Through the fundamental reform of its energy policy, Mexico has laid the groundwork to become a major global energy player. Melodie Michel takes a look at what’s changing.
Mexico’s energy reform is undoubtedly the most ambitious transformation the country has seen in years. Introduced by a modification of the constitution in December 2013, it eliminates the monopoly of state-owned energy companies Petróleos Mexicanos (Pemex) and Comisión Federal de Electricidad (CFE) in energy production, and opens the market to private players – domestic and international.
By doing this, the country hopes to revive declining energy production and boost its manufacturing sector’s competitiveness through a price drop. A February 2015 study by the IMF’s Jorge Alvarez and Fabian Valencia found that electricity prices in particular have the largest impact on manufacturing output, and that by changing the structure of electricity generation towards natural gas and away from fuel oil, the reform could lead electricity prices to drop 13%, increasing manufacturing output by up to 3.9%, and boosting GDP by up to 0.6%.
Pedro René Ojeda Cisneros, head of the large companies segment and energy sector at BBVA Bancomer, explains: “The gas and electricity costs will both decrease, bringing great benefits to the manufacturing sector. This, combined with the fact that we now have a weaker peso, means the competitiveness of the manufacturing sector will increase.”
Attracting foreign investors in the current low-price environment is no easy feat, especially as competition from other oil-producing nations has increased since the time the Mexican market was last open to international investment, in 1938.
“The new laws are very nice but the real issue here for success or failure of the reform is whether the contracts can be made competitive on an international basis. Mexico, having such a closed sector, was not used to thinking about the rest of the world. They thought everybody would come knocking on our door, but the reality is that there are so many countries that have reserves that Mexico is not unique,” says Marcelo Mereles, a partner at Mexico City-based energy consultancy, EnergeA.
It seems as though the Mexican government is proactive in improving the competitiveness of its contracts. The first auction of the so-called ‘round one’ tendering process fell short of expectations, with only two contracts awarded out of 14 – both to Mexican company Sierra Oil, in partnership with Texas’ Talos Energy and London-headquartered Premier Oil. But the second phase, held last September, proved more successful, with three out of five production-sharing contracts signed: one with Italy’s Eni International; one with Argentina’s Pan American Energy, in consortium with Hidrocarburos y Servicios; and one with US-based Fieldwood Energy, in consortium with Mexico’s Petrobal.
Mereles explains that the improved interest came from an adjustment in the terms of the contracts on offer. “The contracts for the first bids had a clause that was very one-sided: the government had the power to rescind the contract for various reasons, and this kept bidders away. For the second phase what they did was specify the reasons why the government could cancel contracts, and also added a provision for arbitration. There are now safeguards that make this a more bilateral process. I think they’re doing a good job overall, because they are listening to the comments from the industry,” he tells GTR.
Besides its geographical advantage – being located next door to the world’s second-biggest energy consumer after China – the country also benefits from its geological attributes: on top of its 9.8 billion barrels of proven oil reserves and 17 trillion cubic feet of proven natural gas reserves as of the end of 2014 (according to Oil & Gas Journal), it has enormous potential for renewable energy production. In fact, the reform also aims to encourage development in the renewables sector through an electricity purchasing scheme that favours clean sources, with the goal of generating 35% of total electricity from clean sources by 2025, compared to 6% in 2013.
As opposed to the oil sector, which requires contracts with the government, in the electricity industry, any company that wants to build a power plant now simply needs a permit. All the players can then sell their power to a new government institution called CENACE (Centro Nacional de Control de Energía), which will dispatch it to the end users.
There should be no shortage of companies wanting to tap that market, particularly considering that in recent years, manufacturing and other companies have invested a lot of resources to generate energy to fulfil their own needs. “Walmart for example is producing its own energy. These are now becoming energy companies because of that, and now with the energy reform, it is opening the market for them to sell power too,” Ojeda Cisneros says.
One potential issue that could come in the way of the market’s opening is the fact that Mexico’s retail energy prices are currently controlled by the ministry of finance: this started as a subsidy initiative, but the government then started to increase prices every month, which led to a reverse subsidy situation when global oil prices dropped by half last year. According to Mereles, the domestic price of petrol in Mexico is currently about twice that of the US. Although the ultimate goal of the reform is to liberalise pricing, there is no fixed deadline to do so, which could deter investors. “This is a big problem in terms of having a functional, free and open market. It’s stipulated in the reform that the government may liberalise these prices in 2018 but that if there are arguments about it they can still hold back. Until the price of gasoline is liberalised, you cannot have any competition in the midstream or downstream, because you have to compete on price. Nobody is going to want to build a refinery in Mexico if they have to sell at the same price as Pemex,” Mereles points out, though most in the market are convinced that the government will eventually open the prices to competition.
