energy reform under the new administration september update · energy reform under the new...

Energy Reform Under the New Administration

Alejandro SchtulmannEnergy Trade Mission

Mexico CitySeptember 2018

© 2018 Emerging Markets Political Risk Analysis - EMPRA, S.C. All rights reserved.

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Lopez Obrador’s Landslide Victory

In order to make amendments to the Constitution, Lopez Obrador needs 2/3 of each federal chamber and 1/2 of all state legislators to vote in favor. Lopez Obrador’s party now controls 18 state legislatures.

Lower House Senate

Coalitions % Seats

PRI-PVEM-Panal 13 63

PAN-PRD-MC 26 130

Morena-PT-PES 61 307

Coalitions % Seats

PRI-PVEM-Panal 16 21

PAN-PRD-MC 31 39

Morena-PT-PES 53 68

New Mexican Congress: Blank Check for Lopez Obrador?

Candidate Votes Percentage

Lopez Obrador (Morena-PT-PES) 29,985,934 53.19%

Anaya (PAN-PRD-MC) 12,552,325 22.26%

Meade (PRI-PVEM-Panal) 9,254,576 16.41%

Jaime Rodriguez “El Bronco” (Independent) 2,951,110 5.23%

Voter Turnout

71,801,425 63.44%

1,563,875 2.77%

Null Votes

61%26%

13%PRI-PVEM-Panal

PAN-PRD-MC

Morena-PT-PES

53%31%

16%

Morena-PT-PES

PRI-PVEM-Panal

PAN-PRD-MC


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Lopez Obrador: National Hydrocarbons Project (2018-2024)

• “Rescue” the sector• Increase production• Strengthen Pemex finances and

operations• Increase self-sufficiency (energy

security)

• Improve production capacity of Pemex and other private companies

• Improve refining capacity• Increase biodiesel production• Improve supply chain security • Revert the financial losses of Pemex• Strengthen the autonomy of regulators

Andres Manuel Lopez Obrador has historically opposed reforms to the energy sector. However, in his National Hydrocarbons Project, he does not propose an outright rollback of the reforms undertaken in 2013.

Central Objectives

Key Proposals

Action Plan (Selected Issues)

I. Downstream • Temporarily reverse the deregulation of fuel markets (until

conditions are optimal)• Construct one or two new refineries• Review tax rates on fuels

II. Upstream • Increase gas E&P efforts• Assess the performance of E&P contracts, review their

adjudication processes and their legality• Temporarily postpone farmouts until the conditions set out

in the contracts are revised

III.Increase efficiency and safety in the refined products and natural gas supply chains • Eradicate fuel theft• Expand gas pipelines

IV. Pemex • Eliminate regulatory asymmetries • Full autonomy

VI. Accountability • Guarantee transparency • Improve mechanisms for the appointment of regulators

VII. Social Issues • Include citizens in the design of energy policy (through

public hearings)• Require companies to invest in social development• Carry out free and informed consultations


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How Much Support does the Energy Reform Have?The energy reform has a negative connotation for a majority of Mexicans, most of whom heavily associate it with the high price of fuel and utilities.

Source: March 2018 poll conducted by The Brookings Institution, the University of California at San Diego, IHS Markit, El Financiero

Pragmatic Consumers

The reforms to the energy sector in Mexico were necessary

The reforms to the energy sector are rendering good results

The reforms to the energy sector must be continued

Private investment in oil E&P will harm the Mexican people

0 25 50 75 100

10%

9%

7%

8%

5%

6%

5%

4%

34%

37%

61%

47%

51%

48%

27%

41%

Agree Disagree Neither Did not answer

12%

34% 54%

AgreeDisagreeOther

Private competition in gasoline sales could lead to:

13%

36%51%

Higher quality fuels

Reduced prices

Do you agree or disagree with the following statements?

