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Analysis: Mexico to rewrite 'sacred' text in long-awaited energy reform

A fuel burner is seen at Mexico's state-run oil monopoly Pemex platform "Ku Maloob Zaap" in the Northeast Marine Region of Pemex Exploration
A fuel burner is seen at Mexico's state-run oil monopoly Pemex platform "Ku Maloob Zaap" in the Northeast Marine Region of Pemex Exploration

By Dave Graham

MEXICO CITY (Reuters) - How far Mexico goes to overhaul its oil industry this year hinges largely on a single sentence in the constitution that has stood as a bulwark against private capital for more than 50 years.

Article 27 of the constitution bans the government from granting private sector concessions for oil or gas, making their exploitation the sole preserve of the Mexican state.

But reform of state oil monopoly Pemex is a touchstone for President Enrique Pena Nieto's readiness to make tough decisions to foster economic growth, and senior officials in his party say a bill due to be presented by September will propose modifying the article in a bid to reverse declining oil output.

Changing the article is the key to opening up Mexico to foreign oil majors - but it also risks breaking a fragile political consensus Pena Nieto has built in Congress to support his economic agenda, as well as inciting mass protests.

"It's like changing the ten commandments, it's a very sacred thing," said Ewell Murphy, an expert on Mexican energy law from the University of Houston Law Center.

The clause is inextricably linked to the birth of Pemex, a company that provides a third of the federal budget, and which has become firmly ingrained in the national psyche since its creation by President Lazaro Cardenas in 1938.

Setting out his case for expropriating British and U.S. oil firms, Cardenas cited article 27 in justification, and he and successors subsequently revised a section of the law to tighten the state's exclusive control over Mexico's petroleum.

Aside from a minor addition to include nuclear energy, that sentence has been unchanged since President Adolfo Lopez Mateos made it even more explicit in 1960 after the Cuban Revolution.

"Regarding petroleum and solid, liquid or gaseous hydrocarbons ... neither concessions nor contracts will be granted, nor will any that have been granted persist and the Nation will carry out the exploitation of these products in the terms indicated by the respective regulatory statute," it reads.

Without changing it, experts say, Pena Nieto will not be able to offer lucrative contracts to companies whose expertise in deep water exploration and shale fields could turn around a 25 percent slide in oil production over the past decade.

Pena Nieto's Institutional Revolutionary Party, or PRI, insists Mexico's oil will remain property of the state. But it aims to create a platform for major investors with a combination of nips and tucks to the constitution and deft legal work.

"The world is not going to wait for us if we don't do an energy reform that guarantees the country's energy security," said Javier Trevino, an energy expert in Congress from the PRI.

"My personal view is that we need changes to article 27 of the constitution, and articles 25 and 28," he added.

Tweaks to article 25 could give Pemex more operational independence, while alterations to 28 could ease curbs on private capital in the petrochemical industry.

By modifying article 27, the government would open the door to risk contracts which allow private companies to participate directly in the exploration and production of crude oil.

All three are likely to be modified. The changes would be a major departure for the PRI, which blocked similar proposals when in opposition between 2000 and 2012 to defend the legacy of its former leaders Cardenas and Lopez Mateos.

In March, the PRI altered its manifesto to pave the way for constitutional change on oil policy, as well as for a proposal to apply value added tax (VAT) on food and medicine. A VAT change is expected to form part of a major fiscal reform Pena Nieto plans to flank the energy bill he sends to Congress.

Senior PRI officials have told Reuters the energy bill put forward will aim to create the legal framework necessary to at least permit profit-sharing agreements with oil majors.

PRIVATIZING RISK

Pride over the creation of Pemex, an event historian Lorenzo Meyer likened to Mexico's "moon landing", still runs deep in the PRI and in the Mexican left. Polls show a large majority of the population oppose letting foreign capital into the oil industry.

In 1938, Britain and the United States reacted with fury to Cardenas' expropriation of their companies and sought to cripple Pemex by closing down global markets to Mexican oil.

Mexico's socialist government, which had given shelter and support to enemies of Francisco Franco's dictatorship in Spain, was forced to prop up Pemex by bartering oil for goods from Franco's allies, Nazi Germany and Fascist Italy.

The company defied adversity to become one of the world's biggest oil concerns. Over the years though, problems set in.

