Cablegate: Mexican Congress Approves Tepid Energy Reform Package

DE RUEHME #3210/01 3032324
R 292324Z OCT 08




E.O. 12958: N/A

REF: A. Mexico 2335
B. Mexico 1339
C. Mexico 531
D. Mexico 209

1. (SBU) Summary: Following seven months of often acrimonious
debate, the Mexican Congress on October 28 approved a modest energy
reform package - focused almost exclusively on oil - which will give
greater financial autonomy and more decision making power to the
state owned oil company Pemex. The reform also introduces contract
bonuses for firms that complete projects ahead of schedule or
transfer technology to Pemex. However, the reform will not address
the most pressing issues facing Pemex: rapidly declining
production, lack of technological ability to explore in the deep
waters of the Gulf of Mexico, and a Constitutional prohibition on
private sector investment. Mexico has fallen from being the second
largest supplier of oil to the U.S. in 2007 to fourth place as a
result of declining production. The reform places strict
requirements on contracts for private sector participants, rules out
production sharing contracts and bans the private sector from
investing in downstream activities. Domestic and international
financial pressures may allow or even require the Calderon
administration to introduce a second, deeper energy reform package
after the summer 2009 Congressional elections - even if the
opposition parties gain seats in Congress. End summary.

2. (U) On October 28 the Mexican Chamber of Deputies voted to
approve the energy reform package by a vote of 395 to 82. This
follows the Senate's October 23 approval by a vote of 113 to 6.
President Calderon is expected to sign the legislation within the
next few days. Most government officials and industry experts
expect that the reform will be challenged in court, a move which
could delay implementation of at least part of the reform package by
several months.


3. (SBU) President Calderon first submitted the government's
energy reform proposal to Congress for consideration on April 8.
Experts considered the administration's proposal a pragmatic step in
the right direction but described it as what was feasible and
possible, not necessarily what the country needed. At that time,
the Calderon administration hoped for quick passage of legislation.
However, supporters of former presidential candidate Andres Manuel
Lopez Obrador (AMLO) seized control of the lower house of Congress,
and forced agreement among the three main political parties on 70
days of public hearings on a reform package. Over the next five
months, the PRI and the FAP/PRD both developed their own energy
reform proposals, leading to a lengthy congressional negotiation
which resulted in a weak, lowest common denominator reform.

Elements of Package:

4. (SBU) Although the energy reform will help Pemex become a more
transparent and flexible, firm, energy analysts agree that it will
not address the key problem of maintaining production levels or
identifying new reserves. The energy reform is divided into seven
distinct bills which deal primarily with internal Pemex procedures
and requirements. The following are the most significant elements:

--More management and financial autonomy for Pemex:
Pemex will receive complete management and budget autonomy in seven
years - not ten as proposed by the Calderon administration. This is
a positive development that will give Pemex greater flexibility.
The challenge for the GOM will be to plan ahead and replace the
revenue the government currently derives from Pemex. (Oil revenues
currently account for approximately 40% of budget revenues.)
Raising tax collection rates seems the most plausible if politically
difficult solution to this question.

--Limited incentives introduced for service contracts:
Congress approved some limited incentives on service contracts but
eliminated much of the flexibility the Calderon administration had
proposed. Incentives related to performance will be clearly
stipulated up front in contracts and not during the development of
the project as originally proposed. Payment to the service provider

MEXICO 00003210 002 OF 004

will be made in cash and cannot include a percentage of oil rent or
production. Congress added penalties for service providers who do
not meet the requirements of their contracts, i.e. environmental
damage, delays, substandard work. However, contractors will not be
penalized if exploration contracts do not lead to discovery.

--Pemex Service Contracts Exempt from Public Works Law Requirements:

The energy reform approved by congress will also allow Pemex to
award contracts without following traditional government procurement
rules, giving the firm greater access to technology and improving
its ability to operate. For acquisitions and government purchases,
Pemex can launch auctions, make restricted invitations or directly
assign a contract to national and foreign companies. The company
will be allowed to decide when and what to procure in order to take
advantage of lower prices through bulk purchases.

--Improve Pemex administration:
The size of the Pemex Board of Directors will swell from eleven to
fifteen members. Four new independent board members will be
appointed by the President and ratified by the Senate. How this
will affect Pemex will depend on the qualifications of the
independent board members and the level of politicization of the
selection process. The Pemex Board of Directors will play a
substantial role in approving the secondary regulations which will
outline how the new contracting scheme is implemented.

--Issue Pemex "bonos ciudadanos" or citizens bonds:
Congress approved President Calderon's proposal allowing Pemex to
sell bonds directly to Mexicans. The bonds can be obtained by any
Mexican citizen directly and are meant to give bond holders a closer
stake in Pemex. The Congress watered down this initiative by
prohibiting brokers from buying or selling these instruments.

--Allow international negotiations on transboundary reservoirs:
The reform prohibits production sharing agreements between Pemex and
other parties (private companies). However, the legislation
acknowledges that for transboundary fields two countries have the
right to exploit hydrocarbons in a joint field. The legislation
adds that how this would be defined would depend on international
agreements. An international treaty on transboundary reservoirs
would have to be ratified by the Mexican Senate and signed by the

5. (SBU) Several key elements of the administration's original
reform proposal were stripped from the package approved by Congress:

----Pemex will only be allowed to provide performance incentives
based on whether projects are on time and whether technology was

--Private companies will not be permitted to invest in downstream
activities such as transportation and storage. Nor will private
firms be allowed to build and operate refineries on behalf of Pemex.