7

9

11

13

15

17

19

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 Jan-16 Jun-16 Nov-16 Apr-17 Sep-17 Feb-18 Jul-18

Average Magna Gasoline Price per Liter (MX Peso)

Source: Amegas


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-4

-2

0

2

4

6

8

10

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2.7

4.7

-0.2 0

1.5

3.72.5

4.5

2.3

0.9

-5.1

5.1

3.7 3.4

1.62.8 3.3

2.7 2.3 2.5 2.8

Economic Reality and Decision Making AMLO will inherit a relatively healthy but vulnerable economy, with low growth prospects…

•Mexico’s growth and economy have been sustained by manufactured exports under NAFTA, remittances, and oil exports; thus, the renegotiation of NAFTA is a major risk to the economy.

•Lopez Obrador’s energy reform-reform averse party obtained a strong majority in Congress, and so the markets are wary of any changes to the sector.

Energy Ministry (Sener):

The 107 contracts signed between the state and private companies — from all nine oil tender rounds— are expected to result in investments of US$160 billion if all stages of exploration are successful.

With the projects to be carried out this year, the total investment committed to E&P of hydrocarbons, seismic exploration, new pipelines, and clean energy power plants will exceed US$200 billion.

In 2017, the Mexican government received US$339 million from hydrocarbons E&P contracts:• US$180 million in signing bonuses from tender rounds

• US$108 million from the sale of hydrocarbons belonging to the government

• US$36 million from royalties

• US$15 million from contract fees

Source: Sener

Real GDP, Total Annual Growth Rate (%)

Source: OECD

The Energy Reform is extremely important due to its potential contribution to economic growth and economies of scale via greater investment, job creation, oil and power production, and fiscal revenues for the Mexican government.

Vulnerabilities

Source: CNH


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Projected Oil Production and Implications

Source: International Energy Agency (IEA), Amexhi

“No reform” scenario (2015-2040)

US$650 billion: cumulative value of the lost oil output

US$260 billion: cumulative loss of upstream investment

US$130 billion: The Mexican Association of Hydrocarbons Companies (Amexhi) estimates that about 20% of the US$650 billion loss would be Mexican government revenue

Projected Oil Production in Mexico (2015-2040)

In 2015, oil production in a “New Policies” scenario and a “No Reform” scenario starts with 2.5 million barrels of oil per day (bpd). In a “No reform” scenario, oil production remains below 2018 levels until 2039.


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Scenarios: Energy Policy

•Refurbish existing refineries

• Increase thermoelectric capacity

•Review existing hydrocarbons and power contracts; temporarily halt auctions

•Conciliatory approach to technocracy

•Moderately tackle union corruption

•Modification of the constitution and/or changes to laws governing the energy sector

•Strengthen Pemex and CFE at the expense of competitors

•Cancellation of contracts based on the argument that they do not benefit the nation, inciting legal battle with private companies

•Politically-motivated appointments in key posts at CFE, Pemex, Sener, ASEA, CNH and CRE

•Strip the CNH of a great deal of the regulatory power it was granted in the 2013 energy reforms

•Build new refineries (attempt at substituting gasoline imports)

•Artificially manage fuel prices

• Indefinitely halt hydrocarbons and power auctions

•Deem existing contracts to be unfair to the Mexican people

•Develop hydropower projects which are not financially attractive

•An aggressive increase in local content requirements in upstream investments

•Reduce the autonomy and decision making power of the CNH

•Continue the hydrocarbons and power auctions without interruptions

•Strengthen interagency coordination

•Grant ASEA more independence and give greater budgetary autonomy to all regulators

•Eliminate barriers of entry (e.g. better access to information)

• Improve processes for public consultation and environmental impact studies

•Tackle corruption across the board

•Adherence to international best practices in setting fuel prices

•Develop a respectful, non-discriminatory relationship with private companies

Worst Case (Policies with Negative Consequences)

Negative (Promotion of Disruptive Policies)

Optimal (Policies Implemented with Industry Input)

Base (Selective Changes to the Energy Reform)


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Scenarios: Management of Pemex

