Mexico Meets The New Reality With Energy Reform

November 2014, Vol. 241, No. 11

Jeff Share, Editor

The decision of the Mexican government to reform its vaunted energy industry is one of the most important development in the energy sector since the shale revolution, at least for companies in North America. The focal point of Mexico’s energy industry has been Petroleos Mexicanos (Pemex), the state-owned oil company that until just a few years ago ranked as one of the world’s top crude oil producers.

Years of neglect brought about by over-confidence, pride and an inability to work with foreign investors led the company into a steady decline further eroded by a series of deadly incidents, the sudden competition for investments created by the U.S. shale boom, and the overall decline in business activity resulting from the Great Recession. Hence the need to face the reality of a new energy world.

The reform process has been as agonizing to Mexico as it has been complex. It will be a gradual multi-segment work-in-progress for years to come, but the implications in particular for U.S. oil and gas companies are far-reaching. Already more than a dozen cross-border pipelines that would transport natural gas for use in power generation as well as liquids products are on the drawing boards. In addition, Mexico could provide terminals for LNG export. The possibilities are endless for North American companies and ultimately for a new continental energy strategy.

So, who better to discuss the prospects of Mexico’s reforms than Fernando Cano-Lasa, an attorney for the Washington, DC law firm of Squire Patton Boggs. Cano-Lasa joined the firm’s Houston office in July after spending 12 years with Pemex and Pemex Procurement International, Inc. where filled a variety of roles in their legal departments.

With more than a decade of experience handling transactional and legal matters in the Mexican and Latin American oil and gas industries, Cano-Lasa primarily advises U.S. and international corporations in energy and corporate law, including the interpretation of and resulting opportunities created by the energy reform.

P&GJ: What does Pemex’s energy reform mean for investors?
Cano-Lasa:
It is important to clarify that it is not a “Pemex Energy Reform” but a “Mexican Energy Reform”. Understanding this is critical to understanding what has happened in the industry with this new legislation. Prior to the reform, the oil and gas market operated and in a certain way was completely controlled by Pemex.

Post-reform, although Pemex remains a very strong and critical actor of the industry, the resources are directly managed by the Mexican state with the support of its regulators. This means that one of the few sectors of the Mexican industry excluded from NAFTA will now permit private investment in all segments of the chain value. There will be new opportunities in upstream, midstream and downstream.

P&GJ: What are some of the most common misperceptions about the energy reform?
Caso-Lasa:
An important one is that the new framework is not based on international standards. If you review all the new legislation and analyze the explanations of the reform given by Mexican officials, one of the critical elements taken into account for the new regime was to make a scenario that looked very much like what has been done in other successful places in the world, including, but not limited to the United States, Brazil, Colombia and Norway.

P&GJ: Where do you anticipate the most interest in investment coming from?
Caso-Lano: All segments of the industry have been properly designed to attract investment. I certainly think that upstream is a major potential area; but there are also very significant opportunities for private investors in midstream and downstream.

P&GJ: When and why did Pemex’s growth become stagnant?
Caso-Lano:
In my opinion, Pemex has done a magnificent job in administering the resources throughout these years. What has happened is a natural process. Easy oil reservoirs have declined and new technology and investment are needed to exploit the current reality of the country.

For these types of resources, Pemex should not do it alone. It is a wise decision to joint venture for all these projects. On the midstream and downstream sectors, the energy requirements of the country have increased to a point where you need as many players as possible to build, operate and maintain the necessary infrastructure to cover such demand.

P&GJ: What are Pemex’s most promising assets or properties?
Caso-Lano:
Pemex has a very balanced mix of current and potential resources. These provide Pemex with the possibility to maintain an exploration rate of 2.5 million barrels per day for the next 10 to 15 years.

P&GJ: What challenges still await those seeking to invest in Mexican energy, and what would you advise them?
Caso-Lano:
We have not seen the final documents related to the implementation of the reform. This includes the final version of Exploration and Production Agreements (Production Sharing Agreements, Profit Sharing Agreements, Licenses and Services), the final documents and rules for bidding purposes and the rules and final documents related to permits for the midstream and downstream segments. I would advise investors to analyze all factors related to the market, define a strategy (including legal issues) and execute such strategy.

P&GJ: What do the reforms mean for imports of oil and natural gas, particularly for the U.S.?
Caso-Lano:
Although import and export activities for oil and gas will remain restricted by the government until Dec. 31, 2016, starting on 2017 import/export activities will be subject to market conditions and U.S. producers will be able to diversify their export of products into Mexico with the best purchasing option.

P&GJ: How much new pipeline transmission and distribution development do you expect?
Caso-Lano:
This is a critical topic. Infrastructure development in midstream is a must for the development of the industry. You can extract as much oil and gas as you want to, or import millions of barrels of gasoline, but if you lack an efficient means for transportation of such products, you run the risk of making the specific project not suitable or not commercially viable.

P&GJ: How will Pemex’s culture have to change in order to make the reforms work effectively, and how big of a challenge will this be?
Caso-Lano:
To make the reforms work effectively, nothing. Pemex will have to improve its processes and results in order to compete in an open market. Pemex will now have to present results on their E&P projects; otherwise they could revert to the government. They will have to bid as any other participant in future projects. On midstream and downstream, they will compete for new projects and clients. Finally, on procurement, the company will have to make their process equivalent to international standards. Otherwise, they will not be able to compete for the limited resources on goods and services for the market.

P&GJ: Do you eventually expect to see Canada, the U.S. and Mexico become a viable energy entity, and if so, what would it take for this to happen?
Caso-Lano:
Yes. As you know, oil and gas (energy sector in general) is excluded from the provisions of NAFTA. In my perception, this is the first step; review NAFTA and add an energy chapter that may deal with integration for the region and basic principles.

P&GJ: What is your background, including education, and what led you to a career in the energy industry?
Caso-Lano:
I am a licensed attorney in Mexico from the Universidad Panamericana. I have a LLM Masters of Law degree from the University of Houston. I worked for Pemex for six years in Mexico, and then I was hired by a U.S. subsidiary of Pemex called Pemex Procurement International, Inc. You can say that I started my professional career working for Pemex, so I have been substantially linked to the energy sector in Mexico for the past 12 years.

I think energy is a fascinating topic. As long as the world exists, energy will be part of it; whether it is coal, oil, gas, solar, or any other type, energy is co-natural to human existence.

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