Top Stories

Breakthrough & Change Of Paradigms: A Liberalised Mexican Energy Industry

By Rogelio Lopez-Velarde & Jorge Jimenez
Posted: 23rd June 2014 08:58
Mexico is undergoing a dramatic change of paradigms in its energy industry as a whole.  It is no minor task, considering it continues to be the largest sector of its economy, the contributor of 35% of the federal budget and a high producing player in the international energy market. 
Three pivotal changes represent a dramatic turn in the sector’s policy and fundamental principles:
1. As to exploration and production of oil and gas, Pemex, the monopoly of the petroleum industry for more than seven decades, will cease to be the only operator.  Private players will be entitled to operate fields whether onshore or offshore, shallow and deep water, for conventional or unconventional resources, through E&P contracts granted by the Federal State.
2. On the midstream and downstream side, the industry will be fully liberalised and open to private participation competition (domestic and foreign).
3. The electricity market, also historically controlled by the vertically-integrated power utility Comisión Federal de Electricidad (“CFE”), is fully liberalised for participation of private investment in the generation of power, the creation of a power wholesale market where qualified users will be entitled to purchase electricity, an independent system operator and a liberalised supply by private marketing companies.
With the initial step for this major overhaul having been taken back in December 2013 with a Constitutional amendment that laid the ground for the implementing legislation, a series of statutes detailing the framework for the industry have been presented, and are at the time we write this, being discussed by Congress.  Two main statutes constitute the reform’s cornerstone: (i) the Hydrocarbons Law (Ley de Hidrocarburos), and (ii) the Law of the Electricity Industry (Ley de la Industria Eléctrica).  One provides all rules required for the operation of the oil and gas industry, from E&P contracts, to the development of liquids and gas pipelines and terminals, while the other structures the operation of the power market.  Around them, a number of supplementing statutes implement the following organisational principles:
a. Upstream.  As noted, Pemex will cease to be the sole operator in Mexico.  The upstream regulator, the National Hydrocarbons Commission (Comision Nacional de Hidrocarburos or “CNH”) will administer the upstream projects on behalf of the State and will for such purpose, (a) grant administrative allocations to Pemex to continue to operate blocks or fields, and (b) award E&P Contracts to private operators through bid rounds.  The Hydrocarbons Law will regulate not only the specifics of the governance of the contracts, their types (Production Sharing Agreements, PSAs, licences), but also their award.  A new Law of Hydrocarbon Revenues will regulate how the E&P contracts, and the allocations that Pemex will continue to operate for certain fields, will be taxed.  A new law will regulate the operation of the sovereign fund that will receive the compensation and the oil revenues other than taxes.  The fund will be managed by Mexico’s Central Bank, which is covered by Constitutional autonomy, and includes a series of rules for the use and allocation of revenues to ensure their long-term sound investment.
b. Midstream and Downstream.  The Hydrocarbons Law fully liberalises midstream and downstream activities, from transportation and distribution, to processing and refining of gas and crude oil, under the regulatory jurisdiction of the Energy Regulatory Commission (Comision Reguladora de Energia or “CRE”) and the Ministry of Energy (“SENER”).  A transitional regime is established with respect to the foreign trade and retail sale of gasoline and diesel, given the impact to the public and the currently controlled pricing structure, but the sector is nevertheless likely to have a significant inflow of investment given the much needed growth and upgrade of the existing and limited midstream and downstream infrastructure.
c. Natural Gas.  The Hydrocarbons Law calls for the creation of the National Center for Natural Gas Control (CENAGAS) and the transfer of the gas transportation integrated system and associated transportation contractual rights to this new operator.  Specific regulation on operation of transportation systems and their interaction rules with gas marketing companies are expected to reshape the market.
d. Foreign Investment and PPPs.  Amendments to the Foreign Investment Law and Public Private Partnerships Law are harmonised to make them consistent with the opening.  Among other matters, current restrictions on pipelines and wells construction will be lifted, opening additional alternatives for state and local governments to implement their own projects.
e. Reorganisation of Pemex.  Pemex will continue to play a very relevant role in the industry, but it cannot do so under its current restrictive organisational laws.  A new organisational law will reshape it from a governmental administrative body into a “state productive Enterprise”, a new structure expected to operate under commercial principles, with budgetary and operational autonomy.
f.  Environmental Regulation.  Consistent with other international experiences, a new agency will be entrusted with environmental, health and safety issues for the oil and gas industry.  This bifurcated specialisation between the CNH and the Agency for Industrial Safety and Environmental Protection for the Oil Industry (the so-called ANSIPA) is expected to reinforce the ability to efficiently oversee the operators and midstream companies.
g. Power.  As noted above, the new Law for the Electricity Industry will redefine the industry structure, by implementing (i) the full liberalisation of the power generation industry, (ii) dispatch through an independent system operator, (iii) operation of the transmission and distribution grids under the responsibility of the State, but subject to contracting with private parties, (iv) a wholesale electricity market.  CFE will be spun-off to separate distribution, from transportation and a number of generation companies.  Similar to Pemex, CFE (and the entities that will result from its spin-off) will be reshaped as a state productive entity, with commercially orientation. 
h. Geothermal.  A new statute will govern the exploitation of geothermal resources by private participants.  Amendments to the Federal Water Law will also be introduced to harmonise.
i. Renewables.  Although not part of the initial package, supplemental legislation will be introduced to continue fostering development of renewable energy projects, to exploit Mexico’s leading renewable resources potential.  The statute will guarantee the stability of mechanisms such as the banking of electricity, stamp rates for wheeling services, guaranteed dispatch of the system, tax incentives, among others, and set forth aggressive goals for energy transition.
The Legislation Package constitutes a giant step in the direction of providing a coherent structure to a sector that requires massive investment and presents significant opportunities for upgrade and development in each and every front.  Changes will continue to occur for months to come, even once the legislation is passed, as additional regulations and guidelines will require to be put in place by administrative authorities, the specialised agencies, the Boards of Pemex and CFE, among others.  At the same time, the sector will continue to monitor the outcome of the so-called “Round Zero” where Pemex will be awarded the fields for exploration and production that it will keep, in which case it will still have to define which of those it will continue to develop on its own, perhaps with the traditional aide of pure service contractors, and which ones will be developed through commercial joint ventures with international operators.
Rogelio López-Velarde and Jorge Jiménez are partners at the law firm of Lopez Velarde, Heftye y Soria (“LVHS”) in Mexico City.  LVHS is a leader in legal services in the energy industry in Mexico and has consistently been ranked as the top legal advisor in the sector by international ranking services.  It has extensive experience in all areas, from upstream (E&P projects), to the major gas pipeline projects, LNG terminals, power plants and renewables. 
For more information contact:
Rogelio Lopez-Velarde
Jorge Jimenez

Related articles