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On June 7, Mexican voters will go to the ballot box in mid-term elections that will be viewed as a test of the Enrique Pena Nieto presidency and of the ruling PRI party. Despite the many challenges facing the government, it is likely that the president and his party will pass that test by winning a majority in the national Chamber of Deputies, as well as a number of gubernatorial races across the country.
However, a few weeks after the electorate takes to the polls, the government faces another, more demanding examination of its most important achievement thus far: the opening of the nation´s hydrocarbons industry to private and foreign investment, when companies submit bids on the first batch of contracts under Round One. The outcome of that test is far from certain, and there endure substantial concerns in the oil industry over the contract terms that have been issued by the government to date. In fact, there is a growing sense that, unless the government makes major changes to the contract terms, few foreign companies will choose to participate on this occasion.
Mexico’s watershed energy reform process, which culminated in the passage of a constitutional reform in December 2013 and of implementing legislation in August 2014, was seen by many as the missing piece in the picture of an open and globalised Mexican economy that had been made possible by the North American Free Trade Agreement (Nafta) in 1994. Much more than simply a free trade treaty, the Nafta provides a set of rules that protect foreign investors in the three member countries, in particular under the agreement’s Chapter 11 provisions, which prohibit expropriation and acts “tantamount to expropriation” that are undertaken without complying with minimum standards (such as payment of compensation or on a non-discriminatory basis).
The energy reform process seemed to be heading in the same direction as the Nafta, as the government passed ambitious legislation to open the sector and then proceeded at breakneck pace to create a new regulatory and institutional framework. However, the euphoria came to an end in December 2013 with the publication of contract terms for Round One of oil exploration and extraction contracts. Serious questions are now being asked as to whether the liberalising spirit of the Nafta exists in the contracts currently being considered by oil firms.
The fiscal terms have of course come in for criticism, something that is entirely normal at this stage of the conversation between governments and potential bidders, but of greater worry is the need to guarantee long-term stability in the fiscal framework. There is also a growing concern over the amount of regulatory red tape that must be complied with by investors in the sector in order to secure permits and not violate administrative restrictions. Mexico’s regulatory institutions, in particular the National Hydrocarbons Commission (CNH), the Energy Regulatory Commission (CRE) and the Energy and Environmental Safety Agency (ASEA), are still in the process of consolidation, and analysts have noted that they each face major staffing challenges in the next few months if they are to be ready for the investment that the government hopes will flow. One example serves to highlight the problem of regulatory burden: the contract terms call for the CNH to be closely involved in the design of the development plan for oil blocks. Companies are arguing that this involvement is entirely redundant, as the CNH must also approve the development plans before work can begin.
However, the overriding complaint from foreign companies, both the independents and the majors, is that, despite the landmark reform of 2013, the government continues to view them as service contractors rather than as investors who are considering allocating valuable capital to Mexico. The proposed contract terms have been heavily criticized as focusing excessively on the restrictive and punitive elements of the relationship between owner and operator, without providing enough incentives or assurances of legal certainty and a stable investment environment. One of the primordial concerns of potential bidders is that the Mexican Hydrocarbons Law, passed in August 2014, includes language that allows the government to rescind contracts for a breach of terms by the operator, without providing either a due process for appeal, a process for remedying errors or a compensation mechanism.
Despite the frequently voiced concerns of foreign companies, however, the Mexican government has chosen to herald the “success” of the bidding process thus far, by focusing on the number of companies (49) that have paid to enter the data rooms for the oil fields, and the slightly smaller number (34) that have applied for pre-qualification to make a bid. As one industry insider has noted, however, the $20,000 fee for pre-qualification is a minor matter on top of the $365,000 for entry to the data rooms, but in no way does it guarantee that these companies will make a bid when the time comes. In fact, company executives are suggesting that the government faces a rude awakening in June when bids are submitted, unless significant further changes are made to the contract terms.
In the end, the Nafta itself may come to the rescue of both the Mexican government and the investors. According to Beatriz Leycegui, former deputy minister of trade and Nafta negotiator, “companies from countries with which Mexico has free trade agreements or bilateral investment treaties are in general protected from arbitrary rescission or expropriation without compensation. The former since international treaties supersede domestic legislation, such as the August 2014 Hydrocarbons Law. It would be positive if the Mexican government could remind investors of their rights under the trade and investment treaties signed by Mexico.”
Duncan Wood is director of the Mexico Institute at the Woodrow Wilson Center.