Viewpoint: Mexico's Energy Reform

What is in the legislation?

Mexico's energy legislation, passed by Congress on December 12, is the capstone of President Enrique Peña Nieto's first year reform agenda. The energy reforms are more liberalizing than many observers initially predicted would be possible. Once they are implemented, the oil and gas sector will open to private investment through profit-sharing agreements, production-sharing agreements, and licenses.

A profit-sharing agreement, where companies are paid a portion of the profits in cash, is employed when there is perceived to be lower risk in exploration and production. Production-sharing agreements are employed when there is more risk, as the company ends up losing more should exploration not yield oil. Production-sharing contracts allow companies to report projected income and are thus seen as more attractive to foreign investment.

An unexpected inclusion in the bill, and one of the reasons some observers are so pleased, was the inclusion of licenses. These licenses allow companies to manage oil directly and will be used primarily for shale gas exploration. Licenses act in many ways like concessions, where companies control oil and pay royalties and taxes to the government. (The authors of the bill were likely reluctant to use the word "concession" due to the implications that the oil might no longer be property of the state.)

Another legislative feature is the announcement of the creation of a sovereign oil fund. The fund will channel the earnings from oil sales and service contracts into savings and pensions. The fund will be operated by Mexico's Central Bank.

On the power generation side, the reform calls for the Federal Electricity Commission (known as the CFE), Mexico's state electricity monopoly, to become a "productive enterprise," which would allow for private companies to generate and distribute electricity.    

What is the significance of the legislation?

The legislation means that, for the first time in over 75 years, private companies may participate in Mexico's energy sector, although the authors of the bill make clear that hydrocarbons are still property of the Mexican state. Increased production, anticipated primarily in deepwater drilling and shale gas development, could increase annual GDP by a full percentage point, according to Mexican government estimates.

There is strong interest by both large and smaller energy companies in entering Mexico. There are approximately 29 billion barrels of recoverable reserves in the Gulf of Mexico, and Pemex, the Mexican state oil company, does not have the resources for their development. This potential development could double the size of Mexico’s proven reserves. Combined with existing on-shore fields, which need reinvestment, the sector is poised to bring in investment from abroad. Nevertheless, investors would have to see the final law, including secondary legislation, before deciding to invest.  

State oil company Pemex would continue as a key player in the country's energy sector. Once the legislation is implemented, Pemex would decide which projects it wants to keep and which it would open up to investment. The National Hydrocarbon Commission will then run the bidding process on projects, with Pemex able to bid. Also noteworthy in the legislation is the removal of the oil workers union’s five seats off of Pemex's board, providing for more autonomy in the company.

What's next?

The bill passed Mexico's Senate and Chamber of Deputies prior to the close of Congress for the holiday recess on December 15. This was achieved in the face of significant opposition from the Democratic Revolutionary Party (PRD). The three main political parties—the governing Institutional Revolutionary Party, the National Action Party, and the PRD—were in an agreement called the Pact for Mexico, which was formed in order to pass Mexico’s reform agenda. Emerging from the energy debate, the president of the PRD has stated that the Pact is now "dead."

The legislation was then approved by the necessary 17 state legislatures, and will be declared constitutional by Congress on December 18. Secondary implementing legislation must then be passed in 2014 in order to implement the constitutional changes involved in the legislatio. Since the implementing legislation requires only a simple majority, it is likely to pass, given the PAN and PRI’s combined support and majority. Congress will have four months after the legislation is signed into law to pass the secondary legislation.

Although the PRD has pushed for a referendum on the reform, it is our understanding that this would not influence its implementation because constitutional reform cannot be addressed through referenda.

Updated December 17, 2013.