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Big Oil to Get Brazil-Like Terms in Plan to End Mexico Monopoly

Global oil majors from Exxon Mobil Corp. (XOM) to Chevron Corp. (CVX) are about to get the clearest indication yet of how far Mexican lawmakers will go to lure them into the largest unexplored crude area after the Artic Circle.

Senate committees will begin debating a bill to end a seven-decade state oil monopoly as soon as today. On the agenda is a proposal by members of President Enrique Pena Nieto’s Institutional Revolutionary Party, or PRI, and the National Action Party, or PAN, to extend a profit-sharing model unveiled in August by also allowing production sharing or a license model used in Brazil, said two people with knowledge of the talks.

The proposal seeks to offer companies more control over riskier fields and attract enough investment to halt a decade-long output slump in Mexico’s $95 billion industry, the largest crude supplier to the U.S. after Canada and Saudi Arabia. Mexico’s estimated 13.9 billion barrels of reserves are the biggest in Latin America after those of Venezuela and Brazil.

“If Mexico is going to spend political capital on a constitutional amendment, they should try to get the most bang for their buck,” Jeremy Martin, an oil specialist at the Institute of the Americas in La Jolla, California, said in a telephone interview. Granting concessions or licenses “gives stronger support to the end goal.”

Pena Nieto’s government says approval of an energy overhaul would lift economic growth 1 percentage point by 2018 and reverse oil production losses. A more “market-friendly” reform could increase foreign investment by as much as $15 billion annually and boost potential economic growth by half a percentage point, according to a Nov. 28 report from JPMorgan Chase & Co.

Output Declines

Petroleos Mexicanos, the state-owned producer known as Pemex, is headed for a ninth straight year of output declines after production at Cantarell, the world’s third largest deposit when discovered in 1976, slumped more than 80 percent in the past decade. Crude production at Pemex has fallen to about 2.5 million barrels a day this year from 3.3 million in 2004. The country now imports 34 percent of its oil, according to Chief Executive Officer Emilio Lozoya.

“Investment in exploration has multiplied dramatically, though production has fallen,” Lozoya told Congress on Nov. 20. “To increase production in Mexico, more investment is required. One way to do this is to share the investment between other companies and Pemex.”

‘Investor-Friendly’

There is a greater chance the senate will draft a proposal that’s more appealing to investors after the Democratic Revolution Party, or PRD, exited a political alliance that was being used to negotiate the reform, said Gabriel Lozano, chief Mexico economist at JPMorgan. The PRD, which opposes some of the proposed legislation, pulled out of the group known as the Pact for Mexico on Nov. 28.

Without the PRD, “there is room for discussing and submitting a more investor-friendly proposal, something that is more similar to a license type of agreement,” Lozano said in a telephone interview on Dec. 2.

Pemex was created in 1938 by President Lazaro Cardenas after he seized assets from companies that later became part of Exxon, the world’s largest oil company, and Royal Dutch Shell Plc (RDSA), Europe’s largest. More than seven decades later, both companies have expressed interest in investing in Mexico as rules change.

Private and foreign companies were prohibited from exploring or producing oil until October 2008, when the law was revised to allow incentive-based, fixed-fee contracts for some crude production. Pemex is also the only domestic refiner of crude.

Preliminary Deal

PRI and PAN lawmakers reached a preliminary accord in October that would allow Mexico to offer companies service contracts and profit and production sharing and licenses. The agreement remains in place, the two people with knowledge of the discussions said yesterday, asking not to be named as the plan hasn't been made public.

Mexico’s failure to boost output contrasts with a production boom in the U.S., where companies such as Chevron are tapping reserves trapped in shale rock deposits with technology such as hydraulic fracturing, or fracking.

While Pemex produces 19 barrels of oil a day for every employee, Exxon produces 29 barrels. Third-quarter sales at Exxon were triple those of Pemex even though the U.S. producer’s daily output of oil liquids is about 20 percent less.

$1 Trillion

Given increased oil prices and diminished production, Mexico is on track to become a net importer of energy, Pemex’s Lozoya said. Without a reform, Pemex would need an estimated $1 trillion of investment to extract prospective reserves in the next 50 years, he said. To do so, annual investments would have to be increased to $62 billion from $25 billion.

The PRI and the PAN also want to revamp Pemex’s corporate structure to give the company more autonomy to make its own strategy and budget decisions.

“Pemex is a very troubled, poorly run company that has to hand off almost all of its revenue to the government and has declining oil production,” said Pavel Molchanov, an analyst with Raymond James Financial Inc., in a phone interview. “Any changes made to company structure in a reform would be a major improvement.”

Constitutional Change

Allowing other companies to explore and drill for gas and oil in Mexico requires a constitutional amendment that could only pass with a two-thirds majority in both the lower house and Senate. The PAN, PRI and Green Party have enough votes to approve a charter change.

Pena Nieto’s energy overhaul proposal presented on Aug. 12 limited contracts to risk-sharing accords with cash payments. The PAN presented its own initiative in July that seeks concession contracts and allowing companies to book reserves directly to their balance sheets. The preliminary agreement between the PRI and PAN will seek to have as many contract options as possible, including those where producers are paid with oil.

“The most likely scenario for the energy reform is that it includes concessions and production-sharing agreements because the PAN will only approve a truly pro-market bill,” Benito Berber, a strategist at Nomura Holdings Inc. in New York, said in an e-mailed research note on Dec. 2.

To contact the reporters on this story: Adam Williams in Mexico City at awilliams111@bloomberg.net; Eric Martin in Mexico City at emartin21@bloomberg.net

To contact the editor responsible for this story: James Attwood at jattwood3@bloomberg.net

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