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Cablegate: Mexican Congress to Debate Energy Reform

VZCZCXRO2957
RR RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #0209/01 0281434
ZNR UUUUU ZZH
R 281434Z JAN 08
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC 0248
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 07 MEXICO 000209

SIPDIS

SENSITIVE
SIPDIS

STATE FOR WHA/MEX, WHA/EPSC
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD
USDOC FOR ITS/TD/ENERGY DIVISION
TREASURY FOR IA (ALICE FAIBISHENKO)
DOE FOR INTL AFFAIRS A/S HARBERT, ALOCKWOOD, AND GWARD
DOL FOR ILAB

E.O. 12958: N/A
TAGS: ENRG EPET ECON MX
SUBJECT: MEXICAN CONGRESS TO DEBATE ENERGY REFORM

REF: A. 06 MEXICO 5810
B. 06 MEXICO 6783
C. 07 MEXICO 1256

Sensitive but unclassified, entire text.

-------
Summary
-------

1. (SBU) With Mexican oil exports at the lowest point in a
decade, 1.5 million barrels per day, the Mexican congress
will debate energy reform during its spring session. The
most significant debate will begin in the Senate led by
Francisco Labastida of the Institutional Revolutionary Party
(PRI). It is likely that the PRI and the governing National
Action Party (PAN) will unite to develop a single proposal
for reform that will concentrate on 'what is achievable'
rather than 'what is necessary' to reverse Mexico's
production declines. No draft reform proposals have yet been
announced as party leaders are reluctant to draw attacks from
the opposition. The three parties will meet January 30 to
attempt to hash out positions. According to one
knowledgeable insider, the initial proposal will not include
a constitutional change to permit outside upstream
investment, though it may include laws to permit outside
investment in refining, transport, and storage. It will seek
to separate Pemex from national financial accounts and create
a separate petroleum regulator. While most expect the debate
to conclude by April, one well-placed Embassy source believes
the process could slip into the summer. Regardless of the
outcome it is unlikely that the reform will significantly
improve Mexico's energy or financial security. End Summary.


------------
Introduction
------------

2. (SBU) This cable will set the stage for the upcoming
congressional debate on energy reform in Mexico. Our
experience from the passage of pension and fiscal reform
suggests that the Calderon team will work to achieve the
possible rather than strive for an ideal hydrocarbons law.
It is less clear whether an achievable compromise can stave
off fiscal crisis. Supporting a Mexican energy reform, the
International Monetary Fund notes that within "the medium
term" Mexico will cease to be a crude oil exporter. Post has
provided Washington agencies similar assessments (refs. A,
B) Furthermore, in its 2007 economic outlook for Mexico,
the IMF warned that beginning in 2012, oil production
declines would become even more pronounced.

3. (SBU) On the reform agenda, the lead PRI Energy Committee
staffer in the Senate (upper house), Francisco Diaz Palafox
(protect throughout) explained that the Mexican people have
unrealistically high expectations of what they think is going
to be a comprehensive reform of the sector, but what would
eventually pass would be a "light" reform. Nevertheless,
after years of not doing anything with the energy sector,
even this would be a step in the right direction.

4. (SBU) As to the current status of the negotiations
between and among the political groups, the senior Party of
the Democratic Revolution (PRD) staffer to the Chamber of
Deputies Energy Committee, Fluvio Ruiz Alarcon (protect
throughout), noted, contrary to almost constant press
reporting, there is not yet a broad inter-party consensus on
reform. Ruiz believed some package could be approved by
April 2008, but it too would be a patchwork, only what was
"politically possible and not what the country really needed."

5. (SBU) Ruiz suggested that the reform would pass easily in
the Senate, but debate in the Chamber of Deputies would be
more difficult since there were "too many legislators that
respond to special interests, such as their own state
governors." He admitted that March PRD leadership elections
could also complicate progress as in order for the PRD to
play a constructive role in the energy debate, the wing of
the party supporting radicalized former presidential
candidate Andres Manuel Lopez Obrador (AMLO) would have to

MEXICO 00000209 002 OF 007


be soundly defeated.

6. (SBU) Diaz Palafox cautioned that unlike other reforms,
energy reform was a uniquely sensitive issue, because for
Mexicans, oil represents their national identity. Ordinary
citizens would have difficulty understanding that the sector
needs private investment; even if it were made clear that the
government would still own the oil. Regardless of strict
definitions "allowing private investment in the sector" is
equivalent in most Mexicans' eyes -- including Diaz Palafox's
-- to "privatizing" the sector.