The government became increasingly reliant on Pemex to fund the federal budget, saddling it with a crushing tax burden.

Corruption, abuse of the company for political patronage and oil theft further sapped Pemex's strength, and by 2013, crude oil production in Mexico had fallen to just over 2.5 million barrels per day (bpd) from a peak of 3.4 million bpd in 2004.

Since 2011, Mexican crude oil output has been surpassed by Iraq, Kuwait and the United Arab Emirates, OPEC data show.

POLITICAL CONSENSUS

Pena Nieto has said he favors a constitutional reform to revamp Pemex. But he has been very quiet about his plan.

To change the constitution, the president needs a two thirds majority in Congress, and the approval of more than half of Mexico's 31 state legislatures. The PRI governs about two thirds of the states - but it lacks a majority in Congress.

To get around this, Pena Nieto has brokered his biggest reforms in the "Pact for Mexico", an accord that he announced with the leaders of the two main opposition parties just days after taking office in December.

Aimed at revitalizing the economy, the pact has yielded major bills to overhaul the telecommunications industry, the education system and a banking reform still in Congress.

But it is likely to run out of steam on energy reform, forcing Pena Nieto to push through his bill with the aid of the conservative National Action Party, or PAN.

Both the PAN and the leftist Party of the Democratic Revolution (PRD) have their own visions for oil reform.

The PRD's plan aims to give Pemex autonomy and cut its tax burden - ideas which have support across the political spectrum.

But the PRD has rejected any changes to the constitution. It argues that the way to make the company thrive is by rooting out corruption, cutting back on waste and giving Pemex operational independence.

"The cost of (production) in shallow waters is $5-10 per barrel, the international price is $100. In deep waters it costs $30. Who wants to carve up a business like that? Who in their right mind would say 'come on in' so we get less?", said Luis Chazaro, a PRD energy expert in the lower house of Congress.

At the other end of the spectrum, the PAN wants to open up the industry and grant full-blown concessions to oil companies.

The PRI is positioning itself between the two parties, but leaning firmly towards the PAN's side of the argument.

Rather than ceding ownership of the oil to private firms, the PRI has been exploring a change in article 27 that will enable Mexico to remain sole proprietor of the crude while providing oil majors with the incentives they need.

Contracts could be designed that allow oil companies to show crude reserves on their balance sheets without making them the legal owners of the oil, said Jorge Jimenez, an expert on Mexican energy law at law firm Lopez Velarde, Heftye & Soria.

"The rules are flexible enough to acknowledge that a company has a right to receive a contractual revenue on the basis of a barrel of oil produced," Jimenez said. "And that that revenue, as opposed to the fixed fee in the current contracts, is linked to the price of a barrel of oil in the market."

Without changing article 27, Mexico would only be able to continue offering the so-called service contracts it now operates that pay firms a fee per barrel, Jimenez said.

MOMENTUM

For the PRD, such changes would be tantamount to privatization.

"Nobody takes the risk without sharing in the property," said PRD congressman Chazaro. "They don't do it in Brazil, they don't do it in Norway and they're not going to do it here."

Leftists have promised to mobilize millions of Mexicans to oppose Pena Nieto's reform, with Andres Manuel Lopez Obrador, twice runner-up for the presidency, aiming to lead the charge.

So far, however, the mood has been subdued.

Pena Nieto and his cabinet have kept the energy reform out of the headlines by saying next to nothing about it inside Mexico, and the media have followed suit.

Some in the PRI worry that the government is not doing enough to lay the groundwork for selling the reform.

But people close to Pena Nieto say it is a deliberate ploy to avoid stoking a debate. They are confident he can push through his proposal without kicking off a storm of protest.

And thanks to the recent efforts of regional peers like Colombia and Brazil to open up their oil industries to private capital, mass upheaval in Mexico over Pemex looks unlikely, said Federico Berrueto, director general of polling firm GCE.

If Pena Nieto did shy away from a major energy bill, he would find it harder to pass the fiscal reform due to accompany it, Berrueto said. Aside from improving Mexico's weak tax take, that plan aims to cut the state's reliance on Pemex.

"If you carry out a deep energy reform, it opens the door to change on the tax front," Berrueto said. "But if you generate weak momentum, it's very difficult to overcome."

(Reporting by Dave Graham; Additional reporting by Miguel Angel Gutierrez; Editing by Claudia Parsons)

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