CHAPTER 7 MEXICO: LATIN AMERICA'S ENERGY ENIGMA? AN ANALYSIS OF CURRENT OPPORTUNITIES AND FUTURE PROSPECTS

• Jurisdiction: Derecho Internacional

Oil and Gas Development in Latin America
(Mar 1999)
CHAPTER 7
MEXICO: LATIN AMERICA'S ENERGY ENIGMA? AN ANALYSIS OF CURRENT OPPORTUNITIES AND FUTURE PROSPECTS
ROGELIO LOPEZ-VELARDE
Lopez Velarde, Borda Y Quintana, S.C.
Mexico City, Mexico

MARCH 17, 1999

INTRODUCTION

The upstream sector of the Mexican oil and gas industry remains closed for private equity participation. The current administration still believes that such sector shall remain exclusively reserved to the Mexican State; however, midstream and downstream activities are being successfully privatized, allowing private participation in these new highly competitive markets.

I. EXPLORATION AND PRODUCTION

According to the Political Constitution of the United Mexican States (i) the ownership of all domestic hydrocarbons is permanently vested on the Mexican State, (ii) the petroleum industry is exclusively reserved to the State, and (iii) no concessions are allowed for the exploitation of oil and gas reservoirs.¹

Back in 1958 Congress broadly interpreted the aforesaid constitutional mandates and expanded the scope of the monopoly granted to Pemex, upon the promulgation of the Petroleum Law (Ley Reglamentaria del Artículo 27 Constitucional en el Ramo del Petróleo), creating one of the biggest vertically-integrated monopolies of the world in the petroleum industry.

Pursuant to this 1958 Petroleum Law, oil and gas exploration and production are exclusively reserved to the State. These activities are also, by operation of statutory law, exclusively entrusted to a single public instrumentality: Pemex-Exploración y Producción ("Pemex E&P"), one of the four operating subsidiaries of Petróleos Mexicanos ("Pemex"). Pemex E&P, like the other operating subsidiaries of Pemex, is a decentralized public entity of the federal government of Mexico. Under Mexican law, private direct participation is proscribed in such public instrumentalities.

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Upstream activities are normally performed by Pemex E&P through service contracts are mainly governed independent contractors, national or foreign. Such service contracts are mainly governed and regulated by Mexico's Political Constitution, the Government Procurement Code (Ley de Adquisiciones y Obras Publicas), and international treaties ratified by Mexico (e.g. Chapter X of NAFTA). As a general rule, such service contracts can only be awarded through an international public bid. Few statutory exceptions may be invoked by Pemex E&P in order to directly award a service contract to a company without launching an international public tender.²

Under the 1958 Petroleum Law, performance and incentive-based contracts are permitted to the extent no ownership rights over the domestic hydrocarbons are contractually granted by Pemex E&P, as compensation for the services rendered by the independent contractor. Thus, oil and gas risk contracts are forbidden if in rem rights over the oil and gas production were given as consideration of the works. Oil and gas reservoirs belong to the Mexican Nation (not Pemex E&P), until such reservoirs are produced and extracted from the subsoil.³

There is a 49% limitation for a foreign investor who wants to participate in a Mexican oil and gas drilling company. Such foreign investment limitation, however, may be surpassed upon the prior approval of the National Commission on Foreign Investment (Comisión Nacional de Inversiones Extranjeras). In general terms, there are no other foreign investment limitations for the incorporation or acquisition of oil field service companies in Mexico.

Rendering all sort of services to Pemex E&P has been booming (i) since Mexico further liberalized the government procurement market in early 1994 as a result of NAFTA, (ii) since Pemex E&P decided to increase production levels including those related to the Cantarell field in the Campeche bay, and the sweet, unassociated natural gas fields located in the Northern part of Mexico (the Burgos basin), and (iii) since the Mexican government decided to finance such projects through resources coming from the contractors and suppliers, in light of the budgetary constrains that the Mexican government has been facing even prior to the fall of the oil prices. As a result, major equity projects have been launched by Pemex E&P on an off balance sheet financing basis. For example, in 1998 Pemex E&P awarded to a consortium of Mexican and foreign companies a 15-year renewable Nitrogen Supply Contract for the supply of 1,200 million standard cubic feet per day to be injected to the Cantarell field. The net present value of the contract was close to 1 billion US Dollars, and payment to the independent contractor will be done on a throughput basis. Just recently Pemex E&P, after learning the success of the works in Lake Maracaibo in Venezuela, awarded a sour gas compression contract to a consortium of Mexican and foreign companies, substantially on the same basis as the aforesaid nitrogen project. These are some examples of a number of equity projects being pursued by private companies in Mexico aimed at providing services and financing to Pemex E&P.

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In light of the increasing demand on natural gas, and due to the legal reforms described below, Pemex E&P needs to increase the production of natural gas in the short term. The Mexican government, however, is living with the smallest budget in the last 25 years. Needless to say, Pemex is subject and has been subject for years to such budgetary constraints, and by a restrictive tailored-made tax regime which takes almost all of Pemex profits. There is no sufficient federal funding to cope with Pemex investment requirements and production programs. Pemex surplus on natural gas supply will not last very much longer; Pemex E&P requires to be more creative in the implementation of incentive-based turn-key service contracts with private companies; otherwise, Mexico will have to start importing significant loads of natural gas in addition to the importation of refined oil products from the U.S.

II. REFINING

Refining and processing of oil and gas is also exclusively reserved to the State according to the 1958 Petroleum Law. By operation of statutory law, this activity is also exclusively reserved to a single company, namely, Pemex-Refinación, one of the four operating subsidiaries of Pemex.

The refining capacity of Pemex-Refinación is not enough to cope with the increasing demand of certain refined products (e.g. gasoline). Thus, Pemex E&P heavy crude oil is not only being refined in Mexico but also in the U.S. A few years ago Pemex acquired 50% of the Deer Park Refinery in Texas, in a joint venture signed with Shell Oil Co.

Pemex refineries are being upgraded with independent contractors, and two cooking plants are currently under construction. According to Mexican law, only the refining of imported hydrocarbons may be subject to private equity participation.⁴ Currently, there are no crude oil refining activities in Mexico conducted by private parties. Pursuant to the Foreign Investment Law (Ley de Inversión Extranjera), only Mexican investors may own and control companies engaged (i) in retail gasoline stations in Mexico, and (ii) in liquefied petroleum gas distribution.

III. PETROCHEMICAL INDUSTRY

The failure of the privatization of the petrochemical plants of Pemex is well-publicized all over the world.

Currently, Mexican law distinguishes between basic petrochemicals and non-basic petrochemicals; the former are exclusively reserved to the State, and no private participation is allowed; the latter is within the stream of commerce and any company may participate in the manufacture, transportation, distribution and marketing of such non-basic petrochemicals.

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The following basic petrochemicals are exclusively manufactured by Pemex-Gas y...