In December 2013, the Mexican Congress passed an energy reform bill which, for the first time in over three-quarters of a century will remove certain legal restrictions that have limited private investment in Mexico’s electricity and oil and gas markets. The bill, which has been described by Mexico’s President Enrique Peña Nieto as “a fundamental, historic reform”, amends Mexico’s constitution and, after ratification by a majority of the state legislatures in Mexico, was signed into law by President Peña Nieto on December 20, 2013.
The energy reform bill calls for the Mexican Congress to enact secondary enabling legislation within 120 days of the reform’s enactment. Those secondary laws are intended to detail the terms and conditions, including royalty structures, contractual structures and tax structures, that will govern private participation in Mexico’s energy industry. Various participants in Mexico’s energy sectors, including certain of our clients in the self-supply electricity and power production sector, have been engaged in dialogue with legislators and government stakeholders to help shape this secondary legislation.
When fully implemented, the energy reform is intended to open Mexico’s energy market up to private investment and competition, all with an overriding objective of “maximizing [Mexico’s national] revenues.” Key objectives of the reform, which are central to these overriding ambitions, include the following:
- The reform will remove the restriction under Article 28 of the Mexican Constitution which has historically designated electricity generation as a public service reserved exclusively to the government. The intent of this change is to create a framework of open access to the national grid to allow competitive private participation in the electricity generation business in order to develop an open and transparent wholesale electricity generation market.
- The reform will end the Petróleos Mexicanos (“PEMEX”) monopoly on the exploitation of oil and gas resources under Articles 27 and 28 of the Mexican Constitution and the Ley de Petróleos Mexicanos (the “PEMEX Law”) and the Ley Reglamentaria del Artículo 27 Constitucional en el Ramo del Petróleo (the “Article 27 Regulatory Law”). Under these laws, PEMEX has historically maintained a monopoly on exploration, production, distribution, storage, refining and marketing of petroleum products.
- Related to each of the above points, the reform seeks to force PEMEX and the government-owned power utility Comisión Federal de Electricidad (“CFE”) to participate in a competitive marketplace and thereby increase their efficiency and productivity, and enable them to “partner” in various ways with foreign investors, contractors and other market participants to the benefit of their government shareholder and the Mexican people.
For the first time in many decades, the energy reform aims to create a functioning market in the oil, gas and electricity sectors in Mexico by ending the monopolies that have dominated those sectors and prevented the competition and private investment necessary to grow a true market.
ELECTRICITY MARKET REFORMS
Historically, private investors and market participants have had limited opportunities to participate in the generation of power in Mexico. Prior to the reform, Article 28 of the Mexican Constitution classified power generation as a public service activity reserved exclusively to the Mexican government and state-owned entities, most notably CFE. Under this paradigm, private sector participation in Mexico’s electricity generation market began in 1992, and in the period since then private entities have been allowed at various points to participate in only five types of power generation projects and all under varying degrees of CFE control and/or influence: independent power producer (“IPP”) projects, self-supply projects, cogeneration projects, small power projects under 30MW, and self-consumption projects for importers or exporters of power.
Under the pre-reform regime, IPP projects have been awarded and controlled by CFE since the first IPP in 1993, with the requirement that all power from IPP projects be sold to CFE under long term power purchase agreements. Other projects have also been developed pursuant to generation permits and licenses awarded by the Comisión Reguladora de Energía (“CRE”), often in accordance the self-supply scheme under which the developer forms a partnership or joint venture with offtakers who contribute a nominal investment in exchange for a passive partnership interest, following which those offtakers are entitled to purchase power from the self-supply project under power purchase agreements. These self-supply projects have also required the involvement of, and often lengthy negotiation with, CFE for purposes of securing access to the grid, interconnection and wheeling arrangements, and, in particular in the case of many renewable projects, setting the terms of energy banking (a mechanism that allows credits for power produced and put onto the grid to be banked for a period pending offset from power utilized by one or more of the self-supply offtakers).
Under the energy reform, power production will now be de-classified as an activity under exclusive state control, such that private entities will be free to engage in the power generation business with some form of open access to the national electricity transmission network. Transmission, distribution, and planning and control of the grid will remain exclusive public services to be provided by the government and state-owned entities. However, private entities can now participate even in those public service activities under the energy reform by contracting with the responsible state entities.
Within 12 months of the reform’s enactment, the government of Mexico must create the Centro Nacional de Control de Energía (the “National Center of Energy Control”) to operate the national electricity network, ensure open access to the grid for power producers and otherwise administer the wholesale electricity market.
Among other things, we believe the reform will enable IPP developers to enter into bilateral power purchase agreements with industrial and commercial electricity users with large loads, and may provide the contours for a merchant power market in Mexico.
OIL & GAS REFORMS
Historically, under Articles 27 and 28 of the Mexican Constitution, concessions for the exploitation of oil and gas resources in Mexico have been forbidden, as exploration, production, distribution, storage, refining and marketing of petroleum products were strategic areas reserved to the government (through PEMEX). Applicable legal requirements, including the PEMEX Law and the Article 27 Regulatory Law, even prohibited service contracts from offering payments in-kind or fees based on production or profit metrics. As a result, private investment in Mexico’s rich oil and gas resources has been limited.
The energy reform repeals these restrictions with an intent to optimize production from Mexico’s oil and gas reserves by permitting contract rights or licenses to be awarded to either or a combination of PEMEX and/or private entities. The reform also allows PEMEX to enter into joint ventures with foreign private companies, including financial investors, to exploit oil and gas resources.
Under the reform, Mexico’s Ministry of Energy will grant oil and gas rights, designate areas for bidding, manage bid processes and requirements, and award entitlements. Contractual entitlements will be provided by way of contracts and royalty and tax regimes to be further defined in the coming secondary legislation, but will include licenses, production-sharing contracts, profit-sharing contracts and standard service contracts. PEMEX, either alone or in certain joint venture arrangements with private entities, will be given a “Round Zero” opportunity to retain exploration and production rights on certain land it is already exploring before those areas can be opened up to bid by private developers.
With regard to post-production activities, the energy reform mandates that the Ministry of Energy will have control over granting permits for refining and natural gas processing, and the Comisión Reguladora de Energía (the “Energy Regulatory Commission”) will be charged with oversight and control of permits for storage, transportation and distribution, and will regulate initial-point sales of hydrocarbon fuels.
Within 12 months of the reform’s enactment, the government of Mexico must create the Centro Nacional de Control del Gas Natural (the “National Center of Natural Gas Control”) to oversee operation of a national gas pipeline network.
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We are excited about business prospects for foreign investors in Mexico’s energy sectors in the wake of the energy reform, and we would be happy to further discuss any of these topics with you.