---------------
Party Positions
---------------


PAN
---

7. (SBU) PAN legislators have remained relatively quiet
waiting for the Calderon Administration to issue its reform
proposal. Despite their "lead" position, the PAN divides
into two groups on the reform question: those who want
private investment in the sector and those who have a more
nationalistic view, such as former Deputies Energy Committee
chair and the current head of Mexico's Energy Regulatory
Commission (CRE) Francisco Diaz Salazar, and want some
investment restrictions to remain.

Both Energy Secretary Georgina Kessel and Undersecretary
Jordy Herrera, who are both close to President Calderon (ref.
C), have said that they favor private investment in the
sector. Kessel, who has added few details to this statement,
told the press in December that the Secretariat of Energy and
Congress were working very closely in order to achieve a
consensus on the reform. Despite these comments, PRI
staffers with whom we spoke noted that the Administration had
not begun any formal talks with their seemingly natural PRI
allies.

Despite their low profile, the Energy Secretariat has
published energy outlooks emphasizing for the need for more
investment in exploration and production, in particular in
deep water.

In a press interview, the PAN Secretary of the Senate Energy
Committee Ruben Camarillo stated unequivocally that his party
was against privatizing Pemex because that would mean
transferring the parastatal's assets to private industry.
However, he said he was in favor of allowing private
investment in other activities including refining,
transportation, and storage through the amendment of
secondary laws. He explained that PRI and PAN seek to allow
the co-existence of private investment with Pemex investment.
This, despite more forward leaning positions from some less
highly placed PAN members, probably most accurately expresses
the party's current thinking; though, any more specific
position will have to await a formal Government proposal,
which has yet to appear.

Finally, some observers expect that academically inclined
Secretary Kessel will be replaced in favor of a more

SIPDIS
operational politician, though recent news points to the new
Secretary of the Interior (Gobernacion), Juan Camilo Mourino

SIPDIS
as taking charge of the energy debate on behalf of the
Calderon Administration.

PRI
---

8. (SBU) PRI Senator and former Secretary of the Interior
(Gobernacion) and Energy, Francisco Labastida Ochoa
informally leads the PRI faction negotiating energy reform.
Jesus Reyes Heroles, current Pemex CEO, is also working very
closely with Labastida. The two previously drafted a
proposal to reform Pemex's fiscal regime included in the
Finance Secretariat's (Hacienda's) fiscal reform. PRI
national leader Beatriz Paredes, who has said several times
that PRI will not agree to change the Constitution, also
wields power within the party in the debate.

MEXICO 00000209 003 OF 007

According to Diaz Palafox, the PRI is internally divided.
There are several groups ("corrientes") inside the party, and
those groups each have a separate position on reform.
Paredes has instructed party members not to give an
individual opinion to the public on energy reform until the
PRI as a whole has a unified position.

Labastida stated recently that the approval of energy reform
during the first congressional session from February to April
2008, was feasible. According to him, legislators are
working carefully to achieve good and qualitative legislative
changes and therefore, "there was no need to rush things.
PRI legislators were committed to pass an energy reform
package during the upcoming session." Though our contacts
were less sanguine about quick passage in the lower house.

The Senate's Energy Committee held several forums from June
through September 2007. At the forums, Senator Labastida
reported on the Senate Committee's travel to Brazil and
Norway and vigorously praised the success that the oil
parastatals, Petrobras and Statoil, have had despite being
partially state-owned. He said that these companies have
proved how successful state-controlled companies can be. He
also noted that in Brazil, about 1% of the sales revenue is
channeled to R and D, while Mexico only channels 0.05%.
Labastida highlighted that most of the projects in Brazil and
Norway have 70% national investment thanks to legislative
changes and a warmer attitude towards private capital.
Legislators also highlighted investments that both countries
made in research and technology and the integration of
domestic supply chains into the energy sector.

While Diaz Palafox told us he was unable to review the
positions of the various PRI factions, he seemed confident
that both the PRI and PAN would develop a joint reform
proposal. However, even though Labastida, a strong leader,
has been pushing for energy reform since early 2007 and seems
more open to allowing some private investment, Diaz Palafox
was quick to point out that he doesn't represent the whole
PRI, and even Labastida must still comply with the party's
platform, which opposes any constitutional change.

