Cablegate: Calderon Introduces Energy Reform

DE RUEHME #1072/01 1011414
P 101414Z APR 08





E.O. 12958: N/A


Introduction and Summary

1. (U) Secretary Kessel delivered in the evening of April 8th
the Administration's energy proposal, signed by President
Calderon, to the "secretario tecnico" of the Senate, Victor
Orduna Munoz. The proposal will be presented to the full
Senate on April 10 and will be sent to the Energy, Finance,
and Legislative Studies Committees for analysis and approval.
After being approved by the Senate, the bill would have to
be sent to the Chamber of Deputies. PAN coordinator in the
Chamber of Deputies, Hector Larios, said that there wasn't a
100% consensus on the reform, but that approval was feasible.
According to him, Calderon will submit changes to Pemex
fiscal regime on April 10 to the Chamber of Deputies. The
proposal includes five main changes to secondary laws. These
changes are discussed in detail beginning in para 12. and
track relatively closely with the proposed changes suggested
by our sources in refs A and B:

A. The "Organic Law" of Pemex (Pemex founding statutes) (see
paras 9-14 below).

B. The "Organic Law" of the Federal Public Administration
defining government operations (defining the role of the
Energy Secretariat)(see para 15 below).

C. Reforms to the Energy Regulatory Commission (CRE) law on
pricing (see para 16 below).

D. Reforms to regulations of Article 27 of the Constitution
reserving oil production and refining for the state. (see
para 17-18 below).

E. Creation of an "Oil Comission," which will support the
Energy Secretariat in developing policies. The commission
will have five commissioners appointed by the President (see
para 19 below).

At 9:30 p.m. April 8 Mexican President Felipe Calderon gave a
political speech on national television to explain the
proposal. He stressed several times that Pemex will not be
privatized and that Mexican oil will continue to be owned by
Mexicans. He said that his energy proposal was only aimed at
strengthening Pemex. Calderon used information included in
the government's diagnostic several times during his message.
End Introduction and Summary.

Summary of President Calderon's Message

2. (U) Calderon started his speech noting that the government
will act with patriotism to take advantage of oil resources.
"Pemex will continue to be the property of all Mexicans and
will not be privatized. Pemex is a national symbol." Pemex
is losing competitiveness. He said that a few years ago
Pemex was the sixth most important oil company in the world
and currently it is the eleventh. This is the result not
only of its financial problems, but also of its lack of
technology and operational capability. Reserves are
declining. Mexico's remaining proven reserves would last a
little over nine years at current production rates. Output
has declined and Mexico has stop receiving the equivalent of
USD 9.4 billion annually. With these resources, Calderon
argued,the government could have dramatically increased the
budget for the popular social program "Oportunidades." The
lack of refineries has meant that Mexico has had to increase
gasoline and fuel imports. Currently, he reported, 4 out of
10 liters of gasoline are imported. Calderon praised Pemex
employees work. He reminded the audience that that more than
half of Mexican reserves are located in deep water. The
proposal seeks to guarantee that Mexico has oil for future
generations. The proposal will strengthen Pemex. He
repeated that Pemex will continue to be a state-run
company,and the initiative does not propose changing the

3. (U) He listed the six pillars of his proposal:

MEXICO 00001072 002 OF 005

1. Provide Pemex with more management and financial autonomy
over ten years. Pemex will have more freedom to manage its
budget and debt to invest its resources in new projects. In
particular allow it to reinvest profits to strengthen the

2. Create a special regime for Pemex that will allow it to
award contracts without following traditional government
procurement rules, giving the firm greater access to
technology and improving its ability to operate.

3. Reduce gasoline imports. Private companies will be
allowed to build and operate refineries on behalf of Pemex.
Payment will be on a fee-for-service basis. The construction
of refineries will generate more jobs, will trigger economic
development in the states where they are built, as well as
strengthen the petrochemical industry, and produce clean
gasoline and cheaper fertilizers for farmers. Pemex will
continue to own the oil and its products.

4. Improve Pemex administration. Improve its accountability
and transparency to eliminate corruption.

5. Pemex will issue "bonos ciudadanos" (citizen's bonds)
which are debt instruments which will be available to all
Mexicans. The return paid by these instruments will be
similar to the rate of return obtained by Pemex. The value
of these individual bonds will be about 10 dollars.
Individuals, pension and investment funds will be able to
acquire the bonds. There will be restrictions to prevent a
single entity from holding large volumes of the bonds. The
bonds would not confer an equity stake.

6. Calderon also said that regulatory authorities will be
strengthened. He will also implement measures to protect the
environment when producing and replacing oil reserves.

4. (U) He added that the government considered the concerns
and ideas of other actors while developing the proposal.
Calderon also believed that the decision should not be
unilateral and that the proposal should be broadly discussed
and analyzed, but he urged legislators to move quickly. He
also raised the fact that Cuba and the U.S. were already
exploring fields that cross into Mexican waters while Mexico
has been unable to explore for and produce oil in deep water.
Calderon finished his message by repeating that the oil is
and will be owned by Mexicans and that Pemex will not be
privatized, but strengthened.


