Wide-Reaching Energy Reform Could Be Within Reach

BMI View: Mexico's ruling Partido Revolucionario Institucional and centre-right opposition Partido Acción Nacional may be negotiating a far more radical change to Mexico's energy laws than had previously been indicated, including the option to allow for more flexible contract terms to take into account the level of risk faced by IOCs. While still unconfirmed, we note that if true, this would represent a massive step forward for the country's hydrocarbon sector, and encourage us to take a more optimistic long-term stance on the country's oil reserves and production.

While we had previously noted that the risks to energy reform in Mexico were for a more rather than a less aggressive bill, the scope of the changes which may be under debate behind the scenes between the ruling Partido Revolucionario Institucional (PRI) and opposition Partido Acción Nacional (PAN) are nothing less than monumental. Specifically, local and international news sources are now reporting that the two parties may be considering going beyond the PRI's initially proposed profit sharing scheme and allowing for a more flexible system, in which terms are offered on the basis of the risks involved in resource production. This could range from offering profit-sharing contracts in lower risk scenarios (wherein companies would share a percentage of any discovery but receive it in cash and not own direct rights to the oil) to production sharing contracts in the more geologically complex plays, such that firms would own the rights to their share of the oil, and be able to book reserves. The Wall Street Journal even indicates potential for a third type of contract for ultra deepwater fields and shale gas, whereby companies would fully control the oil after paying royalties and taxes - seemingly very similar to a concession model.

Stepping Left On Fiscal Policy To Go Right On Energy

From Exporter To Importer Without Significant Reform
Mexico - Oil Production, Consumption And Net Exports

Wide-Reaching Energy Reform Could Be Within Reach

BMI View: Mexico's ruling Partido Revolucionario Institucional and centre-right opposition Partido Acción Nacional may be negotiating a far more radical change to Mexico's energy laws than had previously been indicated, including the option to allow for more flexible contract terms to take into account the level of risk faced by IOCs. While still unconfirmed, we note that if true, this would represent a massive step forward for the country's hydrocarbon sector, and encourage us to take a more optimistic long-term stance on the country's oil reserves and production.

While we had previously noted that the risks to energy reform in Mexico were for a more rather than a less aggressive bill, the scope of the changes which may be under debate behind the scenes between the ruling Partido Revolucionario Institucional (PRI) and opposition Partido Acción Nacional (PAN) are nothing less than monumental. Specifically, local and international news sources are now reporting that the two parties may be considering going beyond the PRI's initially proposed profit sharing scheme and allowing for a more flexible system, in which terms are offered on the basis of the risks involved in resource production. This could range from offering profit-sharing contracts in lower risk scenarios (wherein companies would share a percentage of any discovery but receive it in cash and not own direct rights to the oil) to production sharing contracts in the more geologically complex plays, such that firms would own the rights to their share of the oil, and be able to book reserves. The Wall Street Journal even indicates potential for a third type of contract for ultra deepwater fields and shale gas, whereby companies would fully control the oil after paying royalties and taxes - seemingly very similar to a concession model.

Stepping Left On Fiscal Policy To Go Right On Energy

In a bid to stem Mexico's plummeting oil production ( see chart below), President Enrique Peña Nieto had made energy sector liberalisation a key component of his policy platform. However, while the PAN proposed a concessions model - quite a radical change - the PRI's original bill had called for a more modest shift, to a profit-sharing model. At the time we noted that the PRI's proposal represented an important step forward from the status quo, and would involve a landmark change to the constitution, however there was some risk that it may be too modest in scope to boost investment to the country's hoped for levels ( see 'A Step Forward, But Investment Still Uncertain', August 14). Indeed, initial signals from the industry suggested many were underwhelmed.

From Exporter To Importer Without Significant Reform
Mexico - Oil Production, Consumption And Net Exports

Since then though, our Country Risk team has highlighted a process of significant horse-trading in the legislature, which seems to have encouraged a greater willingness among PRIistas to accommodate more radical (PAN-supported) changes to the energy sector. Namely, energy liberalisation is one of many reforms currently being mooted in the legislature. However, in one of the others - fiscal reform - Peña Nieto acceded to the country's political left to a far greater extent than many anticipated, allowing food and medicine to remain exempted from the Value Added Tax (VAT). We believe this concession on fiscal reform has increased the centre-right party's (PAN) leverage to push for a more investment-friendly energy proposal. Indeed, the PRI needs the legislative support of the PAN to pass energy sector reform, and after the PAN expressed outrage at the left-leaning fiscal reform, we see Peña Nieto as likely to be eager to mollify the centre-right opposition, increasing the likelihood of a more far-reaching energy bill ( see 'Fiscal Reform: Mixed Impact On Sectors But Upside For Energy', November 6).

PRI Needs The PAN To Reform Energy Sector
Mexico - Breakdown Of Congress By Political Party, Number Of Seats

At this stage, we stress that there have been no official statements from the Mexican government regarding the potential for more drastic energy reform proposal, and it remains uncertain the extent to which the PRI and PAN have been able to come to an agreement on the issue. Further, we note that political reform will need to go through first, with the PAN likely to hold energy liberalisation hostage to the PRI being willing to agree to their proposed electoral changes. However, if the initial indications regarding the scope of the final energy bill are true, it could encourage us to take a highly optimistic view of the Mexican energy sector's long-term prospects. Indeed, such a wide-reaching legislative effort would not only represent a significant departure from the country's previous and more piecemeal reform process, but the potential for production sharing models could lure significant investor interest that would enable Mexico's raw hydrocarbon potential to be tapped.

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