Optimal Strategies Suboptimal Strategies

• Austerity measures, tax burden reduced, budget control

• Appointment of technocrats

• Greater focus on E&P

Short-term E&P in shallow waters and land projects

Long-term E&P of deepwater projects via farmouts

• Industrial Transformation

Maintain target markets and abandon unprofitable markets

• Work towards launching an initial public offering (IPO) on the stock exchange

• Accelerate the speed of farmouts

• Sell unproductive assets

• Soaring costs and fiscal burden

• Lopez Obrador follows through with the appointment of Octavio Romero Oropeza (a political appointee with no experience in the national energy sector) as Director of Pemex

• E&P: Pemex— sans partners in the private sector with capital, technology and knowhow— is given priority in deepwater projects (tampering with free market rules)

• Requiring capital spending to build one or two new refineries, while serving as the sole constructor and operator

These new refineries could easily bleed money if mismanaged

Construction of new refineries implies high levels of debt which would represent a credit and financial risk to Pemex

New refineries would divert spending that Pemex should be using to help increase oil and gas production

• Pemex tenders are postponed which could stifle production, profitability and harm its credit rating


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Constitutional AmendmentsIf Lopez Obrador wants to make serious changes to Mexico’s energy reform, he would need to amend Articles 25, 27 and 28 of the Constitution. The process for amending the Constitution is laid out below.

An amendment is introduced by the President or a legislator

The amendment is approved by 2/3 of both the Lower House and the Senate

Amendment is approved by 1/2 of state congresses

Congress passes ‘secondary laws’ to define the details and implementation of the new amendment.

Lopez Obrador’s party, MORENA, lacks 2/3 of either chamber of Congress, but it could easily get votes from the PRD, PRI or MC legislators to pass amendments in Congress

MORENA controls more than half of the state congresses

Secondary laws only require 1/2 of both federal chambers to pass, which MORENA has.


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Public Consultation (an Unlikely Route)Lopez Obrador has stated that he will conduct a public consultation on the energy reform.

All public consultations must be approved by the Supreme Court of the Nation (SCJN).

So far, the Court has struck down 4 out of 5 proposed national public consultations. These included consultations on the minimum wage, energy reform, and a reduction of the number of legislators via proportional representation.

Public votes against No changes are made

Public votes in favor

Supreme Court rules on the constitutionality of the proposed consultation

If constitutional, the consultation goes to a

national vote

1/3 of a Chamber of Congress proposes a public consultation

2% of registered voters petition for a public consultation

President Lopez Obrador proposes a public consultation

The result is legally binding for the Executive and Legislative powers and

the relevant authorities(if 40% of eligible voters participate)


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Recent Statements from Lopez Obrador and his Team

Jesus Seade says that the preliminary trade deal reached by the U.S. and Mexico on August 27 is consistent with the Mexican 2013 energy reforms. Lopez Obrador has also voiced his satisfaction with the agreement.

Lopez Obrador earmarks the following energy sector budgetary priorities for the 2019 fiscal year:

• MX$75,000 million for exploration and drilling• MX$25,000 million for the refurbishment of the existing refineries• MX$55,000 million for the first phase of the construction of the new refinery• MX$25,000 million for the retooling of the existing hydropower plants

Lopez Obrador announces that he will launch tenders for drilling oil wells beginning early December in an effort to quickly increase Mexico’s crude output.

Lopez Obrador announces that he aims to increase crude production to 2.6 million barrels per day (bpd) by the end of his administration—up from the current level of 1.8 million bpd.

Prospective Director of Pemex Octavio Romero Oropeza says that he is working to reintegrate Pemex into one company and to define this new structure by December (El Heraldo).

After meeting with the American Bechtel and the Mexican ICA Fluor, Rocio Nahle says that Lopez Obrador’s team will continue to meet with companies that are interested and that have the ability to undertake the refinery project.

Prospective Chief of Staff Alfonso Romo says that retail fuel prices will be determined by the market.

Energy adviser Fluvio Ruiz says that the President-elect has enough political support to change Mexico’s energy law.

