A SECOND MEXICAN REVOLUTION?
ENERGY REFORM AND ITS IMPLICATIONS FOR NORTH AMERICAN
ENERGY INDEPENDENCE
Keynote Remarks by Michael C. Camuñez
President, ManattJones Global Strategies
California Independent Petroleum Association Annual Meeting
Lake Tahoe, CA
June 7, 2014
Introduction
Good afternoon and thank you, Rock, for the kind introduction. It’s a pleasure to be with you today. I’m
painfully aware of the fact that I am the last speaker on the last day of what I understand has been an
excellent conference. And whatever I may think of my abilities with the gift of gab, I know the odds of
holding your attention too long are not good. President Kennedy once observed that “public speaking is
the art of diluting a two-minute idea with a two-hour vocabulary.” While my task today may take a bit
more than two minutes, I promise you I’ll try to make this as short and sweet as possible given the
circumstances. Speaking of sweet, I know it’s customary to start a speech with a joke, but coming up with
one for the petroleum industry is no easy task. At the end of the day, the problem is that if I keep it "light
and sweet," nobody laughs --but if I go with "heavy and crude," I won’t get invited back. So let’s hope I
get it just right...
The fact is, there is an important story unfolding just south of the border, and it’s one the members of the
California Independent Petroleum Association need to understand. So if you’ll bear with me, I’d like to
share with you a bit about one of the most interesting and dynamic developments in energy in years, and
how Mexico’s ambitious energy reform agenda will impact not just California, but the United States and
North America as a whole. Let me begin with a short update on Mexico itself, turn to an overview of the
state of play in the current energy reform agenda, say a brief word about what opportunities those
reforms pose for U.S. energy firms, and then conclude with a few remarks on how all of this impacts
North American energy independence. It’s a lot for after lunch, I know, but I hope you’ll find it both
relevant and interesting.
Mexico as a Strategic Economic Partner for the United States
If you read the national press like I do, you could not be faulted for thinking of Mexico as a scary and
violent place that poses significant security challenges for the United States. The national media, in fact,
seem obsessed with projecting what I can only characterize as a lopsided and distorted account of Mexico
and its relevance to the United States. In truth, Mexico is arguably the United States’ most important
strategic partner in the world today.
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No country has a greater impact on the daily lives of Americans, and only Canada has a greater impact
on the U.S. economy. Mexico shapes prices, salaries, and job creation in the U.S. economy; it affects public
health and environmental protection; and it is the core driver of a key demographic change in American
society. Mexico is our second-largest export market. We trade $1.35 billion in goods every day. In fact, we
export more to Mexico than we do to Brazil, Russia, China and India combined. We also share a deeply
integrated supply chain with Mexico that sustains one of the most productive and competitive regional
economic platforms in the world. The U.S. Chamber of Commerce estimates that trade with Mexico
supports some 6 million jobs in the United States. Mexican companies operating in the United States
employ over 80,000 alone.
Mexico also matters for California. Mexico is California’s number one international trading partner,
accounting for over $24 billion in exports and $60 billion in total trade annually, and nearly 700,000
California jobs rely on trade with Mexico.
But this mutually beneficial economic relationship did not happen automatically. It is a direct
consequence of Mexico’s decision to open its economy to world trade in the late 1980s and to join the
North American Free Trade Agreement in 1994. Today, Mexico is in fact one of the most open and tradefriendly economies in the world, with 45 free trade partners.
Today, Mexico is again embarking on the most significant opening of its economy since NAFTA. And the
centerpiece of this dramatic opening is its reform of the energy sector.
Mexico’s Energy Reforms: What Is Happening and What Does It Mean for Mexico?
Mexico’s energy reforms are, simply put, revolutionary.
There are many parts to this reform, but its revolutionary heart is that the monopoly of Pemex – the stateowned and vertically integrated petroleum company– will be broken. For the first time in 75 years,
companies other than Pemex will be allowed to compete for the right to drill for hydrocarbons and to
own the petroleum they produce. Pemex will still be owned by the Mexican government but will now
compete with international energy companies.