Strengthening SENER or just Creating more bureaucracy?
--------------------------------------------- ---------

6. (SBU) The reform package seeks to strengthen the Mexican Energy
Secretariat (SENER) by giving it greater regulatory authority over
Pemex and enhancing its role on energy efficiency and renewable
energy technology. Three new Commissions will be created within
SENER to meet these objectives. What this will mean in practice and
whether this will improve transparency or efficiency is uncertain.
Many experts are skeptical that these new commissions will do no
more than cause confusion, delay implementation of the reforms and
create red tape. One expert noted that there simply are not enough
energy experts with any type of vision for the sector to direct
these new entities.

--The National Hydrocarbons Commission:
The reform creates a decentralized entity, within SENER which will
regulate and supervise oil exploration and exploitation. A
Commissioner will be appointed by the Executive (no Senate
ratification needed). This commission will regulate oil extraction
and exploitation plans and will select the most adequate technology
based on criteria set by the government to address energy security

MEXICO 00003210 003 OF 004

--National Energy Council:
The Federal Public Administration Law will authorize SENER to set
the oil output platforms and establish a long-term (15 years) energy
planning program. The plan will be reviewed by the Congress every
year. The National Energy Council will include members of Congress,
federal and state officials, academia, and the private and social
sectors. SENER will issue standards on energy savings and regulate
the use of alternate energy sources.

--National Commission for the Efficient Use of Energy:
The law for Sustainable Energy Management and Consumption creates a
National Commission for the efficient use of energy which will be
charged with fostering energy efficiency and savings. The bill also
imposes sanctions on anyone who falsifies their electricity
consumption levels.

Other Changes Outside the Reform Package:

7. The energy reform package falls short of the Calderon
administration's goals in several areas. However, the GOM was able
to include some significant energy related initiatives in
legislation outside of the energy reform package:

--Pidiregas: Through the President's Economic Growth and Employment
Program which seeks to address the current economic and financial
crisis, the GOM proposed eliminating the long term infrastructure
debt instruments called Pidiregas for Pemex. This initiative will
increase transparency and significantly decrease Pemex' debt burden.
The Pidiregas project-financing mechanism was developed to allow
the government to undertake priority investment projects by
contracting them out to the private sector, while deferring their
registration as government expenditures in the budget. The private
sector provides the financing during the construction and until the
government acquires the assets. While the information on the stock
of Pidiregas liabilities is publicly available, the public debt
statistics do not consolidate this information with the external
debt. Pidiregas have always been controversial precisely because
they have been considered off-budget items.

--Refinery: Also as part of his Economic Growth and Employment
Program, President Calderon proposed using public resources -
approximately $10 billion dollars - to build a new refinery. The
goal is to decrease the level of gas imports (currently 40 percent
of Mexican gas is imported from U.S. fineries) by strengthening
Mexico's refining capacity. Although this measure was applauded by
the leftist opposition party PRD, it is controversial among industry
experts. Several energy experts have questioned whether the money
invested in a new refinery - which generally has large start up
costs and marginal returns - would not have been better spent either
retooling existing refineries to raise capacity or investing in
exploration and development.

--Tax Regime: Under its revised budget proposal, the Calderon
administration requested and Congress approved a new tax regime for
Pemex which seeks to foster oil production by differentiating tax
deduction rates in proportion to production costs in various fields:
for example, Chicontepec tax deductions rose from US$10 to US$ 11
per barrel while deductions for deep water production rose from US$
15 to US$ 16.5 dollar per barrel. Although the Finance Secretariat
supported this fiscal regime, it will be difficult to audit
different tax regimes for existing activities in oil fields:
Cantarell and Koo-Maloob Zaap, Chicontepec, deep water, and mature
fields. The goal of these differentiated tax regimes is to help
Pemex by reducing its tax burden, and at the same time maintaining
government revenue collection.


8. (SBU) As President Calderon stressed during an address to the
nation on October 28, the energy reform package focuses on
strengthening Pemex and making it a more transparent, modern firm.
Whether Pemex will be able to take advantage of these changes to
become a more efficient and profitable energy company remains to be
seen. Over the next several weeks, the international oil companies
and other private sector experts will carefully review the bills
passed by the Mexican Congress and study the implementing
regulations that SENER is drafting to determine whether this

MEXICO 00003210 004 OF 004

legislation creates new business opportunities. From an initial
analysis, the service companies who already work with Pemex stand to
benefit more from the changes than integrated international oil
companies (IOCs). However, the IOCs feel they have waited this long
for the reform, they may as well carefully analyze the results for
any possible opportunities.

9. (SBU) Politically, the energy reform debate demonstrated the
ability of Mexico's political parties to work together - albeit on
basis of the lowest common denominator -- to approve a reform of
this controversial sector. Unfortunately, priority was placed on
political agreement rather than on substantive changes. The energy
reform package does not tackle the immediate problems of Mexico's
rapidly declining oil production. Nor does it address the
technological and financial constraints Mexico faces with respect to
exploration in the ultra deep waters of the Gulf of Mexico. The GOM
continues to rely on oil revenues for forty percent of its budget.
As oil production falls and oil prices drop while the rest of the
economy slows, Mexico will feel the financial pinch. Economic
necessity may require the GOM and the Mexican Congress to debate a
second, deeper energy reform package after the summer 2009
Congressional elections - even if the opposition parties gain seats
in Congress.

© Scoop Media

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