MexECON Blog

Energy Reform Signed Into Law

Last Friday, the Mexican president signed into law his signature reform of the energy sector.  The key aim of the reform is to arrest the ongoing slide in Mexican oil production by allowing private companies to participate in production for the first time since the energy sector was nationalized in 1938.  Under the prior nationalized regime, state oil company Petroleos Mexicanos (Pemex) owned and produced all Mexican hydrocarbon resources at every stage of production.  Against a backdrop of falling production, a reform effort five years ago allowed private companies to submit bids to Pemex for oil service contracts, but the new rules were not attractive enough to energize significant private activity, and output has continued to trend downward.  Under the new law, several sections of the Mexican constitution are changed to allow private firms to produce oil under a variety of contracts.

Under the reform, Pemex will continue to explore new fields, produce oil and gas, conduct refinery operations, and market hydrocarbon products, but private firms will also be allowed to explore and produce under a variety of potentially attractive contract types.  For example, they will be allowed to explore and produce under profit-sharing, production-sharing, or license agreements signed directly with the government.  Mexico would still own the hydrocarbons in the ground, and highly liberal concession deals would still be prohibited.  However, private firms would be allowed to book discovered resources as their own reserves and take ownership upon production, depending on the type of contract.

Finally, in a bid to improve governance and efficiency at Pemex itself, the new law reduces the size of the company's board of directors from 15 to 10 by removing all representatives of the company's union.

Comment: The Mexican economy is probably much less dependent on the oil sector than many people realize.  These days, for example, some 80% of Mexico's exports consist of manufactured products, and only about 16% consist of petroleum.  Nevertheless, the government relies on Pemex for a large share of its revenues, and the oil sector accounts for a lot of high-paying jobs.  The ongoing slide in oil output from its 2004 peak of about 3.3 million barrels per day to its current rate of about 2.5 million barrels per day is therefore a significant threat to Mexico.  If the specific rules under the new reform are well written and implemented, most observers believe the result will be higher investment, lower energy prices, and stronger economic growth, all of which would help bolster the government's budget position.  One large U.S. investment firm recently projected that the reform will boost foreign investment in Mexico by $15 billion annually and increase annual economic growth by 0.5%.  However, it is likely to take some time before the impact will be felt.  Like President Peña Nieto's other 2013 reforms - in education, telecommunications, finance, and taxes, for example - the likely positive impact is not so much in the near term but in the medium term and longer.

Patrick Fearon, CFA
Vice President, Fund Management

Last Friday, the Mexican president signed into law his signature reform of the energy sector.  The key aim of the reform is to arrest the ongoing slide in Mexican oil production by allowing private companies to participate in production for the first time since the energy sector was nationalized in 1938.  Under the prior nationalized regime, state oil company Petroleos Mexicanos (Pemex) owned and produced all Mexican hydrocarbon resources at every stage of production.  Against a backdrop of falling production, a reform effort five years ago allowed private companies to submit bids to Pemex for oil service contracts, but the new rules were not attractive enough to energize significant private activity, and output has continued to trend downward.  Under the new law, several sections of the Mexican constitution are changed to allow private firms to produce oil under a variety of contracts.
Under the reform, Pemex will continue to explore new fields, produce oil and gas, conduct refinery operations, and market hydrocarbon products, but private firms will also be allowed to explore and produce under a variety of potentially attractive contract types.  For example, they will be allowed to explore and produce under profit-sharing, production-sharing, or license agreements signed directly with the government.  Mexico would still own the hydrocarbons in the ground, and highly liberal concession deals would still be prohibited.  However, private firms would be allowed to book discovered resources as their own reserves and take ownership upon production, depending on the type of contract.
Finally, in a bid to improve governance and efficiency at Pemex itself, the new law reduces the size of the company's board of directors from 15 to 10 by removing all representatives of the company's union.
Comment:  The Mexican economy is probably much less dependent on the oil sector than many people realize.  These days, for example, some 80% of Mexico's exports consist of manufactured products, and only about 16% consist of petroleum.  Nevertheless, the government relies on Pemex for a large share of its revenues, and the oil sector accounts for a lot of high-paying jobs.  The ongoing slide in oil output from its 2004 peak of about 3.3 million barrels per day to its current rate of about 2.5 million barrels per day is therefore a significant threat to Mexico.  If the specific rules under the new reform are well written and implemented, most observers believe the result will be significantly higher investment, lower energy prices, and stronger economic growth, all of which would help bolster the government's budget position.  One large U.S. investment firm recently projected that the reform will boost foreign investment in Mexico by $15 billion annually and increase economic growth by 0.5%.  However, it is likely to take some time before the impact will be felt.  Like President Peña Nieto's other 2013 reforms - in education, telecommunications, finance, and taxes, for example - the likely positive impact is not so much in the near term but in the medium term and longer.
Patrick Fearon, CFA
Vice President, Fund Management

 

 

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