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Mexico has been one of the big emerging market success stories in recent years. Its formidable manufacturing base has led to a strong period of export-driven economic growth, and seen Mexico’s economy remain robust even while its nearby rival, Brazil, has floundered. In 2013, nearly a quarter of the automobiles imported by the US came from Mexico. This success has come despite a regulatory framework that many in the business community say restricts economic growth.

The energy sector is at the core of the problem. Since 1938, when President Lazaro Cardenas expropriated the assets of private oil companies in the country, oil exploration, production and transportation has been under the purview of Petroleos Mexicanos (PEMEX), the national oil and gas company. Electricity generation and distribution has been controlled by state firm Comision Federale de Electricidad (CFE).

This monopoly has, in many ways, proved detrimental to the broader economy. Energy prices have long been extremely high, which has stymied the growth of energy-intensive industries such as metals and plastics production. According to The Economist, industrial energy prices are 80% higher in Mexico than they are in the US. Complaints about inefficiency and poor customer service are rife from business owners and individual consumers alike.

PEMEX has also struggled with its status as the government’s chief earner, accounting as it does for a third of state revenues. Lack of cash has made it unable to take full advantage of potentially fruitful but capital-intensive deepwater oil plays and shale gas deposits, of which Mexico has the sixth-largest in the world. The country still needs to import oil and gas from the US, a travesty considering that Mexico sits on 115 billion barrels of oil reserves.

Shell is taking subsea exploration to a whole new level by installing the world’s deepest FPSO and gas pipeline in the Gulf of Mexico.

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At the same time, production has been on a consistent downward trend since 2011 – the 3.3bn barrels per day registered that year dropped to 2.4 billion in 2014 and is projected to slump to 2.2 billion in 2018, according to data from energy consultancy IHS Cera. The country’s Cantarell oilfield, the largest single producing oil prospect, has seen production drop from 2,100 barrels a day in 2004 to below 500 barrels today.

Mexico’s time for reform has arrived

The idea of reform has been touted for years, but it finally looks as if change is happening. On 7 August the governing centre-right Institutional Revolutionary Party (PRI), led by President Enrique Pena Nieto, managed to push a law through the lower house of parliament that will allow foreign and private domestic energy companies to explore, produce and refine oil for the first time since Cardenas’ tenure.

The bill made it through the Senate on 24 July. Private companies will now be able to compete against the state player for government-tendered contracts, opening the industry to what the government hopes will be tens of billions in private investment, as well as bringing down the cost of energy and forcing PEMEX to raise its game.

Although Mexican hydrocarbons will still be owned by the state, the new bill allows foreign participation in four forms – licensing agreements, under which oil can be transferred to and monetised by a private player after it’s extracted; conventional service contracts; profit sharing contracts, whereby private players receive a cash share of profits; and production sharing contracts, under which physical barrels of oil are divided between the state and private players. Rules governing local content should encourage participation from Mexican exploration and oil service companies.

There are other structural changes in the fiscal make-up of Mexico’s state-owned energy companies. The state is to assume part (around 30%) of the pension liabilities of both companies, which combined amount to around US$130bn. This is equivalent to 10% of Mexico’s annual economic output and has contributed greatly to their declining competitiveness. In addition, the companies’ pension schemes will be changed from defined benefit agreements to defined contribution, helping slowly unwind the pension burden over time.

"Although Mexican hydrocarbons will still be owned by the state, the new bill allows foreign participation."

A small percentage of pre-tax revenue will go to landowners for hydrocarbons produced on their property while revenues will also go into the coffers of state and municipal governments, mainly those in oil-producing areas.

Mixed opinion on oil and gas reforms

The business community in Mexico and the wider oil and gas industry appear thrilled by the prospect of greater liberalisation. "Transforming the energy sector into an energy market should lower power costs and Mexico’s industry would be unstoppable against China and even the US," Luis de la Calle, an economist and former Mexican trade official, told the Wall Street Journal.

Left-wing parliamentary parties are less keen. They believe the reforms will cause Mexico to lose sovereignty over its hydrocarbons reserves and there’s also fear from within the company that, try as it might, PEMEX will never be able to compete with international market entrants. "The goal to attract private investment has been put above the necessity of making sure that PEMEX will continue to be the dominant player in Mexico’s oil industry," said Fluvio Ruiz, a PEMEX board member.

The counter-argument is that PEMEX’s relationship with the central government has long been too comfortable – it is tacitly understood that the head of the oil workers’ union will be a PRI supporter (the party has held power for 71 years, altogether) and will be well treated as a result.

Essentially, it all comes down to the implementation of these laws. Generation firm CFE has already started to embrace the new status quo, announcing in July that it is to tender power plant and pipeline projects worth $2.8bn. The government, unused to running tenders, will have to ensure that these initial contract offerings run smoothly.

It will also need to ensure that it keeps sceptical members of the public and powerful unions onside if these sometimes painful reforms are to be fully realised. And as is often the case in Mexican politics, if a new political party gets elected in 2018, all the changes could be undone at the drop of a hat. Either way, it will be an interesting year for the Mexican oil and gas industry.

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