Let me pause here and let this staggering development sink in. Since the oil industry was nationalized in
1938, state control of energy resources has been a central element of Mexico’s sense of nationalism and
sovereignty, especially with respect to the United States. Nationalizing the petroleum industry in 1938
was a milestone for Mexican sovereignty – it was the first time Mexico directly challenged the United
States and got its way. Beyond these nationalist sentiments, Pemex plays an essential financial role:
petroleum revenues provide about a third of the federal budget, to say nothing of countless opportunities
for patronage.
The political untouchability of Mexico’s petroleum resources has blocked needed reforms for decades and
imposed a terrible opportunity cost. The Mexican oil industry has long had the capacity to be a powerful
driver of the country’s economic development. But, that opportunity has been missed as “resource
nationalism” has kept the latest know-how and technology out of the Mexican oil industry and held
production and revenue back.
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Looking ahead, the economic impact of the energy reforms will be significant, but these changes also tell
us something important about the kind of country that Mexico is becoming – an increasingly selfconfident and credible player in the global economy, willing to expand the role for private capital and the
free market. Continuing a trend that it began with the economic reforms it launched with the negotiation
of NAFTA, Mexico now stands poised for significant growth.
This is not to say, however, that Mexico’s political culture has changed entirely. The government’s right
and sense of responsibility to manage key resources for the benefit of the Mexican people remain firmly
in place. The Pemex reforms, while revolutionary, still took place in a political culture deeply informed
by a legacy of statism and nationalism. Allow me to highlight three elements of the reform and look at
how what I am calling a second Mexican Revolution reflects this reality.
First, the government has decided to allow risk contracts in petroleum exploration and production
through a new category of contracts – licenses – rather than allowing concessions. This legal sleight of
hand ensures continued national ownership of the petroleum in the ground, a politically essential
precondition for approval of the reform, while allowing private ownership as soon as the petroleum
leaves the wellhead. Allowing foreign ownership of reserves still in the ground would have been
politically impossible.
Second, the reform does not merely empower the government to indicate which fields will be put up for
auction, it directs the Energy Ministry to establish the contractual terms (for service, production-sharing,
profit-sharing, or licenses) and the Finance Ministry to set the fiscal terms under which each individual field
will be exploited. The Mexican government justifies this state-heavy bid structure as necessary to ensure
that the investment and tax regimes match the specific characteristics of each field. While this logic is not
incorrect, in the United States the market sorts this out.
Finally, the reform transforms Pemex into a “productive state enterprise” rather than privatizing it or
even allowing significant private investment in the firm. In this sense, Brazil’s Petrobras is not the model
for Pemex’s future. In addition, by establishing a so-called “Round Zero” to allow Pemex to request the
exclusive right to work 83% of Mexico’s currently producing fields and 31% of its prospective reserves,
the government has made clear its stated desire that Pemex remain the dominant actor in Mexican
exploration and production, even if some of the company’s requests are pared down as expected.
Beyond Petroleum E&P
Beyond petroleum exploration and production, there are several other elements of the energy reform that
are worth highlighting since they also have an impact on energy independence and continent-wide
economic growth. First, in the area of regulation, the constitutional reform transformed the regulatory
entity, the National Hydrocarbons Commission, into a truly independent regulator of petroleum E&P in
Mexico. In a very significant move, a National Hydrocarbons Information Center will make public all the
information about Mexico’s petroleum resources currently controlled by Pemex, making this information
freely available to all players in the market.
The energy legislation will also revolutionize the electricity sector. For the first time in 50 years, private
capital will be free to produce and sell electricity in a free market; much like Pemex, the state-owned
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Federal Electricity Commission (CFE) will now compete with private firms to sell electricity into the grid.
The CFE will now have the authority to both import and reexport natural gas, as well as buy and sell it in
the domestic market, an important step for the CFE, which uses natural gas to generate much of its
electricity.
