The hottest topic of conversation in the energy industry at this time isn't the Eagle Ford shale. It isn't the Bakken. And it isn't the Permian Basin. The one subject I have heard more about this past summer than anything else is energy reform in Mexico. Everybody is talking about it.
It's been nearly 80 years since the government of Mexico nationalized the oil and gas industry and expelled foreign companies, mainly British and American, operating in that country. Mexico felt it was being unfairly exploited by outside interests and wasn't getting its fair share of the proceeds. As a result, lawmakers there wrote into the constitution that foreign companies would not be permitted to operate in Mexico, particularly in the upstream sector. Although enforcement of this statute had loosened a bit over time, allowing in certain service providers, for instance, the provision remained enshrined in the Mexican constitution, which also created Petroleos Mexicanos (Pemex), the state-owned petroleum company.
Unfortunately for Mexico, a major oil producer, there was a downside to this exclusivity. Pemex wasn't allowed to reinvest enough of its profits to grow exploration and production sufficiently to meet demand, and the constitution kept it from bringing in outside help to exploit the country's vast mineral resources.
This was particularly apparent in the offshore arena. As the supergiant Cantarell oil field in the Gulf of Mexico, which was discovered in 1976, began to decline, Pemex saw the need to develop deepwater reserves beyond the continental shelf. To accomplish this, Pemex required expertise from companies with experience in the deepwater realm, but it was prohibited from doing so because most of these companies wanted a piece of the action.
Mexico's business leaders and government officials were not unaware of the so-called "energy renaissance" that has been occurring in the United States and Canada since 2008. They knew that shale oil and gas reserves do not stop at the border and that Mexico has its own substantial shale formations. However, they lacked the specific technological expertise in horizontal drilling and well completion procedures that US companies had acquired over time.
The US Energy Information Administration (EIA) had forecast that unless Mexico turned things around, the country would soon go from one of the world's largest oil exporters to becoming a net energy importer. Already Mexico was importing natural gas from the United States, and prospects for improving production were dimming unless the government would allow certain energy reforms that would enable Pemex to partner with US and other foreign oil companies to develop the deepwater reserves and to unlock its shales. Doing so would not only improve Mexico's worsening trade deficit, it would create tens of thousands of good-paying jobs for Mexican citizens as well.
The EIA estimates that Mexico's oil production could rise to 3.7 million barrels per day by 2040 following the reforms that open its oil and natural gas markets to direct foreign investment.
"The changes in EIA's assessment of Mexico's liquids production profile are profound," says the agency. "Last year's [outlook] projected that Mexico's production would continue to decline from 3.0 million barrels per day in 2010 to 1.8 MMbbl/d in 2025, and then struggle to remain in the range of 2.0 to 2.1 MMbbl/d through 2040. The forthcoming Outlook, which assumes some success in implementing the new reforms, projects that Mexico's production could stabilize at 2.9 MMbbl/d through 2020 and then rise to 3.7 MMbbl/d by 2040 - about 75% higher than in last year's outlook."
The Atlantic Council has also issued a report in which it says that the recently enacted energy reform will "transform Mexico into a major energy and industrial power." (See www.AtlanticCouncil.org)
The report concludes that the reforms that seek to increase investment in Mexico's hydrocarbons sector and boost oil and gas production levels will also present "ample investment opportunities" in pipelines and midstream infrastructure that will bring natural gas to and throughout Mexico.
"Natural gas is the lynchpin of the energy reform," says David Goldwyn, a senior energy fellow at the Atlantic Council's Adrienne Arsht Latin America Center and co-author of the report. "The key to delivering lower cost and more reliable electric power to Mexico is increasing access to natural gas, first by pipeline from the United States, and then over time from indigenous production."
The report assesses that the creation of a competitive market for electric power will be essential to creating broad-based economic growth and ensuring the long-term sustainability of the reforms. Mexico's ability to ensure its new gas and power regulators enforce competition will be a key bellwether for investors. Great interest is predicted in Mexico's deepwater, shallow water, and heavy oil auctions, and in regulator-approved partnerships with Pemex.
Goldwyn and his co-authors say that "Investor confidence due to the reform will enable Mexico to quickly attract capital necessary to spur near-term macroeconomic growth long before oil and gas flows appreciably increase."
To learn more about these Mexican energy reforms, we invite you to turn the pages of this issue and read two detailed articles on the subject. The first, "Exploration & production in Mexico," by Manuel Vera and Andrew Farris of Bracewell & Giuliani LLP provides an update on the reform measures with respect to upstream, midstream, and downstream regulation and examines exploration and production contracts.
The second article, "Mexican energy legislation," by Bracewell & Giuliani partners James D. Reardon and Vera, discusses tax reform as it relates to liberalizing the oil and gas industry and the tax consequences for US investors in Mexico's energy sector.
