APLA: Mexico to open oil & gas sector

15 November 2013 13:04  [Source: ICB]

Proposed reforms to Mexico’s constitution could open up the oil and gas sector to private investment, boosting opportunities for petrochemicals investment in the longer term


Mexico’s new president, Enrique Peña Nieto, is planning significant reforms

Copyright: Rex Features

By the end of this year, Mexico’s constitution will likely be amended, opening up the nation’s energy sector to outside companies and potentially increasing production. Mexico’s new president, Enrique Peña Nieto, introduced the proposed reforms earlier this year, in the form of changes to the nation’s constitution.

If Peña Nieto’s reforms pass, then Congress would draft secondary laws that would determine who could participate in Mexico’s energy sector and under what terms. The fate of these proposed reforms are crucial to Mexico’s petrochemical industry because it depends on the nation producing enough feedstock for future plants.

Already, the industry cannot meet domestic demand. In 2012, Mexico’s petrochemical trade deficit was $8.15bn (€6.0bn), according to the Instituto Nacional de Estadistica y Geografia (INEGI), a government agency that keeps economic statistics. For products that originated from petrochemicals, the deficit reached $5.24bn.

Mexico’s remaining ethane will be consumed by the upcoming Ethylene XXI project, the Braskem Idesa joint venture. The ethane will be used by a cracker that will supply raw material for the site’s polyethylene (PE) production. Once Ethylene XXI starts operations, Mexico will not have enough ethane to build another cracker.

To secure more feedstock for future plants, Mexico has to increase energy production, the goal of the proposed reforms. The reforms would allow outside companies to participate in oil, gas and natural gas liquids (NGLs) production in Mexico. Right now, production is limited to the state energy producer, Pemex.

By allowing third parties to fractionate natural gas, the reforms could lay the foundation for a petrochemical resurgence along the lines of what is already occurring in the US. Like the US, ethane would give Mexico’s petrochemical industry a competitive advantage, since much of the world relies on more expensive oil-based naphtha as a chemical feedstock.

“The economics of gas and liquids production in the US are exactly the same in Mexico,” said Jose Valera, a partner with law firm Mayer Brown. He made his comments during a recent presentation the law firm gave in Houston entitled “Mexico Energy Reforms”.

The proposed reforms are not intended solely to boost petrochemical production, however. They are also intended to reverse Mexico’s declining oil production and reduce its trade deficit in every other class of hydrocarbon.

In 2012, oil production was 2.60m bbl/day, down 25% from a high of 3.48m bbl/day in 2004, according to the Energy Information Administration (EIA). Mayer Brown warns that Mexico could become a net importer of crude oil by 2020. Meanwhile, Mexico’s natural gas trade deficit reached $2.15bn in 2012, according to the INEGI.

Natural gas imports now supply one-third of Mexico’s demand, up from 3% in 1997, according to the EIA. For oil products, Mexico had a trade deficit of $24.7bn in 2012, according to the INEGI.

Mexico’s declining energy fortunes come as the country is running out of easily developed fields. Pemex lacks the funds and know-how to develop unconventional reserves. In 2012, Mexico drilled three wells in shale formations, while the US authorised 9,100 permits, Peña Nieto said in his reform proposal. The paltry drilling came despite Mexico having the world’s fourth largest reserves of shale gas, according to the EIA.

That same year, Mexico drilled six deepwater wells in the Gulf of Mexico, while the US drilled 137. Such unconventional reserves will become increasingly important for Mexico if the country wants to increase its energy production, Peña Nieto said in his proposal.

To develop such reserves, Mexico will need the investments and capabilities of outside energy firms, the Mexican president said. Even without their participation, Pemex should not bear all of the risk of developing such complex fields.

Several constraints are preventing Pemex from developing the country’s energy resources, says Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center, a think tank that researches national and international topics. He was also a speaker at the Mayer Brown presentation.