As the first affected by the reform, it would appear the state-owned energy companies are welcoming the changes.
Speaking to GTR on the sidelines of the GTR Mexico Trade and Export Finance Conference in October, Pemex director of ECA finance Alfonso A Rodriguez explained that the company had been suffering from the strain of its own monopoly, and that the opening of the market would bring significant efficiency improvements.
“We tend to think that monopolies are a good thing for [those who have it], but in our case, since we were the only ones that were allowed by law to do everything, the allocation of capital would have to go to activities that were not necessarily what we were best at. With the opening of the market to the private sector, we can allocate our capital to the best uses, yielding the most results and profits,” he said.
Additionally, the reform now allows Pemex to enter joint ventures (JVs), opening opportunities for equity capital raising. “Before the reform, we had to drill our deep-water wells alone in the Gulf of Mexico. Now we can do a JV with somebody to share risk and raise equity on a specific project – not at the level of Pemex. That’s a milestone for Pemex in order to raise capital. We also have midstream pipeline terminals worth millions – assets that used to belong to the government and that we can now sell,” explains the company’s associate managing director of finance, Carlos Caraveo.
This should provide much-needed relief to Pemex’s finances: as of the end of June 2015, the company’s debt stood at Mex$1.33tn (US$85.5bn), 75.5% of which is denominated in US dollars. The rapid depreciation of the peso, combined with the fall in revenue caused by the low oil prices means that the company’s budget deficit has gone over the official limit of Mex$155bn (US$9.6bn) set as part of the federal budget passed by Congress. Caraveo adds that he is not concerned about competition, as foreign firms new to the Mexican market will probably prefer to team up with Pemex through JVs than do it on their own – unless they manage to lure current Pemex employees to work for them.
“We are aware of competition in terms of other companies ‘stealing’ people from us, because they already know the market, the people, the resources… Our CEO is very aware of these things, so even though we are limited financially because of the current price of crude oil, the idea is to put together careers for people in Pemex,” he explains.
Further up the supply chain, companies are also feeling the repercussions of the reform. In a conversation with GTR, Alejandro Chiapa Monroy, treasurer at Mexican valve manufacturer Walworth, explained that there is a need for clarification regarding the current local content ratio imposed on Pemex for equipment purchasing: if removed, it would increase competition from foreign firms and put pressure on companies like Walworth. On the other hand, the arrival of international firms into the exploration and production market means more potential clients for equipment manufacturers.
The construction sector is also bound to benefit from the changes, as more oil fields and power plants will lead to increased needs for roads, bridges and power lines. “We hope that these changes will result in larger infrastructure needs so we can go out and bid for them, and participate in the developing. We see that some of these projects are frequently coming in the way of buy-operate-transfer set-ups (BOTs), so we developed a new division so we cannot only bid on the infrastructure project but also if we need to build concession contracts into our own construction company we can do that as well,” says Rodolfo José Flores Dominguez, director of construction firm Grupo Tradeco.
However, he believes that there is a need for the government to allocate more budget to infrastructure development, on top of encouraging foreign companies to invest in it.
“Right now, what we have is enough for foreign companies to come and build infrastructure in Mexico. It’s more a strain on the government budget that blocks more development on the infrastructure side,” he adds.
Banks too are having to adjust to the reform. While the opening of the market will undoubtedly create numerous project, trade and structured financing opportunities, the multiplication of players is bringing its own challenges. BBVA Bancomer’s Ojeda Cisneros explains: “Right now, we have to create different ways to fund companies but our risk models are not ready for that; they are accustomed to evaluating only two companies. We have to enhance our risk models in order to enhance our response time and give private investors the service they want.”
One thing is sure: the reform could not have come at a better time. The signing of the Trans-Pacific Partnership (TPP), announced on September 5, brings with it a lowering of the rule of origin ratio for the automotive sector, from 60% under the North American Free Trade Agreement (NAFTA), to 45%, and even 35% for certain auto parts, according to reports. This means that auto manufacturing countries – Japan in particular – will be able to source more than half of the parts they need to build a car from countries outside the agreement, yet still benefit from the deal’s tariff advantages upon selling them. Though the percentage included in the final TPP document is an improvement on the 30% rumoured to be discussed during negotiations, it will force the Mexican automobile sector to increase efficiency in order to maintain competitiveness – something that the reform will most likely help them achieve