On August 11th, Mexico’s Congress approved a package of legislative measures to reform the State’s energy market and open up its oil and gas industries to foreign companies. This is the latest reform to emerge from the administration of President Peña Nieto which, in its first 9 months, has seen an extraordinary amount of Congressional activity in Mexico. Nieto and his team are implementing this mandate through the Pacto por México, an agreement between the main political parties to promote a series of constitutional reforms in the areas of education, politics labour, telecommunications, financial services and energy. The energy reform is the centrepiece of Nieto’s modernisation programme designed to re-energise Latin America’s second largest economy.

The oil and gas industry is central to the history of Mexico and its economy.Early exploration resulted in the creation of a public company, Petróleos Mexicanos (“PEMEX”), which has had operational jurisdiction over all hydrocarbon reserves throughout the country for the last 75 years. PEMEX has grown to become an economic powerhouse for the State – currently PEMEX accounts for 7.7% of Mexico’s GDP with production at 2.5 million barrels per day, although this is considerably below the peak of more than 3.4 million barrels per day which was achieved in 2004. Similarly the Mexican electricity industry has been controlled by the State monopoly Comisión Federal de Electricidad (“CFE”). Under these reforms PEMEX and CFE will be transformed into “State-owned productive companies”.

During the last 20 years or so, declining oil production, political stagnation, globalisation of consumption, and an underperforming economy have all contributed to the need for change. Elsewhere advances have been made in shale gas extraction, deep-water drilling and other related technologies, but Mexico has been isolated from these developments because of its protectionist approach. “Today, a great step was taken for the future of Mexicans,” Nieto wrote on Twitter following the vote in Congress, adding that the reforms will lead to a “more competitive and prosperous Mexico.”

The reform package aims to address a number of key areas:

  • The introduction of formal liberalisation of oil and gas exploration and production activities, through a competitive licensing scheme.
  • Gradual liberalisation for petrol retail starting in January 2016 and private imports of gas and hydrocarbons from January 2017.
  • National content for oil and gas licences to be set at 35% to support strengthening of the national supply chain and building the capabilities of Mexican labour to internationally certified standards.
  • Clear rules on land-use, including profit sharing schemes to be paid in “rents” to owners of properties where onshore hydrocarbons resources are to be explored and produced.
  • A restructuring of current electricity subsidies, and formal liberalisation of electricity generation and transmission, through the granting of licenses, mainly to companies that will boost the renewable and clean energy mix.
  • Limitations on the current PEMEX and CFE unions.
  • Controversially one measure calls for the government to absorb part of the PEMEX worker union’s unfunded pension liabilities, which total more than US$125 billion, or 10 percent of the country’s GDP. The company and workers will then have to renegotiate their labour contracts.

“This reform allows private investment in the entire value chain of Mexico ?s resources and very importantly, opens this possibility in the upstream activities” comments Jesús Rodríguez Dávalos, Founding Partner, RDA*(a legal firm specialised in the energy sector in Mexico), adding This implies opening up Mexico ?s potential capacity with new players and new rules.The new set of rules involves new regulations and regulators, new actors, new business administrations, and many other challenges regarding economic, geological, and political factors. The new laws are new to all. They have been oriented to develop the sector in all its potential, but need to be carefully evaluated to understand how best to implement them”.

Foreign companies have eagerly awaited the final details of the legislation, which will allow them to sign profit-sharing contracts as soon as next year to drill for oil and natural gas. US giant ExxonMobil and British rival BP have been leading an “energy task force” within the American Chamber of Commerce of Mexico in order to prepare for this. The government says the reform will allow Mexico to obtain the technology to drill for shale gas over its land and for deep-water oil drilling in the Gulf of Mexico and is predicting inward investments of up to US$200 billion by 2020, with the potential for even more beyond that. “Investing in Mexico will be hot news in the forthcoming days as foreign companies become willing to invest significant sums of money in future energy projects” observes Raúl Romero, Consultant, RDA. An example of this is the Fermaca Global acquisition by Partners Group Holding AG, a US$750 million M&A transaction that was held earlier this year. Fermaca is one of the most important natural gas companies, as it has always been able to develop its projects through private equity. “Given the current regulatory amendments in Mexico it is foreseeable other companies will undertake similar strategies. It is also important to recognise that M&A opportunities exist all over the country, however it will be necessary to keep in mind the relevant antitrust regulations”, concludes Romero.

Carlos Flores Flores, Partner, RDA, makes an additional point: “Another important factor is going to be the human capital. Mexico will now attract many more specialised workers, in the public as well as in the private sector. The success in attracting more specialists to the national sector, will impact directly the speed with which the energy reform will deliver the expected results”.

There is no doubt of the importance of this reform to the future of Mexico, and no doubt either about the scale of opportunity for outside companies to become involved. But there are many potential pitfalls, and those wishing to enter this market will need a thorough understanding of the new paradigm being introduced, particularly the many and varied legal aspects.*RDA (Rodríguez Dávalos Asociados) has been awarded ‘Best Oil & Gas Firm, Mexico- 2015′, ‘Best Energy Firm, Mexico- 2015’ and ‘Best Shipping Firm, Mexico- 2015’ in the Business Worldwide Legal Awards 2015.

RDA  is a leading provider of legal services mainly focused in the energy and infrastructure sectors, and has experience and knowledge in developing first of a kind projects.