Mexico poised for constitutional reform on upstream O&G
HOUSTON, May 31, 2013
MEI: Colin, you have been involved in Mexico for 45 years, first as a young petroleum geologist doing technical work, then more recently as E&P manager in Mexico for a major oil company before you retired. So tell us, if you were still employed by a major, what would you report to upper management about the promised energy reform?
Colin: The short answer is this: Get ready! But if my manager asked me to give him my rationale, I’d first of all give him a brief review of recent history of energy reform in Mexico (the rotation of management being what it is), as a lead-up to explaining my views about the present situation.
MEI: How far back would you need to go?
Colin: Just to 1988, when the PRI party candidate Carlos Salinas was elected president after a close fight with Cuauhtémoc Cárdenas, the leftist PRD candidate. Salinas soon showed he meant business by arresting the oil union leader, thereby signaling that he, not the unions, was in control. He then went on a privatization spree. In the next few years he privatized telecommunications, banks, highways and railroads.
Many of us in the oil industry expected that Pemex would be next, especially as demand for oil was increasing at such a rate that it would exceed supply in the near term, so requiring foreign investment to boost production. The majors started to vigourously engage with Pemex management by either establishing an upstream representative office in Mexico City or travelling frequently to and from their home office. Such offices were established by Mobil, Amoco, ARCO, BP, Chevron, Exxon, and later by Shell. Today, there are offices in Mexico of Repsol, Total, ENI and other operating companies.
Various types of technical assistance were offered, from studies to exchange visits, all free but all leading to technical transfer to Pemex personnel. However, Pemex was not privatized because it was able to obtain needed capital from the international banks on the basis of its oil production. The only energy reform that did take place was in downstream power generation that allowed private investment for self-supply.
The next President, Ernesto Zedillo, also of the PRI party, enacted an unprecedented reform in 1996 that allowed private investment in natural gas transport, distribution and storage. But no change was made to upstream industry activities partly because in the 1997mid-term elections the PRI party lost its majority control of congress. The opposition party PAN blocked all major initiatives for electoral political reasons, looking forward to the 2000 national elections.
The PRI party duly lost the next national election and expectations were high that the new PAN President, Vicente Fox, would quickly fulfill his election promise and introduce upstream reform. But this was now blocked by the PRI party in congress and no reform was possible. A work-around of the procurement laws allowed service companies to take on quasi-operating roles under the Multiple Service Contracts in the northern Burgos gas producing basin. But few international oil companies showed any interest.
The next president, Felipe Calderon also from the PAN party, finally introduced energy reform in 2008, but this was diluted so much by the opposition, now mainly from the left party, PRD, that the final result was only a slight improvement to the existing regulations, now allowing production-indexed compensation. The next few rounds of Incentivized Contracts for mature fields still only attracted the service companies and small independents. The majors have not been interested because of the small scope, intense labour required, lack of bookability of reserves and lack of investment security.
MEI: So what do you see that is different with this new PRI Government?
Colin: I see the ability to negotiate and seek consensus. The day after Peña Nieto was inaugurated as the new PRI president, he convened the leaders of the other two main parties and they all signed the National Pact (the so-called Pacto por México), listing nearly fifty Items that were all agreed to include in reforms, putting aside party political advantages for the benefit of progress of the country as a whole. Obviously, this had all been worked out beforehand. The pact has been under strain a few times, as when local representatives of the Veracruz State Social Security department were caught trying to get promises of support in the upcoming local elections in exchange for social handouts. However, crying foul from the two opposition parties was smoothed over with promises by the ruling party to behave in the future. Nor has the going been smooth within the opposition parties.
On the left, the PRD has had to defend its support of the government initiatives from splinter groups. On the right, a major row has broken out because the leader in the senate does not support the Pact and has been removed, which has at least temporally split the party. Nonetheless the Pact is holding firm.
MEI: So how what about the reforms agreed on in the Pact?
Colin: The reforms have been coming out, I’d say, very frequently. The first major reform was in education. Obviously agreed upon beforehand, the constitutional reform quickly passed by both houses and gained enough support from the States (two thirds needed) to pass. Then the SNTE teachers union took notice and started to object. The politically powerful teachers’ union leader, Elba Esther Gordillo was arrested on embezzlement charges. (She had flown to Mexico City on her private jet for the purpose of attending a nationwide union conference; but she was detained on arrival in Mexico.)
