As Mexico Oil Reform Accelerates, Firms Wait for Fine Print

Pemex's Infrastructure
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MEXICO CITY (Dow Jones Newswires), October 20, 2008

Mexico's energy reform just got a shot in the arm. The financial crisis and tanking oil prices puts a premium on private capital to help shore up the struggling industry, dampening a nationalist backlash.

But oil firms are unsure if the reform, which was watered down earlier this year following heavy attacks from left-wing politicians, will offer enough to deploy capital south of the U.S. border.

The risks are high for both Mexico and the U.S.

Mexico will be importing crude within seven years unless it finds and develops new pools of oil fast. This would undermine state revenue and erase a main source of U.S. crude imports.

With oil prices down by nearly half since July and credit markets in retreat, Pemex needs help.

"The credit crunch has certainly put pressure on Pemex to utilize all its resources and design the most enticing incentive-based contracts that it can conjure up," said Gianna Bern, the president of Brookshire Advisory and Research, Inc., an energy and capital markets consultancy.

Pemex normally borrows around $5 billion a year to finance operations and smooth out its debt payment schedule.

"Financing costs have gone up markedly and credit is scarce," said Bern.

If passed, the reform will introduce fee-based exploration and production contracts. It will also streamline bureaucracy at state-run Petroleos Mexicanos, making it easier to outsource projects to traditional oil service providers.

"The entire world is going through a difficult time, and we have to find solutions," said Francisco Labastida, the head of the Senate energy committee from the centrist Institutional Revolutionary Party, or PRI.

He said the Senate vote could come as early as next week. Any changes also have to be passed by the lower house of Congress.

Oil Firms Not Convinced  

Oil majors with the capital and know-how to march into Mexico's untapped fields, especially those buried deep in the Gulf of Mexico, are still waiting to jump on board. The reform will have to deliver similar conditions to what is on offer in other oil provinces such as Colombia, Nigeria or Angola, to win them over.

Compared with these countries, Mexico is handicapped by its nationalist oil tradition. International oil firms normally lease acreage in oil-rich areas, explore, and pay local taxes on production.

In Mexico it's not that simple. The 1938 oil expropriation remains a source of pride to a nation that suffered U.S. and French invasions in the 19th century. In 1938 Mexico faced down U.S. and European oil firms and pressure from their home governments, earning then-president Lazaro Cardenas a star role in history books.

His legacy lives on in oil legislation. Every Mexican oil molecule remains under state ownership, and the most Mexican politicians can stomach is paying outsiders to pump Mexican crude for a fee.

"We have to wait for Pemex to come out with contracts to see if they are globally competitive," said a Mexico City-based executive at an international oil firm.

President Felipe Calderon openly describes the reform as what is politically possible, but falling short of what the industry really needs. A plan to legalize joint-ventures between Pemex and international firms for deepwater fields died before Calderon even sent the reform to Congress.

It is the latest attempt by business-friendly presidents to chip away at Pemex's monopoly.

In 2004 Mexico launched service contracts in the well-explored Burgos natural gas basin south of the Texas border. This attracted companies looking for a foothold in Mexico such as Spanish-Argentine Repsol YPF, Brazil's Petrobras and smaller companies such as Houston-based Lewis Energy.

Executives say they would need more attractive returns before moving into higher risk areas such as the Gulf of Mexico.

"In deepwater the drilling cost is huge, and it is kind of risky for our company," said an executive at a firm that pumps natural gas in Mexico. "If they keep the service contracts, they need to be modified."

The reform allows Pemex to include incentives, such as bonuses when operators complete a project under budget or find more oil than initially expected. This gives Mexico a small but welcome opportunity.

"Incentive-based contracts are better than nothing," said Bern.

Crisis Gives Political Opening

The global credit crisis has edged oil reform out of the limelight and taken the fire out of left-wing detractors who routinely call it a masked privatization.

Mexicans are worried about the economy, which relies heavily on remittances from Mexicans in the U.S. who are sending less cash home.

The peso has taken a beating by foreign investors fleeing the stock market, and a rise in drug-related crime has dominated newspaper headlines and politics in recent months.

"For now the main topic is the economy," said Miguel Segura from the Mitofsky polling firm.

The left-wing Democratic Revolutionary Party, or PRD, still opposes the incentive-based contracts. But so far it has failed to break up a consensus between the ruling National Action Party and the PRI, who both want to push it through.

The PRD stalled reform talks in April by camping out in both chambers of Congress for two weeks. This delayed formal debates for three months.

But with economic insecurity running high and congressional elections slated for mid-2009, PRD politicians will think twice before turning to civil disobedience, said Segura.

Copyright (c) 2008 Dow Jones & Company, Inc.

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