Pemex itself is unlike other national oil companies found around the world, Wood explained. “It is not even a company. It is a decentralised agency of the state,” he added. Constitutional restrictions prevent Pemex from entering into partnerships with the private sector and, in addition, Pemex’s employment rolls are bloated, he said. “There are thousands and thousands of Pemex workers who receive a pay check but who do not work. It produces fewer barrels per worker than almost every oil company in the world.”

Although Pemex makes a lot of money, it has massive pension liabilities and it returns substantial amounts of money to the government, he said. Those government payouts are one of the reasons why Pemex has failed to meet Mexico’s growing need for natural gas, Wood noted. To boost government revenue, Pemex was encouraged to develop Mexico’s lucrative, low-cost oil reserves at the expense of natural gas.

As a result of so many constraints, Pemex has failed to develop the technology and expertise to develop more technically challenging energy resources, Wood said.

Other barriers come from the nature of Mexico’s energy regulations. Currently, it has one of the world’s most restrictive legal frameworks for energy production, according to Mayer Brown. Valera said Peña Nieto’s proposals essentially clean Mexico’s constitution of prohibitions on production, allowing the nation’s legislature to draft new rules that would determine who can develop the country’s energy resources and under what terms.

Amending the constitution will require a two-thirds vote from Congress, and Peña Nieto already has support from two of the three major parties. Afterward, the reforms would require the ratification of the majority of Mexico’s states. Peña Nieto’s party already controls a majority of those states, Wood said.

Importantly, the reforms do not specify how private companies could participate in the country’s energy sector, Valera added.

Instead, the proposed reforms remove the country’s constitutional restrictions in the energy sector, from oil production to fuel retailing, he said. If adopted, Mexico’s constitution will no longer limit Congress from determining the scope of private participation in the country’s energy sector.

That leads to the second part of Mexican energy reform. If Peña Nieto’s reforms are passed, then Congress will need to decide through legislation the scope of private participation in the country’s energy sector and under what terms and conditions. This legislation would also determine whether energy and production companies can book reserves, a key financial consideration.

If Mexico adopts the reforms, it will still own its subsoil hydrocarbons. However, this is no different than most of the world, Valera said. The US, in fact, is the exception to state ownership of subsoil energy reserves. For Mexican energy reform, the crucial point for companies is not whether the state owns the subsoil hydrocarbons but whether the state allows companies to book the reserves.

Mexico will likely adopt the energy reforms proposed later this year, Wood said. Once the reforms pass, Wood expects the first contracts would go to deepwater oil production since it represents the most lucrative venture, he said. Contracts under the reforms could be awarded by the end of 2014, he added.

But given the extent of Mexico’s trade deficit in all other hydrocarbons, companies could pursue other projects as well, such as natural gas and NGL fractionation.

Energy reform could allow other companies to fractionate ethane and supply it to petrochemical plants.

In addition to opening up Mexico’s energy sector, the reforms would also lower the amount of money Pemex contributes to the federal government.

Those transfers have been so large, they have limited how much Pemex could spend on exploration and production.

Pemex, meanwhile, will remain a state-owned entity, and the reforms will not open the door to privatisation or selling shares of the company, Mayer Brown said.

The momentum for reforming Mexico’s energy industry has been building for years, Wood said. Three Mexican presidents, starting with Carlos Salina de Gortari (1988-1994), had sought to reform the nation’s energy sector, he said. Felipe Calderon tried to reform Mexico’s energy policy while he was president from 2006 to 2012. As a member of the Partido Accion Nacional (PAN), however, Calderon faced opposition from the Partido Revolucionario Institucional (PRI).

In the end, Mexico adopted only modest reforms during Calderon’s term. It allowed Pemex to enter into service-type contracts with other companies.

However, while reform was promoted, the Mexican public heard repeatedly that Pemex needed to change in order to meet the country’s energy needs, Wood said.

“For the first time in years, Mexico believed that there was a problem,” he said.

This year, all three of the major parties in Mexico introduced proposals to reform the nation’s energy sector. ■

By: Al Greenwood
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