5. (U) Both former Economy Secretary Luis de la Calle and
Economist Ernesto Cervera speaking on television said after
the debate that the proposed reform was "what was feasible
and possible" and not "what the country needed." De la Calle
said that it was a good step forward, particularly the fact
that Calderon tabled the reform and that he understood the
country needed a broad debate. De la Calle said he expected
many of the issues, if passed would be challenged before the
Supreme Court of Justice, though Administration officials
told Emboffs last year that they would worked with the court
to study the constitutionality of reform measures before
introducing them. De La Calle thought though that a challenge
was positive because it helped the democratic process. He
also commented that more than an energy reform, Calderon's
reform was a political reform, because of all the
negotiations it required.

6. (U) AMLO Economic Advisor Mario di Constanzza complained
about the possibility of Pemex directly entering into service
contracts and the private sector's participation in
refineries. He said the PRD has always been afraid of the
creation of more monopolies as it has happened before with
the financial and telecommunication sectors. He also said
that the Frente Amplio Progresista had drafted and
distributed and alternate proposal, which didn't include
private participation but steps to correct and modernize
Pemex. When asked why they had not sent it as a formal
proposal to Congress rather than complaining, he said that
their experience is that nobody cares about their proposals
and the other parties do not even think of discussing them.

MEXICO 00001072 003 OF 005

7. (U) About "removing" Pemex from public finances, all
comentators were disappointed that Pemex' fiscal regime would
be modified in a ten-year period. This seemed too long to
continue with the status quo before Pemex could use its own
resources for projects. However, they all agreed that since
there has not yet been a broad tax reform, public finances
would still have to depend on oil revenues through the medium
term. They mentioned the importance of implementing taxes on

Political Parties' Reaction

8. (U) PRI leader Beatriz Paredes said her party had
committed to carefully review and analyze the proposal. AMLO
said that the proposal intended to privatize the sector by
allowing private capital in refineries, but said that
protests would not begin immediately. April 10 Senate PRI
leader Manilo Fabio Beltrones called for a series of open
fora between experts and political leaders to debate the
proposals. Beltrones also suggested that PRI would make some
changes to the proposal.

Summary of Energy Reform

Pemex Organic Law

9. (U) To improve corporate governance and strengthen the
Pemex board of directors, legislation proposes adding 4
professional (independent) counselors. The number of union
members (5) and government officials (6) will remain
unchanged. The board of directors will be independent.
Professional board members will be appointed by the President
of Mexico to staggered eight-year terms beginning on January
1, 2009. The appointment could be extended for an additional
period. These board members must be Mexican and must have
experience in the sector. Two of them would be considered
representatives of the State and will be full-time. The
other two will be part-time members. Any decision made by
the board would have to have at least two votes from the
professional counselors. If not, the decision would be
approved by simple majority in a following session. The
quorum required to vote any decision will be eight members of
the board (Comment: thus, under this proposal the government
plus two of the professional counselors could outvote the
union, and perhaps unsurprisingly, the PRI opposes having the
President nominate the professional members). To make the
Board's decision even more transparent, Calderon proposed the
creation of an Auditing and Transparency Committee, the
Strategy and Investment Committee, and Salaries Committee.
The board has the power to create more committees as
necessary. The President will also designate a commissioner,
who will be responsible for reporting information on Pemex
activities, and for protecting the interest of the owners of
the citizens' bonds. The law also includes mechanisms to
sanction the members of the board, regardless if they are
independent or government officials or members of the union.

10. (U) The legislation seeks to provide Pemex with
financial autonomy from the government. Pemex will be
allowed to propose its debt schemes to the Finance
Secretariat (Hacienda), which will have to approve them.

However, Pemex will be able to determine its own foreign
currency or foreign capital market financing without having
to obtain Hacienda's authorization. Hacienda will; however,
have the authority to prohibit any of Pemex' financial
decisions if they threaten the country's macroeconomic

11. (U) Pemex will be able to sell bonds directly to
Mexicans. The bonds could be obtained by any Mexican
citizen either directly or through financial intermediaries.
These bonds will not grant holders any equity, and their
return would be tied to the firm's performance.

12. (U) Pemex will be able to use additional revenues it
generates without Hacienda's authorization as long as the
decisions do not interfere with the government's
balanced-budget target.

MEXICO 00001072 004 OF 005

13. (U) To improve Pemex's ability to enter into contracts
and procure supplies, Calderon proposes a mixed scheme that
will distinguish substantive operations (exploration and
production) from other less-substantive activities. The
first will be exempted from the requirements established in
the Acquisition, Leasing and Public Services Law which had
made Pemex's contracting extremely unweildy. The Board of
Directors and the Auditing Committee would decide to grant
contracts (for operations including exploration and
production activities) either through public bidding, direct
award or limited invitation. For exploration and production
work there would be a clause in the contract that allows the
amount to be paid to be determined after the contract is
signed, giving Pemex a flexibility it did not previously
have, as many operations such as drilling can involve a
significant change of scope during the execution of a
contract. Pemex will also be able to pay companies based on
their performance.

