Mexico: Energy & Natural Resources
By David Enríquez & Jorge Sandoval
Energy Partners with
Goodrich, Riquelme y Asociados
As commented in previous introductions, Mexico’s 2013 Energy Reform amounted to an unprecedented game changer due to its scope and depth. In essence, it created a market ecosystem under the umbrella of robust and independent regulators. Its magnitude attracted global recognition, including that of specialised agencies such as the OECD’s International Energy Agency.
Upon its acknowledgement of the Energy Reform, President López Obrador's decision to keep it intact has been well received by the market. Additionally, the institutional design remains in place and reasonably functional, despite the changes to public policies, such as the temporary suspension of E&P rounds and energy auctions.
Nonetheless, the economic scenario for the first quarter and beyond has been deteriorating due to the spread of the COVID-19 pandemic and the health emergency declared on 30th March 2020, halting all non-essential activities and hitting private consumption and investment hard.
The International Energy Agency (IEA) indicated that “[a]round the world billions of people are affected by one of the worst health crises of the past century. The global economy is under pressure in ways not seen since the Great Depression in the 1930s; businesses are failing and unemployment is surging.” (1)
The challenge for oil and gas companies in confronting the COVID-19 pandemic has been increased by the collapse of global oil prices and their volatility; global oil demand is expected to fall by a record 9.3 mb/d year-on-year in 2020.
In response, the OPEC+ group has announced a supply cut deal of 10m barrels per day, which amounts to the world’s largest-ever supply cut deal. Such measures will not rebalance the market immediately, but they will help absorb the worst of this crisis, whose consequences for the oil market remain very uncertain in the short term.
According to the IEA, the initiatives will impact the oil market as follows: i) the production cut will provide some immediate relief from the supply surplus, lowering the peak of the build-up of stocks; ii) the decision made by China, India, Korea and the United States to offer their strategic storage capacity will create extra space for crude oil, helping the market to stabilise; and iii) other producers could see output fall in the second half of 2020, ensuring a return to more normal market conditions.
Naturally, the collapse of global oil prices has impacted the Mexican blend, which has been sold since March at below USD40 per barrel, reaching it lowest level on 20th April, when the price was under USD-2 dollars per barrel; this situation contributed to PEMEX's credit rating downgrade from “stable” to “negative” in the past few months. This is why PEMEX investment in the following years will not be enough to achieve its oil reserves of 2019 and 2020, emphasising that the entity will cut its investment budget by approximately USD1.6 billion, focusing only on projects with high profitability margins.
The International Monetary Fund has projected that the Mexican economy will contract by 6.6% in 2020, meanwhile Mexico's central bank estimates a drop of 3.99% in the same period, expecting that GDP will grow by no more than 1.8% in 2021.
In such a gloomy context, although the Mexican energy markets might not look as hot as in recent years, there are numerous areas of opportunity throughout the value chain to be considered precisely at the current low level of the economic curve. This is why the wise investor should look at the bright and vibrant instrumental component of the Energy Reform: the private sector.
The stability of the Energy Reform, in addition to the materiality and the de-risking of multiple fields, has been instrumental in upstream activity. In addition to nearly a dozen sizeable secondary market transactions already conducted (i.e. Shell/Chevron and Wintershall DEA/Riverstone’s Sierra), the infrastructure and oilfield services needed in order to honour over 60 exploration plans and over 30 development programmes, both onshore and offshore, amount to tens of billions in guaranteed investments by IOCs, NOCs and independent operators from almost 40 countries.
In the midstream arena, over 70 storage terminals have already been authorised, with a 4.5 million-barrel capacity and USD5 billion of investment being deployed. Despite skepticism as to the governmental plans regarding downstream, there are private modular refineries in the permitting pipeline. Top global brands are a reality in the retail sector, with over a third of the market already in private hands. Multimodal and mobile stations are part of a new market approach to an ever-evolving industry. As a result of a robust approach towards natural gas by previous administrations, Mexico is now better connected to the abundant and efficiently produced US unconventional resources. An illustration of this is the 800 km marine pipeline that will benefit industrial activity in various regions.
The electricity and renewable markets are also experiencing fresh input from the private sector. The Energy Reform provided for almost 100 new players, including private generators from over ten nations. Combined cycle plants, together with solar (Mexico will be the second largest solar market in under five years) and wind fields are facing an increase in aggregate demand and the ageing of CFE’s generation portfolio. This growing ecosystem - heavily composed by the private sector - will need to mobilise over USD80 billion in investment just for generation over this decade. As in the upstream, handsome secondary market opportunities have emerged (i.e. ENEL/CDPQ) and will continue to do so. Massive distributed generation and electro-mobility for public transportation are trends that are growing rapidly in Mexico. We will certainly have interesting developments to report in these two fields in the near future.
From an investment protection perspective, under the United States-Mexico-Canada Agreement (USMCA), which entered into force on 1st July 2020, investments in the hydrocarbons sector and electric power production will continue to be protected by their inclusion in Chapter 14, the Investor-State Dispute Settlement protection; this not only contemplates national treatment and protection against direct expropriation, but also against indirect expropriation, meaning that the exhaustion of local remedies requirement does not apply to energy. Such a development should be regarded as a positive sign for forthcoming regional investments within the sector.
Finally, in April 2020 Mexico and the European Union updated their free trade agreement by adding new areas of trade, such as energy and sustainable development, providing significant value to the hydrocarbons and electricity sector that will help EU investors "to ensure access to new liberalised Mexican hydrocarbons and clean energy markets worth up to 15 and 6 billion dollars respectively a year.” (2)
All in all, the ecosystem created by the Energy Reform has proven to be the very soul of this major endeavour in Mexico's history. Despite the economic hardship to be lived as a result of the COVID-19 pandemic and some energy policies designed by the current administration, the energy sector is here to stay. In the end, its evolution will be better for the economy and for the consumer.
2. New EU-Mexico agreement - The agreement in principle dated April 23, 2018.