore in helping to stimulate Mexican crude production—and they would not require constitutional amendments.
Perhaps the most obvious adjustment to the PEP model contracts to increase interest would simply be to increase the fees and possible bonuses payable to contractors. There are also a number of changes to the non-financial terms and conditions of the model contract that would probably increase private participation, including strengthening contractors’ rights to cure defaults (and lengthening the cure period), ceding more operational control and decision-making authority to contractors, allowing for arbitration outside Mexico, allowing for increased flexibility on guarantee requirements, making environmental liability provisions less risky for contractors and reducing national content requirements.