14. (U) The proposed financing changes changes will be
implemented over a ten-year period because the government
acknowledges that the recent tax reform was not sufficient
and public finances still rely on oil revenues. The gradual
implementation will also prevent states and municipalities
from significant short term revenue swings. Most of the
states' resources -in some cases more than 95%- come from
federal transfers and not from local taxes. Changes to
Pemex' contract requirements will be implemented immediately.
Pemex will be able to channel from 10% to 90% its own
revenues to investment projects gradually. Pemex'
subsidiaries will continue to operate as usual until the
Executive issues a decree.

Federal Public Administration Organic Law

15. (U) With these modifications Calderon seeks to
strengthen the Energy Secretariat (SENER) as the agency
responsible for establishing, conducting and supervising the
energy policy; for fostering the participation of the private
sector where applicable, for creating regulations to protect
the sector's security, for regulations to exploit oil
resources, for the elaboration of medium and long term plans
to exploit oil resources, for fostering the use of alternate
energy resources, and for issuing an opinion on the
feasibility of Pemex investment proposals.

Energy Regulatory Commission (CRE) Law

16. (U) The government will continue to control the
first-hand sale of oil related products. The existing Energy
Regulatory Commission (CRE), which now only regulates
electricity and natural gas prices, as well as aspects of
natural gas and gas liquids (LPG) transport and storage,
would be given additional authorities. The newly empowered
CRE would work to foster investment to complement the
government's investment in the distribution, transportation,
and storage of petroleum products. This reform will help
Pemex to expand and maintain its pipeline and distribution
network with private investment so that Pemex can channel
more resources to oil and natural gas exploration and
production. Following the reform the CRE and not Hacienda
would determine the price of refined products until effective
competition conditions existed or as determined by the
Executive. This would permit development of a petrochemical
industry, now impossible because of the Finance Ministry's
control of hydrocarbon pricing. The CRE would also create
the contract models for private participation in the
petrochemical industry and be able to propose changes to
energy laws. Five commissioners will be appointed to
staggered five-year terms as opposed to the concurrent terms
they now serve.

Reform of Constitution Article 27 Implementing Regulations
--------------------------------------------- -------------

17. (U) The Administration's reform also proposes several
changes to implementing laws of Article 27 of the Mexican
Constitution. On the downstream side, third parties will be
allowed to provide transportation, distribution, and storage

MEXICO 00001072 005 OF 005

services to Pemex. Oil products will continue to be owned by
the government. Private capital would be permitted in oil
refining activities, but through a processing fee scheme in
which ownership of the hydrocarbon would remain in government
hands. The private sector would be allowed to build and
operate refineries, and own the pipelines, facilities and

18. (U) On the upstream side, the reform would allow the
government to sign international agreements to develop
transboundary wells. SENER would be able to direct Pemex to
specific areas to explore and develop. Article 6 of the
regulation gives Pemex the authorization to hire the services
of individuals or companies to explore and develop resources
(these services could include maintenance of facilities,
technical analysis, drilling of wells, and three dimensional
seismic). The payment for the services would be in cash but
not through a percentage or share of production. SENER would
have to grant a permit for the areas to be explored and
developed. (Note: Calderon acknowledges that for many years
Pemex has been using contracts with private companies, but he
wanted to make article 6 more specific to prevent legal
challenges and provide companies with more legal certainty:
one is that Pemex keeps control over exploration and
production, and second that risk contracts would remain
illegal.) The Administration, by decree, would establish
blocks which could be developed to guarantee future oil
supply. Additional regulations would help to guarantee that
private companies provide good service in oil transportation,
storage and distribution, measures to prevent the creation of
monopolies, and mechanisms to guarantee energy supply and
national energy security.

Oil Commission Law

19. (U) Following the lead of Norway, the UK, and Brazil,
Calderon proposes the creation of a technical and specialized
Commission to support SENER in overseeing energy regulation,
exploration and production activities, and technical
analysis, determining oil reserves and production volume, and
in the evaluation of areas to be developed. The Commission
would evaluate the exploration and production projects
submitted by Pemex. The Commission would also grant the
permits to perform the projects or works. The commission
would depend on SENER, but would have administrative and
operational autonomy. The president would appoint five
commissioners proposed by SENER (the PRI specifically opposes
this provision).


20. (SBU) Though the proposal is barely 24 hours old, we
believe that this very token resistance is a sign that much
of the package was negotiated before hand, nevertheless,
initial comments by PRI leaders indicate that some additional
negotiation remains. Beltrones fora, however, (see para 8)
are likely designed as a sop to placate the PRD before a vote
is held.

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