Monday, October 27, 2008

A Preliminary Assessment of Mexico's Energy Reforms

By George Baker

In relation to Mexico's Energy Reform Bill, I have gone through the Pemex Administration Act of 2008, the so-called Ley Orgánica.  Below are my preliminary comments and observations, in reply to questions posed by a journalist in Mexico.

Question: In your opinion, what are the most favorable points of the reform and why?

Response (George Baker/GB):

a) Strengthening of the authority of the director general of Pemex.
b) Inventing (creating) real authority for the board of directors.
c) Creating executive committees of the board and a comisario.
d) Creating citizen bonds.
e) Flexibility of contracts.
f) Performance bonus for contractors.
g) National hydrocarbons commission.

WHY are these measures positive?

a) At present, the director general has little real authority and influence in the plans and programs of the subsidiaries.

b) The board of directors has been a ceremonial body, with no independent authority at all.

c) Executive committees with real responsibilities may give more leadership weight to the board; also the Presidential Auditor (Comisario) adds a new oversight dimension.

d) The idea of a citizen bond creates the precedent that there are specific outside parties that want their investment protected. This is an intermediate step toward having a percentage of Pemex future revenue on the stock market.

e) Contractual flexibility is needed to permit Pemex to maintain technological parity by upgrading to new technology developed during the period of the contract.

f) Performance contracts motivate greater efficiency for Pemex and the contractor.

g) While it is far from certain that such a committee or commission will have real weight in policymaking or on the behavior of Pemex, there is, implicitly, the RECOGNITION OF A SERIOUS PROBLEM, which is the technical insolvency of the Mexican government in relation to Pemex.
 
Question: Will this reform take on the main challenges Pemex faces? Why or why not?

GB: It is striking that none of the language in the law acknowledges the present situation of the international oil market. Furthermore, the old song of Article 6 of the Petroleum Law of 1958 now has new verses – explicitly, for example, prohibiting the posting by a contractor of petroleum reserves as his commercial property.
 
One of the most important challenges is the reorganization of EXPLORATION, but the Ley Orgánica is silent on this issue. (I found the word "exploración" only once, in Article 3, in all of 77 pages.)  The Ley Orgánica does, however, give the board the authority to reorganize Pemex.  I do not believe, however, that they will be told about the importance of separating exploration from production, creating (as one possibility) a separate PEMEX EXPLORACION.

Question: What does it lack?
 
GB: The interface between Pemex and the international oil industry is somewhat improved by the reform package, but there is nothing, specifically, that will help Pemex or Mexico move into a serious program of deepwater exploration and development.

It has not yet been proposed, for example, to divide up the Mexican side of the Gulf of Mexico into concession blocks, even if, initially, it were only Pemex that would be authorized to explore and develop hydrocarbons.  The discussion of cross-border oilfields would be more precise and intelligible if Mexican waters were mapped into 3x3 mile blocks.

There is no realistic way for Pemex to gain the leverage in people, capital and technology to successfully explore in deepwater except through association(s) with international oil companies. The government (and all of the vested commercial and ideological interests behind it) is no yet willing to lead public opinion to a new course of public policy, and, instead, chooses the traditional (if discredited) philosophy of Mexican exceptionalism in the upstream.

Similarly, one of the urgent needs of Mexican society (as represented by the Mexican federal government) is to have real policy and regulatory oversight of Pemex.  Establishing new commissions or committees in the Energy Ministry will have questionable effect without a serious commitment to establishing a career path for regulators.

In this sense, it is a pity that the CRE (Energy Regulating Commission) reform bill has not been taken up for a vote in Congress.

Question: Ultimately, how will Pemex end up with respect to attending to its challenges?

GB: When you say "Pemex," you have to ask who are you talking about in Pemex? The system of presidential appointments of director generals of the Pemex subsidiaries seriously weakens the authority of the director general of Pemex Corporate. Why? Because the heads of the subsidiaries real boss is not in Pemex but somewhere else – either in the government or the private sector, but with an influence with the President.

Another weak point in leadership is the custom of new presidential appointments every six years, both for the director general as well as the heads of the operating units.  This system works against policy continuity and executive retention, and is generally bad for Pemex. Unfortunately, this perverse system of presidential appointments has not been touched in the energy reform.

The new legal terms have little impact on the subsidiaries themselves, which are free, more or less, to do what they want. It remains to be seen if a newly empowered Corporate Director General and Corporate Board of Directors will significantly influence their behavior.

——————————

George Baker is the director of Energia.com, a publishing and consulting firm based in Houston.  He can be reached via e-mail at g.baker@energia.com.