The electricity reform also allows government contracting with private firms to expand the country’s
transmission and distribution network and transfers management of the wholesale electricity market
from the CFE to an independent agency, although transmission itself will remain under government
control.
The reform also encourages the development of renewables. Mexico has enormous resources in solar,
wind, and geothermal, and the government has set ambitious goals to derive up to 35% of its electricity
by 2025 from clean and renewable sources.
While the constitutional reforms that set Mexico’s energy revolution in motion were passed last
December, there is still important political work to be done in the Mexican Congress to pass
implementing legislation that will transform these new constitutional provisions into a functioning
regulatory scheme. President Peña Nieto introduced a bill in late April that closely follows the contours
of the constitutional reform, and we expect the Mexican Congress to approve this legislation without
significant modification by August. Nor do we anticipate that the Mexican left’s effort to overturn the
legislation through a popular referendum will meet with success. In my estimation, energy reform is a
done deal.
Implications of Mexican Energy Reform for the United States.
So, what do these reforms mean for U.S. energy firms interested in operating in Mexico? What
opportunities and challenges will this reform present for California energy companies?
Let’s begin with opportunities. There will be significant opportunities for investment in the Mexican
energy sector. President Peña Nieto is highly motivated to attract significant foreign direct investment. To
this end, the reform requires just 25% domestic content for E&P operations (compared with an onerous
40% in Brazil), and firms have ten years to meet this requirement. The reform also creates a sliding scale
for royalty payments designed to encourage investment, even if the price of oil drops significantly.
Second, Mexican geology means that this energy reform opens up opportunities on land and in shallow
water, where Pemex is most active, but most especially in deep water, shale, and enhanced recovery,
where Pemex’s operations have been limited. There are also opportunities created by the reform for
midstream and downstream operations and electricity generation.
The earliest investment opportunities are expected in the last quarter of this year and through joint
ventures with Pemex to develop the fields it controls following the completion of the Round Zero process
in September. But opportunities are hardly limited to the big IOCs. Mexico’s reserves of shale oil and gas
– among the largest in the world – create a huge market where the entrepreneurial characteristics of
smaller petroleum companies create a clear competitive advantage (companies working in the Eagle Ford
play in Texas might, for example, be interested in going into the Burgos Basin just across the border).
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Mexico also has a large number of older fields ripe for tertiary recovery but which are simply not large
enough to be of interest to Pemex or the IOCs.
But these opportunities do come with a number of challenges. The decision to determine contractual and
fiscal terms of tenders by individual field rather than asset class will inevitably interject complexity and
delays into the bidding process.
And, once a firm wins the right to exploit a particular field, it must then negotiate with the owner of the
surface land rights to be able to access the subsurface resources.
Companies operating in deep waters currently face unlimited liability for gross negligence, making it
difficult, if not impossible, to insure deepwater operations.
Finally, there is the challenge of Pemex itself. It is unclear if the Mexican government will treat Pemex as
just one more company operating in Mexico and create a truly level playing field. Several factors will
shape the answer to this key question:
First, will the federal government be able to raise sufficient revenue from the taxes and royalty payments
paid by private energy firms to replace the third of the federal budget now covered by Pemex? If not, the
temptation –and political pressure-- to backslide and un-level the playing field will be significant.
Second, will the National Hydrocarbons Commission become an effective and unbiased regulator of the
sector? No Mexican institution has ever attempted to regulate the petroleum market before, and there
will be a steep learning curve. In general, Mexican regulatory agencies have only just begun to receive the
legal and budgetary autonomy needed to produce real independence and the capacity to do their job
fairly and effectively. This is new terrain for Mexico, and the potential for missteps and regulatory
capture is very real.
Finally, and importantly for U.S. firms that face the long-arm jurisdiction of the American Foreign
Corrupt Practices Act, will there be true transparency in Pemex contracting? Historically, this has simply
never happened. Mexican governments, regardless of party, have treated Pemex as a financial tool to
reward favored allies, as the recent Oceanografia corruption scandal reminds us. How effectively the
elaborate mechanisms created by the reform legislation will promote transparency and fairness remains
to be seen.
