Mexican Energy Reform, Three Years Later

Texas Lawyer | October.03.2016

In December 2013, Mexico passed a comprehensive constitutional reform that opened Mexico's energy industry to private investment and competition. Because of prior reform attempts, there was initial skepticism by industry participants regarding Mexico's ability to implement the reform. Almost three years after passing the reform, however, Mexico has successfully developed a new energy regulatory framework, which has created a brand-new energy play in the North American region. The reform has translated into tangible opportunities in different areas of its energy sector, where a broad range of national and international players are currently participating. This article analyzes the main developments in these sectors and future opportunities.

1. Upstream. Mexico's upstream legal framework has been effectively implemented, starting with the publication of the Hydrocarbons Laws and related laws and regulations, the transformation of PEMEX into a productive state enterprise, and the revamping of the upstream regulators, such as the Ministry of Energy (SENER), the National Hydrocarbons Commission (CNH) and the Environmental Hydrocarbons Agency (ASEA).

Despite declining oil prices, three upstream bidding rounds have concluded (Round 1.1 for shallow water exploration areas, Round 1.2 for shallow water production areas, Round 1.3 for onshore areas) with the CNH successfully awarding more than 30 exploration and production contracts to new operators. Three more bidding rounds are currently ongoing (Round 1.4 for deep water areas, including a joint venture opportunity with PEMEX for the Trion block in the Perdido basin, Round 2.1 for shallow water areas and Round 2.2 for onshore areas, including natural gas areas).

Future upstream bidding rounds are expected to include more joint venture opportunities with PEMEX, for both deepwater and shallow water areas. To date, major international oil and gas companies, Mexican energy companies and financial investors have prequalified for many of these bidding rounds. The general consensus among industry players is that contractual, legal and regulatory terms for upstream operations are within international market parameters (with a few minor exceptions) and attractive for financing sources.

2. Midstream. Mexico's midstream legal framework has also been implemented, starting with the publication of the midstream permitting rules, open access and nondiscriminatory access rules, the creation of the independent natural gas network operator (CENACE), and the revamping of the Energy Regulatory Commission (CRE). Midstream infrastructure in Mexico needs to grow significantly to support: (i) fuel consumption by local industry, (ii) transportation and storage of additional crude oil and natural gas as new operators come online, and (iii) the planned build-out of modern natural gas-fired power plants by the Federal Electric Commission (CFE), Mexico's state utility.

During the past few years, the CFE has launched an ambitious program for tenders for natural gas infrastructure and power projects, requiring several billion dollars in investment. These include several cross-border pipelines that will bring U.S. natural gas into Mexico and a subsea natural gas pipeline connecting southeast Texas with Tuxpan, Mexico.

Several private pipelines and marine and storage terminals for the transportation of imported refined products in Mexico have been announced. These projects are expected to result in long-term, take-or-pay contracts that could attract investment from funds, institutional investors and other financing sources.

Inspired by successful experiences with master limited partnerships in the U.S., the Mexican government recently created the FIBRA E, a publicly tradable vehicle that is aimed at promoting specific energy and infrastructure investments by allowing tax benefits and a lower cost of capital. FIBRAs E are also aimed at helping PEMEX and CFE monetize midstream assets, allowing them to focus on their core businesses. FIBRAs E are expected to soon emerge as new publicly traded assets.

3. Power. Mexico's power legal framework has been successfully implemented, starting with the publication of the Electric Industry Law and wholesale market rules, the creation of CENACE, the commencement of the short-term market and the publication of rules and manuals governing power auctions and the new electric market.

To date, CENACE has conducted a power auction that resulted in awarding several, long-term power purchase agreements to clean energy generators. In these auctions, power generators participate as potential sellers of electric energy, capacity and clean energy certificates, while the CFE participates as a potential buyer and as the only current supplier to regulated consumers in the Mexican market.

This first power auction was considered a success, 15 times oversubscribed by generators, and resulting in the awarding of 15-year power purchase agreements to 11 solar and wind companies. The view among generators, financial players, and industry participants was that the auction was transparent and well conducted and set a very positive precedent for future competitive tenders in the Mexican electric market.

CENACE is currently conducting a second power auction for long-term power purchase agreements that will soon be awarded. SENER and CENACE have yet to create and implement the capacity and clean energy markets, financial transmission rights and the clearinghouse that will allow other offtakers to participate in the power auctions as buyers. Furthermore, SENER is expected to soon release tenders for the development of electric transmission and distribution infrastructure, which is in need of significant investment in Mexico. The successful implementation of the Mexican energy legal framework has laid a solid foundation for private investment in the Mexican energy sector.

Gabriel Salinas is a partner in Orrick, Herrington & Sutcliffe's Houston office. His practice focuses on the O&G, power and infrastructure sectors. Rodrigo Dominguez Sotomayor is a partner in the Houston office and serves as co-head of the firm's Latin America practice. Both are dual-licensed in the U.S. and Mexico.

Reprinted with permission from the October 3, 2016 edition of the Texas Lawyer © 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or [email protected]