Mexico’s the energy reform: new roles for oil producing states

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Despite being a federal country, energy policy is highly centralized in Mexico, as is the collection and disbursement of oil revenues. Before the energy reform of 2013, Pemex was responsible for all hydrocarbon related investment and production decisions, while the federal treasury, which in Mexico is the Secretaría de Hacienda y Crédito Público (SHCP), managed the collection and distribution of revenues. While fiscal centralization continues under the new regulation, and federal entities like Pemex,  SHCP, and the energy regulatory agencies, SENER and CNH, continue to control energy policy, state and local governments will play increasingly important roles in the oil & gas business as private companies negotiate with them, and the communities they represent, important matters such as land and water use. First, some background.

Oil & gas producing states

Mexico’s oil and gas production is located in 9 states: Campeche, Chiapas, Coahuila, Nuevo León, Puebla, San Luis Potosí, Tabasco, Tamaulipas, and Veracruz, with another two, Hidalgo and Oaxaca, coming on board as new reserves are opened up for exploration. As the graph below shows, production has been highly concentrated in the state of Campeche, where the Cantarell off-shore field is located, but is likely to become more dispersed in the future as determined by the location of newly accessible resources.

Thousands of barrels per day.

Oil Production by State (thousands of barrels per day). Source: Quiroz, C. 2014. La reforma energética en México: retos y responsabilidades para la implementación en los estados.

Revenues

Oil revenues have been central to Mexico’s finances since the 1970s, amounting to 8% of the country’s GDP and 30-40% of the federal budget in the last decade. Roughly 60% of all revenues collected by the federal government is redistributed to the states, and oil revenues have typically accounted for 65-75% of those funds.

Royalties are set at the federal level. As currently mandated by the Hydrocarbon Law, they vary by product and follow a sliding scale based on price: for oil, for example, the royalty rate is 7.5% if the price is lower than $48/barrel and (0.125*Price) + 1.5 if the price is above that figure (so if the contracted sale price is $100/barrel, the royalty rate would be 14%).

Under the new legislation, the federal government is still in charge of collecting all oil & gas related revenues, which include royalties over production, a percentage on profits, rent and taxes on exploration and production destined to the states and counties where the activity takes place. All of these revenues, with the exception of the taxes, are collected into the newly created Oil Stabilization and Development Fund. Taxes are collected by the SHCP.

After a transition period, the states will receive 78.5% of the revenues collected in the Oil Fund, roughly in keeping with the allocation levels prior to the reform. But the decline in the price of hydrocarbons has, as expected, reduced fiscal revenues available to the government at all levels. The revenues allocated to oil producing states via the Hydrocarbon Extraction Fund, for example, are expected to decline  by 36% in 2016. The Compensation Fund, which distributes revenues to the poorer states, on the other hand, will only suffer an estimated decline of 1.1% (La Jornada).

New responsibilities for the states

While on paper the distribution of revenues to the states has not undergone major changes, and by all appearances the federal government continues to call the shots on matters of oil and gas, the reforms have changed the nature of the relationship between the oil business and the states and we should expect state and local governments to have greater say on important matters.

  1. Land use. In the past, when Pemex was the owner of all things oil, conflict over the use of land was kept in the family. With the reforms, private oil & gas companies have to negotiate land use by the project. On average 50% of the land in oil producing states is communal property and the law says proper channels of consultation must be used to obtain community approval and social license to operate. That responsibility now falls on private companies. If the experience with mining activity is an indicator, land use could be the most important source of conflict for oil & gas companies starting up operations in Mexico. According to the Mining Conflict Observatory (Observatorio de Conflictos Mineros de America Latina), Mexico is almost on par with Chile and Peru on the number of conflicts (34 v. 35), and has as many conflicts due land use disputes as environmental complaints. State and local governments are going to play an increasingly important role in mediating these situations.
  1. Non-conventional technology. There is little experience in Mexico regarding non-conventional technologies, such as fracking, and their use is expected to increase greatly, as the country’s reserves cannot be produced with conventional technologies. Producing states will bear the brunt of supervising issues such as use of water and chemicals and the proper disposal of abandoned wells, and addressing the environmental impact of these activities.
  1. Competition among producing states. While the state governments have no say on the setting of royalties and taxes on oil production, they can offer other advantages to oil & gas companies, such as tax breaks and infrastructure improvements, in a pattern of inter-state competition that is not uncommon in federal systems. The state of Coahuila has announced the creation of an energy business cluster and Tamaulipas has created a state-level energy agency, while Veracruz and Campeche promote their oil resources in international events.

The advice to all energy companies seeking to do business in Mexico is to pay attention to the local scene, including communities, governments, and organizations, because understanding what they want and how they operate is just as important as paying taxes and being in good standing with Pemex and SENER.

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