PRD
---

9. (SBU) According to staffer Fluvio Ruiz, on energy
reform the PRD will field a negotiating team, which includes
Senator Graco Ramirez from the Senate Energy Committee,
Senator Carlos Navarrete, and Congressman Javier Gonzalez
Garza. Ruiz reported that Ramirez met with his PRD
colleagues the weekend of January 15 to present PRD's
proposal and position.

Ruiz, who works closely with Ramirez, represents the more
moderate wing of the PRD on energy reform. Statements from
the three PRD leaders bear this out.

Ruiz admitted that the PRD has been discussing the reform
with a similar "low profile," because his moderate faction is
convinced that Mexico needs an energy reform without losing
sovereignty or the government's control over oil. However,
this moderate faction continues to fear a confrontation with
AMLO and his supporters because his divisive rhetoric would
endanger realistic negotiations.

In a December 13 Senate press conference Carlos Navarrete
said his party's priorities for the February to April
congressional session would be the State, Judicial, and the
Supreme Court of Justice reforms. He said rhetorically that
PRD will also commit to "defend Mexican oil and Pemex as
national patrimonies and as a State's property."

Navarrete has also said that the government was deliberately
using Pemex as a tax-cash cow to take into bankruptcy and
justify the need to privatize it. PRD estimates that the oil
export price during 2008 will be higher than the USD 49 per
barrel approved by Congress (Note the current price of the
Mexican Basket is USD 74 per barrel), giving additional
resources to Pemex including 13 billion dollars that could be
used for investment in the construction of a refinery,

MEXICO 00000209 004 OF 007


without resorting to national or foreign investment, to
reduce gasoline imports. Navarrete said that one of the
proposals tabled by his party was to amend the Budget and
Fiscal Responsibility Law and sell the idea to PRI to allow
Pemex to keep these additional resources.

During the same forum, Senator Ramirez said that PRD's
priority would be to have an adequate tax regime for Pemex so
that it "stops being Hacienda's cash cow; the second issue
would be to modify Pemex' board of directors, not with
members of the private sector, but with specialized
technicians; and third, achieving Pemex' independence from
the Finance Secretariat and the federal government." More
than investments in exploration and production, Ramirez said
that the government should focus on revamping Mexican
refineries. Again, he insisted that there would not be a
consensus regarding changing Article 27 of the Constitution.
He pledged that he would not be tempted to support
privatization and called for working for a "different Pemex
in Mexican hands."

States
------

10. (SBU) While not formally separate actors in the reform
process, Mexican States, personified by their governors,
acting in may cases regardless of party, will play an
important role limiting the degree of autonomy granted to
Pemex and the energy sector as a result of the reforms. Most
governors strongly oppose any changes in Pemex's taxation
scheme since generous surpluses resulting from the high oil
price accrue directly to the states. Most of the states have
never developed effective ways to collect local taxes, so
about 95% of the money they receive is transfers from the
federal government financed largely from oil revenues.

11. (SBU) Going even further, according to Ruiz, the
governors of Tabasco, Campeche, and Veracruz believe that
because the oil is found in their states, they should get an
even bigger share of state transfers from energy sales.
Hacienda establishes energy prices, collects taxes from
Pemex, and makes transfers to the states. They remain a
natural counterweight within the government to the Energy
Secretariat on reducing the interdependence between Pemex and

SIPDIS
the government. Nevertheless, Hacienda has agreed that there
is a need for more transparency on how states spend oil
revenue transfers.

Aspects of the Energy Reform Proposal
-------------------------------------

12. (SBU) Neither the government nor any party has made a
formal reform proposal. While the party representatives have
discussed the need to pass some form of energy reform and
make the sector more competitive, there is no consensus on
the steps necessary to achieve those changes.

13. (SBU) In the weeks leading up to the start of the
congressional session in February, Deputies and Senators from
the different parties are meeting to discuss their agenda for
the upcoming session including the position each party will
have on the energy reform.

