The positive reaction to the announcement in December, of the constitutional amendment to pave the way for ground-breaking energy reforms has generated considerable excitement among investors, bankers and energy companies in Mexico.
The reforms open up the oil and gas and electricity industries to private-sector companies, and reform the monopolistic role of state-owned oil company Pemex. The breadth of the reforms surprised many, specifically the inclusion of the ability to grant licences, which opens the possibility that oil companies should be able to book oil and gas assets, making large exploration and production projects more feasible for private companies. Profit- and production-sharing contracts will also increase the incentives on offer to private-sector companies in upstream, midstream and downstream projects.
Estaban Polidura, energy analyst at Deutsche Bank in Mexico City, says the scope of the reform has led the bank to raise its projected increase on Mexican GDP growth in the mid-term to 150 basis points annually. "This is our best guess today with the very limited information we have," says Polidura, who notes that secondary laws will provide much-needed clarity on how CFE, Pemex and the private sector will interact. "But I would say this is probably a conservative scenario and if things work well we might even have some slightly higher figures than we are forecasting."
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However, although there might be an upside on GDP growth, the equity market seems to have already priced in the energy reforms despite there being so much yet to be determined by the secondary laws. Pemex’s CEO, Emilio Lazoya, may be predicting the first drops of oil flowing under the new regime by the end of 2014 but most think the end of 2015 or 2016 is more realistic.
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Undeterred, the Mexican stock exchange has leapt and was trading at multiples of between 17x and 18x price to earnings, equivalent to an 80% premium to other emerging markets indices. Despite a small sell-off in mid-January the bolsa looks expensive. Does Polidura think the macroeconomic boon of the reforms is already all priced in? "At least in the short term, yes," he says. "The valuations really tell you that a lot of the incremental growth has already been accounted for by the market and there is a risk that delays will lead to some negative reaction, in the form of profit-taking, and we have already seen some adjustments." Pemex will have to engage with the private-sector companies in lucrative projects, especially in areas like deepwater exploration where Pemex doesn’t have the experience, expertise or capital to act unilaterally.
"Most of these projects are capital intensive but the risks are known by the banks and the development banks. The banks like the Pemex [credit risk], so if you have that [with others] and a good project I think there could be a good project financing structure that the banks could participate in," says Francisco Ibañez at PwC Mexico. He adds that new sources of capital will also be necessary: "We will need the participation of the international banks and the development banks because we are going to need a lot of money. We have very well-known banks in Mexico but there could be a lot of projects. We have also been talking to some of the international [oil and gas] companies and they have their own banks that support them. For example we have been in talks with companies from China and they have money they can bring to Mexico – also maybe the Japanese, Korean and European companies."
Private-sector companies have been working with Pemex on a service basis for years and the experience of one company – Spain’s Enagas – provides a practical warning for those companies looking to enter the sector. Enagas’s CFO, Justo Garcia, says his experience with Pemex was salutary. Enagas entered into a joint venture with France’s EdF to bid on a pipeline project. As the only bidder – and having satisfied all the price and supporting qualifications – he thought the tender had been successful, only for Pemex to scrap the entire procurement process.
"Pemex is not working in an open way right now and, linking that to the energy reform, there needs be care about the way they are implementing the energy reform," says Garcia. "We suspect that Pemex will select one or two companies and invite them to bid. It’s not very transparent."
Pemex’s current exemption from the Public Works Act and the Acquisitions Act provides the company with considerable procurement flexibility and that exemption will be a question for the seconday laws. For Polidura, however, the more interesting and important unknown that will be determined in the upcoming secondary laws is the level of incentive that will be available to private-sector companies through profit- and production-sharing contracts.
"What still needs to be discussed, and I don’t think it is an easy discussion, is how much of that variable proportion will be payable to the private companies," says Polidura. "In other words, will that variable be capped? The regulator may want to allow variable returns to a certain IRR [internal rate of return] and that decision is probably the most important unknown as far as the private sector is concerned."
