(Image: Clipart)

On Aug. 11, President Enrique Peña Nieto signed into law new rules to open Mexico’s state-run oil, gas and electricity industries to foreign and private companies after 76 years of government control. A key objective of the reform is to reverse the declining oil and gas production taking place over recent years.

The decline is commonly attributed to insufficient operational capabilities and capital of the state-owned oil company, Petróleos Mexicanos (Pemex) which prevents it from producing from the country’s deepwater and shale resources. According to a March 4 article in Bloomberg, “Pemex CEO Invites World to Tap Mexico’s Energy Shale Reserves,” Crude production from Pemex has fallen for nine consecutive years, from 3.3 million barrels a day in 2004 to 2.52 million barrels a day in the fourth quarter of 2013 due to insufficient investment in exploration and production. The production has fallen to the point where its petroleum trade balance with the United States has fallen into negative territory for the first time in at least 40 years, according to a March 14 article in the Wall Street Journal, “Oil-Rich Mexico Becomes Net Importer of U.S. Petroleum Goods.

This is not the first time Mexico has considered energy reform, but there is strong evidence that this time may be different. The 2008 reform proposed by former President Felipe Calderón did not seek to amend the Political Constitution of the United Mexican States—the main regulatory instrument for the Mexican energy sector—and ultimately failed to attract oil and gas companies for upstream activities. In contrast, the reform could have a genuinely transformative effect due to amendments to several key provisions of the constitution, as well as new regulatory and oversight agencies implementing the reform beginning in August 2014.

During the signing, President Peña Nieto announced 10 actions that his government will perform in the coming weeks and months as part of its reform efforts:

• On Aug. 13, the Secretariat of Energy (SENER) submitted assignments for exploration areas.

• On the same day, SENER announced which areas it will include in the first round of contracts for oil exploration and production. Pemex also announced the first areas in which it has chosen to partner with third parties in exploration and production (E&P) and drilling operations.

• By the end of August, the President is to submit a bill to create the National Energy Control Center and Natural Gas, which will be the natural gas pipeline and storage system operator.

• By the end of August, President Peña Nieto will submit to the Senate nominations of those who he has chosen to make up the National Hydrocarbons Commission (regulating upstream activities), the National Energy Commission (regulating midstream and downstream activities) and the Mexican Petroleum Fund for Stabilization and Development (administering state revenues from E&P activities). He will also place five new independent appointees to Pemex’s board of directors.

• In September, the Mexican Petroleum Fund will be formed.

• A program geared toward training Mexicans to work in the hydrocarbon industry will also be created.

• By the end of October, any secondary regulations of the reform legislation will be prepared.

• By the end of October, a proposal will be announced to restructure and improve the Mexican Petroleum Institute, the governmental research and development agency.

• By the end of October, guidelines for issuing clean energy certificates will be released.

• In the upcoming three months, bylaws of the National Agency of Industrial Safety and Environmental Stewardship for the hydrocarbon sector will be promulgated.

There are 12 amended laws and nine new secondary laws, with changes governing the upstream, midstream and downstream hydrocarbon sectors. Key aspects include a 35 percent target for local content, up from 25 percent, and compensation to affected landowners of between 0.5 percent and 3 percent of pre-tax natural gas revenues, according to an Aug. 8 article in Upstream newspaper, “Congress Votes to Open Up Energy Sector.” Joint venture opportunities with Pemex are an important but undefined area, likely initially subject to an open bid process as opposed to direct negotiations.

Private companies now will be empowered to compete directly with Pemex, rather than being relegated to doing work only for Pemex under service contracts. With the change in contracting regime, private parties will have more flexibility to receive payments beyond pure cash for services performed, for example, as cash linked to a percentage of profits or payment as a percentage of production.

The government is currently studying new forms for contracting in an effort to bring Mexico’s practices up to international standards. The forms under consideration include profit-sharing agreements, production sharing agreements, and license agreements, as well as service agreements and entitlements (asignaciones). Different types of contracts likely will be used depending on the type of field and its expected profitability, and Pemex may continue using a service contract regime in its most well known and highest producing fields.

In less than a month, on Sept. 17, Mexico’s energy ministry will reveal the acreage Pemex will be permitted to retain, and the first round of bidding expected in early 2015. With the pace of the transition period, companies interested in the Mexican energy market should quickly begin working to understand the legal framework and implementing the proper corporate structure in order to maximize their chances of success in the bidding round.

Some have described the new rules as a watershed and a change in the energy paradigm, and many say the reform contains all elements those in energy could have hoped for. Monitoring the Peña Nieto administration’s progress against its publicly stated 10 actions and evaluating how the regulatory and oversight agencies handle their challenges, will help outside parties to understand whether the reform is actually being implemented adequately. If it proceeds as planned, it will create a large new market in which U.S. companies can utilize their cutting edge technologies for oil and gas drilling and production.

The good news for the Houston economy is that energy companies here are not taking a wait-and-see approach, but have already begun positioning themselves to take advantage of this potential new market.