14. (SBU) While no party has released a specific package of
proposals that would be included in a reform proposal, from
our discussions, we have pieced together a broad outline of
the issues that could be addressed:

15. (SBU) Budgetary Independence: At the very broadest
level, the reform will attempt to give Pemex budgetary
independence, removing it from national accounts. Hacienda
is reluctant to separate the parastatal from the budget
because of the difficulty of maintaining the fiscal balance
required by the budget and fiscal accountability law without
Pemex coffers to 'raid.' One senior Pemex Finance official
closely linked with Hacienda, told us more bluntly. "Pemex
is one of the worst performing oil companies in the world,
would you trust us to invest your money the most wisely?
Until we can better manage our own business, why give Pemex
more autonomy or more Mexican government money?"


MEXICO 00000209 005 OF 007


However, PRD staffer Ruiz claimed that by his calculations,
separating the Pemex balance sheet from national accounts
would only represent a reduction of 1.5% of GDP. According
to the PRD, Hacienda has approximately USD 41 billion
obtained from Pemex' revenues "frozen" or invested in
financial instruments that could be invested in
infrastructure.

16. (SBU) Constitutional Changes: While Pemex has worked to
provide contracts that allow private participation in
production of gas fields on a fee for service basis, and they
continue to search for new mechanisms to develop Mexican
resources, article 27 of the Mexican Constitution forbids
Pemex from entering into any risk based contract for the
development of hydrocarbon resources. Without such
contracts, no outside firm would invest in the oil sector in
Mexico, especially in the very risky and technically
complicated deep-water fields where Mexico's greatest
potential lies.

The PRD and PRI remain strongly opposed to any constitutional
change, but Ruiz explained that there could be some space for
private investment in the sector. While outside analysts
have written that the main issue being discussed by political
parties is whether or not to pass constitutional changes,
both the PRD and PRI representatives with whom we spoke
reiterated that given sensitivities in Mexico, such a
constitutional amendment could never pass, and thus was moot
anyway.

17. (SBU) Private Participation: While private
participation in the upstream is almost certainly off the
table without a constitutional change, simpler legal changes
may permit private investment in other areas including
refining, transportation, and storage, as well as the special
case of transboundary fields (developing those reservoirs
that lie on the border with the U.S.), though this latter
case may be difficult. The PAN seems to be in favor of
private investment; the PRI is somewhat on board, but the PRD
remains strongly opposed.

According to Ruiz, the PRI and PAN would make amendments to
regulations allowing private investment in transportation,
storage, and refining. The PRD still does not have a
position on transboundary wells, except that they strongly
oppose private investment.

On refining, in 2006 Mexican gasoline demand exceeded
national refining capacity by 268,000 barrels per day. Pemex
estimates this gap will grow to over a half million barrels
per day by the end of Calderon's term. The gasoline pipeline
from Mexico's Gulf Coast terminal to Mexico City is currently
loaded to capacity. Much of the surplus Mexico earns through
crude sales it uses to purchase gasoline. President Calderon
has included construction of a seventh national refinery in
his national infrastructure plan. Nevertheless, the USD 3-5
billion cost of such a refinery would represent a third or
more of Pemex's annual capital budget. Private investment
could resolve the problem. No specific constitutional
restriction on refining exists. Some have suggested allowing
only Mexican private investors to participate any new Mexican
refinery project, but Hacienda would like to open the
opportunity to foreign investors as well.

However, Ruiz noted that without changes to legal framework,
investors would be reluctant to invest large amounts of money
in a new Mexican refinery. Because the prices of gasoline,
as well as all inputs are now fixed by Hacienda, private
investors would be unlikely to find an appropriate rate of
return in such an investment. In transportation, Ruiz saw a
problem of creating monopolies, which could represent a risk
in fuel distribution. Private investment in storage,
according to Ruiz is not as risky as the other two.

Diaz suggested the PRI also had a proposal to open refining,
transportation and storage services to private investment,
and shared concerns that given the current Mexican legal
framework, it would be difficult to attract potential
investors without special incentives. Diaz also said that
some PRI members proposed establishing restrictions on
foreign investment as an incentive for national investors in

MEXICO 00000209 006 OF 007


these areas.

18. (SBU) Board of Directors: Currently the Pemex board of
directors is made up of six government representatives and
five representatives of the Pemex union. According to Ruiz,
one PRD proposal with, reportedly some PAN support would be
to include seven members from the government, four members
from the union, and three independent members. Unlike the
PAN, the PRD would called the independent members "social
members" since the PRD would like them to be academics,
technicians, or experts in energy, and not businessmen or
financiers as the PAN has suggested. The PAN also suggests
having more independent members than government ones.