Aug 27

Sept 2

Sept 6

Sept 8

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Sept 12

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Sept 19


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A higher capital expenditure from a company that is not generating that same amount in cash is seen as a risk. Company’s rating could change if there’s a change in the trajectory of spending.

-Moody’s

Overly ambitious because hydropower costs ($50/MWh) are much higher than solar and wind power generation costs ($20/MWh). -Director of renewable energy at Sener

Doubtful hydropower investments would come to fruition during Lopez Obrador’s administration because of “timing issues.”

-President of Mexican Energy Association (AME)

Represents a credit risk and would be the top financial risk for Pemex in the short- and medium-term. Investment would take resources, which Pemex lacks, away from key priorities like increasing oil and gas production. New refineries typically end up costing much more than originally planned.

-Moody’s

Proposed investment would be only enough for the maintenance of the refineries, not for the refurbishment of the refineries to improve overall efficiency. A modernization of the facilities is necessary, but costs would be much higher.

-KPMG

Four Strategic Priority InvestmentsOn July 27, Lopez Obrador announced four strategic projects for the energy sector that would require a MX$304,000 million investment in the next three years.

MX$304,000 million Total

MX$75,000 million Capital injection into

Pemex for the extraction of oil and gas

MX$20,000 million Modernize existing

hydroelectric plants to increase capacity

MX$160,000 million Construction of a new

refinery in Paraiso, Tabasco

MX$49,000 million Refurbish Pemex’s six

existing refineries

Expert Opinion


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Key Energy Sector Appointments

Position Background Views on Energy Reform

Rocio Nahle Minister of EnergyNahle holds a degree in chemical engineering with a specialization in petrochemicals. She began her professional career with Pemex.

Relentless critic of the reform. She has repeatedly said the reform was designed to weaken Pemex and has called it a “serious mistake.”

Alberto Montoya Deputy Minister of Hydrocarbons

Montoya is an academic who has written extensively on the Mexican economy. He is currently president of the National Center for Strategic Studies (CEEN).

Has said the energy reform would subordinate policy and the energy industry to foreign companies and cause Mexico to become a “colony dependent on foreign powers.”

Octavio Romero Oropeza Director of Pemex

Romero holds a degree in agricultural engineering, is a long-time collaborator of Lopez Obrador’s, and has held roles within the PRD. He has no experience in the national energy sector.

Staunch critic of the reform who has insisted that current officials are “handing over the country’s wealth to foreigners.”

Miguel Angel Lozada

Head of Pemex Exploration and Production (PEP)

Lozada holds a degree in petroleum engineering and a master’s in Exploration and Production. He is currently deputy director of Technical Assurance of PEP.

Has said the energy reform is a great instrument for incentivizing investment that is necessary to boost production and improve the recovery factor in mature fields.

Manuel Bartlett Director of CFEBartlett has served as the Governor of Puebla and in the cabinets of multiple admins., e.g. as Sec. of the Interior and Education. Lacks technical expertise in energy issues.

Published a book in 2016 deriding the energy reform and what he perceived as the destruction of Mexico’s energy sector. Bartlett recently reversed course and said the reform is “functioning.”

Carlos Morales Deputy Director of the CFE

Morales holds a degree in mechanical engineering and is the president of the State Council of the Morena party in Veracruz. He has previously represented energy companies in Veracruz.

Critic of the energy reforms when they were launched.

Luis Abelardo Gonzalez

Coordinator of Renewable Energy Policy

Gonzalez is the director of the company Ecoenergiza which aims to develop energy savings systems. He is a proponent of hydroelectric energy.

Previously criticized the energy reform. Has characterized the reforms as handing over oil and slowly destroying Pemex.


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Future Key Appointments

National Hydrocarbons Commission (CNH)Six commissioners will be confirmed for another term or replaced (Mexico’s President submits shortlist, Senate appoints):

•Three in 2019

•One in 2020

•One in 2022

•One in 2023

Energy Regulatory Commission (CRE)Six commissioners will be appointed, same process as the CNH:

•One in December 2018

•Two in 2019

•One in 2021

•One in 2023

•One in 2024

National Agency for Safety, Energy and Environment (ASEA)The Executive Director of ASEA will be appointed and removed freely by the President:

•The Executive Director has the power to name and remove the public servants of the Agency

National Center for Energy Control (CENACE)Energy Minister makes the appointment of the General Director on the recommendation of the President.