Then the splinter group, CNTE, violently objected to the change in the constitution and demonstrated in Mexico City and in many southern cities. They were especially violent in Chilpancingo, capital of Guerrero State. The government reacted most intelligently by documenting the illegal behavior, then arresting the leaders. Upon releasing them it was agreed to allow them to voice their complaints with the Pact committee. It can be assumed that they were told that they did not have enough support nationally to reverse the constitutional reform: they had a choice to conform or spend the rest of their days in jail, (I surmise). These union leaders are now focusing their attention on lobbying for teachers benefits in the secondary laws at the national and also the semi-autonomous state levels. Further reforms have followed: telecommunications, fiscal and labour, all following the outline of the pre-agreed Pact.
MEI: Ah! So you think the way the education reform was handled is a guide to the energy reform?
Colin: Exactly! At the Petroleum Congress in June the Under-Secretary of Hydrocarbons at the Energy Ministry announced to the assembly of petroleum engineers that the energy reform to be introduced in September will include the ability for investment in risk sharing contracts.
This time around , and in analogy with the educational reform, I believe it likely that this reform will pass smoothly and quickly through congress and get the States approval for the required constitutional changes. Then the left splinter group of parties will wreak havoc in Mexico City with demonstrations. However I do not expect to hear even a whimper from the oil workers union, STPRM, as the union leader has been burned in the press on account of his alleged exorbitant spending far beyond his union salary. He could face jail for appropriation of union funds if he does not fall in line. Demonstrations will slowly die down and life will return to normal. Only now will the international oil companies will have the assurances they need to enter into the big deals in deep water exploration and production in the Gulf of Mexico.
MEI: What should the majors be doing then?
Colin: Clearly, the Mexican lawmakers are proceeding with their internal plans and negotiations. There seems little point in interfering unless asked. The situation is reminiscent of Venezuela in the early 1990s and Brazil in the mid-1990s when change was in the air. The majors now, just as then, should be attending conferences to learn about Mexican deepwater and building up relationships with Pemex management and contacts with Pemex technical staff. They should also start planning to increase their staff in Mexico with explorationists and engineers in order to prepare for the deepwater bid rounds that could well be ready and on offer in 2014. This would be my recommendation to upper management.
MEI: How can the international oil companies mitigate changes to the contracts if they achieve major successes, such as what happened in Venezuela and Brazil when higher oil prices sweetened existing contracts?
Colin: First of all, I have always advised that you need a constitutional change to lock in the legal framework. Mere changes to regulations do not give enough security for mega investments as the regulations can be reversed too easily and you could lose your investment completely. But changes to the detailed terms of a contract can work both ways. This is a risk with all international investments, one that the major oil companies manage every day. I do not think this should be a deterrent to majors seeking new E&P contracts in Mexico once the constitutional reform allows private investment in return for risk-related returns.
MEI: If the reforms move ahead, is there still enough potential hydrocarbons yet-to-find to entice the major oil companies?
Colin: It is always difficult for old geologists to believe there is any more oil and gas to be found, especially as these are finite resources. But my experience has been that new minds and new technologies find new reserves. So I expect this will be the same in Mexico but I cannot imagine exactly where the new fields will be found.
MEI: Several years ago, before Pemex had drilled its first well in Perdido, you predicted that Pemex would find oil there. Now that they have found oil, what are Pemex’s best options for development?
Colin: It´s still too early to tell as this depends on the total amount of recoverable oil found by the next few discovery wells. If not that much, it could be produced via sub-sea completions and loaded onto an FPSO for transport. If sufficient to justify, the wells could be linked up to [Shell’s] Great White hub. If a large enough volume were shown, a separate producing platform with a pipeline to Matamoros could be justified.
MEI: How important is it for the future of Pemex for it to become an operator outside of Mexico?
Colin: Assuming that all the ventures should be profitable under the host countries tax and royalty regime, I think this will give valuable economic, business and technical learning for Pemex staff, especially in deepwater and unconventionals like shale oil and shale gas.
Colin Stabler is a consulting geologist who began his career as a Pemex contractor in the late 1960s, working in the Poza Rica area. He recalls having been met at the airport on his first trip to Mexico by Raúl González, also a geologist, who in the mid-1990s would become director of exploration for Pemex E&P. Colin is a well-known figure in upstream circles in Mexico, and has served as a consultant to the National Hydrocarbons Commission (CNH) and as a member of the committee on energy and environment of the British Chamber of Commerce in Mexico. (In the present text, we respect his British spellings.)
Colin, who resides in Mexico City, may be reached at email@example.com.