So yes, there is opportunity. Enormous opportunity. But companies entering the competitive and rapidly
changing energy space would be wise to bring along not just experienced counsel, but partners who
know Mexico, who can help navigate the complex political and cultural terrain, to help them along the
way.
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Energy Security, Energy Independence, and Economic Growth
Let me conclude by turning to the question of Mexico’s impact on energy security and North American
energy independence.
The implications of Mexico’s energy reform for the United States and for North American energy security
are profound. From a pure energy security standpoint, North America is poised to become a swing player
in global energy markets. This means the United States can turn to Mexico and Canada to ensure U.S.
energy security rather than relying on adversaries such as Venezuela, and problematic partners such as
Nigeria.
Mexico has been a loyal partner of the United States for decades. This partnership has deepened and
matured over the past 20 years as NAFTA has helped forge an increasingly interdependent economic
relationship. In that time, Mexico has also left behind much of its anti-American rhetoric, which has
helped our two countries collaborate more comfortably and effectively than ever before.
Now, the Mexican government wants to extend this collaboration and interdependence into the energy
sphere. Petroleum, the most significant remaining bastion of Mexico’s historic anti-American nationalism
at the outset of the 21st century, is poised to become a powerful tool for further North American
integration. Indeed, President Peña Nieto’s energy reform is both a reflection of how much popular
sentiment about the United States and petroleum has changed as well as a means to deepen and solidify
that change.
From a broader economic perspective, energy reform in Mexico and the deeper energy integration with
the United States it will create promise to magnify the economic benefits of the shale revolution. The
result should be a pronounced global competitive advantage for North America, especially as our
economies continue to integrate into an advanced manufacturing platform.
Let me emphasize this point. North American trade today is concentrated in production inputs – parts
and materials – which cross back and forth across our national borders creating an integrated
manufacturing supply chain. As The New York Times recently observed, the competitiveness of this
manufacturing platform has recently benefited from the nearshoring of China-based production into
Mexico, motivated by rising production costs in China (due to higher wages, credit shortages, and a
stronger Yuan) and rising competitiveness in Mexico. At the same time, cheap natural gas flowing from
the U.S. shale boom has prompted the return of manufacturing production to the United States.
When inserted into this mix, a successful Mexican energy reform will increase North American energy
production and the integration of our national energy markets. In the near term, this will significantly
reduce the cost of natural gas and electricity for Mexican manufacturers and further increase their
productivity. In the longer term, increased Mexican energy production will flow into the North American
market reinforcing our energy independence and security. And, a more secure and integrated North
American energy market will reinforce North America's global competitiveness as a manufacturing and
production center.
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The United States and Mexico are actively collaborating on enhancing North American competitiveness
through the launch of the new High Level Economic Dialogue, an initiative I had the privilege of working
on and helping President Obama launch last year in Mexico. The central thesis is that the United States
and Mexico are strategic economic partners and should be acting that way, collaborating on a range of
initiatives to promote innovation, connectivity, and competitiveness in North America. Energy is and
must be a central part of that agenda. And that’s because much still needs to be done to achieve energy
independence in North America. We need a common market structure, harmonized regulations, and
even deeper infrastructure integration. We will also need more technical exchange, access to investment
capital, and many more engineers, geologists, and geophysicists to develop all the new energy plays in
North America. But Mexican energy reform has clearly jump-started this process.
Risk and uncertainty remain, but a new North American energy future is on the horizon, and Mexico is a
willing and able partner. The resulting opportunity for our two countries – together with Canada – to
build North American energy interdependence and achieve regional energy security and all of its
concomitant benefits is upon us. California energy firms are well positioned to participate in this
burgeoning opportunity. The market is there. Will you be?
As we say in Mexico, “Muchas Gracias y Buenas Tardes.”
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