19. (SBU) Oversight: Ruiz noted there was support across
parties for creation of an independent agency or organization
such as Brazil's National Petroleum Agency (ANP) or the
Norwegian Petroleum Directorate (NPD), which would define oil
and gas policy separately from government financial demands
and Pemex operational needs. The relationship, funding, and
power of this organization relative to Pemex, the Secretariat
of Energy, and Hacienda will generate significant discussion.
Existing actors are likely to oppose the concept because of
the loss of control it implies. Ruiz suggested one
alternative to the independent oil and gas regulator would be
creation of a separate "contract-plan" between the government
and the parastatals to establish goals and commitments.

20. (SBU) Mexican Petroleum Institute (IMP): The PRD has
proposed strengthening the largely ineffective IMP, the R and
D arm of Pemex, by increasing its budget.

21. (SBU) Other changes: Ruiz and the PRD also suggest
combining Pemex's four separate business units (Exploration
and Production, Refining, Gas and Basic Petrochemicals, and
Petrochemicals) to save on overhead. The change would also
give the company more flexibility on transfer pricing;
currently all product transfers between the four companies
must now be at Hacienda dictated prices. Finally the change
would simplify management. The Presidents of the four
sub-companies are all appointed by the Mexican President
making it difficult for Pemex's CEO to lead the companies.

----------------------------
Timetable: After You Alfonso
----------------------------

22. (SBU) Although the PRI, PAN, PRD and government have
been discussing energy reform since the fall of 2007, neither
party nor the government have been willing to present a
reform proposal because of the political cost of being the
first to move. Nevertheless, legislators from different
political parties will meet for two consecutive days in
late-January outside Mexico City to move forward what
Labastida called an integral reform. Diaz Palafox told us he
believed that eventually the PRI, PAN, and the government
could reach an agreement to present a reform package within
the month.

23. (SBU) If either PAN or PRI individually announced an
energy proposal the other parties would be obligated to
attack it, stifling the process. Diaz Palafox also felt the
Congress and Calderon would have to "sell" the reform as a
patriotic gesture rather than an economic issue. He noted
that President Fox's electricity reform failed because he
sold it as a business issue.

24. (SBU) Most sector analysts believe that the February to
April Congressional session is the last opportunity to pass
reform because after the spring session, the 2009 mid-term
congressional elections would make the political environment
too difficult to pass any reform. Diaz Palafox told us his
boss, Labastida, also wants to pass an energy reform before
April, but Diaz Palafox believes the time is too short given
the complexity of the issue. He suggested discussions could
be extended to a special session during the summer.

25. (SBU) Ruiz suggested there would be two potential
outcomes to the initial debate. In either case the PRI and
PAN would agree on some reform. The PRD would either oppose
any change in the sector or it would agree on some aspects of

MEXICO 00000209 007 OF 007


the reform. Even as the lead PRD staffer, it was difficult
for Ruiz to predict the outcome because any agreement would
involve more "political" considerations than an analysis of
what was best for the sector or the country.

26. (SBU) Ruiz said in his estimation, the PRD would have
nothing to lose if it voted against a reform. Conversely, if
the whole PRD supported the PRI and PAN they would likely
lose political capital with their key constituents.

-------
Comment
-------

27. (SBU) Petroleum Intelligence Weekly reported that
Mexican oil exports fell to a decade-low monthly average of
1.496 million barrels per day in December and average 2007
output was 3.082 million barrels per day down 174,000 barrels
per day from a depressed 2006. Senior representatives of
Halliburton and Chevron in Mexico suggested to the Ambassador
this week they expected the 10% drop in production from
Cantarell to continue. Initial indications show that the
energy reforms likely to pass the Mexican congress in 2008
are unlikely to stanch this decline. Worse yet, individual
Senators continue to suggest reform proposals that would
ensure that international oil companies remain barred from
the Mexican upstream sector.

28. (SBU) To help inform the debate on the Mexican Energy
sector, we have proposed that the Mexican Senate Energy
Committee visit the U.S. Gulf Coast to learn more about what
U.S.-based industry would have to offer Mexico and as a
counterweight to the committee's visits to Brazil and Norway.
We are hopeful that such a visit might help to squelch some
of the more nationalistic proposals that have arisen in the
debate.

Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity and the North American
Partnership Blog at http://www.intelink.gov/communities/state/nap /
GARZA

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