In recent weeks, two of the three major political parties in Mexico — the center-right National Action Party (PAN) and the center-left Institutional Revolutionary Party (PRI) — have announced proposals to significantly overhaul the Mexican energy industry by opening it to foreign investment. Although their proposals contain certain differences, both parties seek to amend Articles 27 and 28 of the Mexican Federal Constitution to open the door to direct foreign investment in the upstream, midstream and downstream energy sectors, which, aside from the natural gas industry in the midstream sector, have been closed to foreign investment since 1960. The significance of this development cannot be overstated, not only because of the potential to reform an industry that has been monopolized by the state for decades, but for the first time such reforms seem to be a plausible political reality.
With respect to the upstream oil and gas sector, while both the PAN and the PRI bills contain statements of intent that title to hydrocarbons will remain with the Mexican State, they do open the door to profit-sharing arrangements in the upstream sector. However, depending on the content of the concessions or contracts to be awarded (e.g., ability to acknowledge revenue from future production), international oil companies would be permitted to include in a footnote within their financials a reference (book reserves) to their economic interest under the applicable accounting guidelines for booking of reserves published by the U.S. Securities and Exchange Commission.
Regarding the midstream and downstream industries, both bills would allow private companies to participate in refining, transportation, storage and distribution (after obtaining permits from the Energy Regulatory Commission — hence enabling the much anticipated refurbishment of the refinery and transportation infrastructure).
In the electricity sector, both bills propose the creation of a wholesale power market. In similar fashion to the oil and gas proposals, both bills contain statements of intent that the national electricity grid shall remain in control of the State-owned utility, the Comisión Federal de Electricidad (CFE). However, they also propose allowing CFE to enter into contracts with private investors to perform the distribution and transmission of electricity. Again, this is a very significant development in the Mexican economy. At current, the cost per kilowatt hour in Mexico is roughly three times what it is in the United States. Clearly, the need to modernize and economize the Mexican electricity industry represents opportunities for foreign investors — not only for players in the traditional utility sector but also those in the renewable sector.
It should be noted that both the PAN and PRI bills propose only constitutional amendments, and they do not contain provisions for any change in statutory law affecting either the oil and gas or electricity sectors. Both bills leave the details on how any concessions or contracts would operate to be decided at a later date by the Mexican Congress.
One Potential Challenge: Environmental Liability
Assuming that a compromise bill is passed to amend the Mexican constitution and that specific statutory laws are eventually enacted, one of the main challenges will fall on the Mexican Courts to construe the newly enacted Environmental Liability Federal Law, which has opened the door for the first time in Mexico to consequential and punitive damages against parties that either directly or indirectly causes damage to the environment. Hence, even though the submission and potential approval of either bill or a hybrid of both represent a major advancement to the Mexican energy market, it remains to be seen how the Courts will deal with the new broadened liability for participants in such sector as well as how the participants would react to such new potential liability.