National Gas Control Center (Cenagas)Energy Minister makes the appointment of the General Director on the recommendation of the President.


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Ongoing and Upcoming Hydrocarbons Tenders

Tender In Charge Purpose Launch Date Bids Due Award Date

Exploration and Extraction CNH Lopez Obrador plans to launch tenders for oil exploration and

extraction. December 2018 TBD TBD

Pemex Farmout CNH Tender of rights for seven onshore farm-out opportunities with Pemex. The blocks are located in Veracruz, Tabasco and Chiapas. April 27, 2018 February 14, 2019 February 19, 2019

Round 3.3 CNH Tender of development rights for nine shale projects in Burgos, Tamaulipas. March 2, 2018 February 14, 2019 February 19, 2019

Round 3.2 CNHTender of 37 onshore blocks. Tender of E&P license contracts includes conventional areas in Tampico-Misantla, Veracruz, Burgos and the Sureste Basin.

February 25, 2018 February 14, 2019 February 19, 2019

The CNH has scheduled key hydrocarbons tenders, including an unconventionals round. However, Lopez Obrador has voiced his opposition to fracking and he may also suspend the upcoming oil and gas rounds.


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Final Considerations

• IOCs and electricity companies delay and postpone investments•Pemex has less success

with farmouts

orLopez Obrador can reap

the benefits of the Energy Reform

•Greater upstream investment•Expansion of the country’s gas

pipeline network•Private competition and

imported commodities that provide lower-priced and more reliable electricity• Income for the government• Increased oil production output

once key investments begin to bear fruit in the coming years•Help Pemex and CFE

strengthen their finances•Funds for regional development

for host communities where projects are developed

Less income from signing bonuses, sales, royalties, contract fees

Less E&P of hydrocarbons

Delayed and less investment in the

energy sector

Tamper with the reform and cause

uncertainty

•A less effective Mexican Oil Fund that struggles to insulate public spending from transitory fluctuations in oil revenues and that allocates less money to R&D, oil and gas projects, a universal pension fund etc.

•Undermine Mexico’s reputation as an attractive investment destination

•Oil production will likely plateau

Fewer tangible benefits for the

Mexican population

•Fewer jobs•Cost of fuels and power

can go up•The same or worse

utility services for the public


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Final Considerations

Things to Watch

• Lopez Obrador’s picks to head key agencies suggest that he does not understand the importance of the Energy Reform

• Nahle will have the authority to dictate policy that determines the future of tenders

• The final text of a NAFTA energy investment chapter could provide assurance to North American investors in Mexico

• The contract review process is welcome but the incoming administration should be more transparent about the procedures and criteria

• Lopez Obrador should place more weight on industry input when implementing policies

Key Risks Ahead

Ideology vs. Pragmatism

Political or inexperienced appointments vs. technocracy

Vested interests disguised as social protest

Inability of a Lopez Obrador administration to solve conflict

Attempt to strengthen Pemex or the CFE at the expense of the nascent markets

Halting hydrocarbons and power auctions and not making full use of other tools created by the energy reform

Placing excessive emphasis on transforming the hydrocarbons industry instead of promoting the renewables industry

Lopez Obrador continues to send mixed signals to the markets as a result of his contradictory policy rhetoric and politically-motivated appointments to key energy sector positions


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About EMPRAEmerging Markets Political Risk Analysis (EMPRA) is Mexico’s leading political risk advisory firm. EMPRA delivers critical intelligence and independent analysis on political, policy, and security developments and their impact on key areas of the economy. Our services help decision makers anticipate upcoming changes in the political spectrum and formulate timely, successful strategies in the face of sudden changes and uncertainty. This has a direct impact on investment, decision making, and corporate performance.

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