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Risks Abound in Mexico’s New Oil Laws

Risks Abound in Mexico’s New Oil Laws

Much has been made of the recent announcement that Mexico is seeking to update its oil laws, allowing foreign companies a role in the industry for the first time in decades. How serious investors should take the news depends largely on how the political process plays out in Mexico.

The reforms unveiled by President Peña Nieto won’t offer full concessions (which is the preference for oil and gas companies), but will instead offer profit-sharing arrangements, that allow oil companies to receive the cash equivalent of the oil they help produce.

The new law will be the most significant upgrade to the Mexican oil industry since it was nationalized over 75 years ago. It will involve changing Articles 27 and 28 of the Constitution and face stiff resistance from some factions of Mexican society.

The ruling Institutional Revolutionary Party (PRI) and the country’s second largest party (PAN) both support the changes, however the Party of the Democratic Revolution (PRD) led by the popular Andres Manuel Lopez Obrador have come out against the changes and have promised street protests later this year.

Related article: Sweetening the Deal for Foreign Investors in Mexico

More importantly, a recent survey shows that 65 percent of Mexicans oppose opening the country’s oil and gas fields to foreign investment. The PRI plan is something of a middle path between the PAN proposal that sought to allow full concessions and the PRD plan that would involve only minor tweaks to Pemex (the state-owned petroleum company).

PRI and PAN should have enough votes between them to force through the changes without any help from the PRD. However, PAN could see potential political gains from derailing a reform that Peña Nieto made a major piece of his campaign for the presidency.

The consensus opinion among analysts is that the constitutional changes will be approved, though not without a fight. Peña Nieto has already demonstrated he can get tough things done, by passing sweeping changes to Mexico’s education and telecom systems. However, this is only the first half of the battle.

The constitutional changes would serve to make foreign oil and gas investment in Mexico legal, but it would not spell out exactly how such investments would take place. That would come in a subsequent series of laws, which would be much more complex. Drafting those laws will take time and be susceptible to lobbying efforts by interests on both sides. The outcome of that process will provide a clearer picture of just how much foreign oil companies stand to gain in Mexico.

Another unanswered question is how the SEC and other regulators will interpret Mexican law. It is possible U.S. companies would be able to list profit-sharing agreements with Pemex as reserve holdings (similar to the accounting for a traditional concession). This would be a big win for an industry in which investors tend to place high value on physical reserve assets and their potential for future production.

Related article: This Week in Energy: Mexico’s Desperate Leap Forward to Jumpstart Oil Production

Thus, even if the constitutional amendments pass (which does seem more likely than not), there are still significant uncertainties. The series of secondary laws could take years to be fully implemented and could be filled with caveats and loopholes. The foreign accounting rules based on this secondary law are equally complex with a variety of potential outcomes. Finally, even if all goes according to plan there is still the potential for the government to walk back its reforms down the road, should the changes become politically unpopular.

In a country that sees its natural resources as a source of tremendous national pride and holds a strong historical disposition toward foreign interference in the oil industry, it is not unreasonable to imagine future governments under significant pressure to alter the law in ways unfriendly to foreign companies.

By Evan Abrams




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