The Mexican Energy Reform Oil and Gas Alejandra Elizondo Center for Research and Teaching in Economics (CIDE), Mexico 2016 USAEE Annual Meeting October 2016 The Mexican Energy Reform Oil and Gas

Oil production and investment Oil production (MBOED) Investment in exploration and exploitation (billions USD) Increasing investments and decreasing production (from 3.4 millions of barrels of oil equivalent per day to 2.5 million, affecting public finances when oil prices dropped Source: Base de Datos Institucional de Pemex, Anuario Estadístico de Pemex 2014-2017.

The 2013 Energy Reform completely modified the institutional framework Before After Investments only from Pemex Lack of: reliable energy supply and economic competitiveness Increasing investments – decreasing production 76% of prospective resources in unconventional and deepwater reservoirs Set the policy and regulate business activity Comprehensive in electricity and oil and gas Private system + Pemex Investment + technology for deep/ ultradeep waters and mature fields Before Investments exclusively from two state companies Energy security risk and lack of economic competitiveness 76% of prospective resources in unconventional and deepwater reservoirs In need of the latest technologies and financial resources. Mature field’s remaining oil is 3 times the prospective resources The easily accesible oil was gone. The country needed to change the strategy or the oil industry was going to collapse After Leave behind the monopoly model and change the role of the state: set the policy and regulate business activity There were attempts in the past to reform parts of the system. But this is a comprehensive reform in electricity and oil and gas The reform looks for a private system that coexists and complements the actions of Pemex Objective: attract investment and technology to access oil in Deep and ultradeep waters and oil in mature fields

A new energy model for Mexico Former energy model New energy system Pemex Environ. Reg CRE --- CNH Private companies + PEMEX ASEA CRE CENAGAS CNH Agency for Industrial Safety and Environmental Protection National Commission for Hydrocarbons Energy Regulatory Commission In the past, Pemex dominated the scene. The Regulatory Commission was in place, but its functions were limited to midstream and downstream activities. With a little more than 100 people it could not actively regulate the monopoly. The Commission for Hydrocarbons was just recently created (2008). The environmental regulations were limited to the delivery of an environmental impact assessment, and transportation was part of the vertical integration The new institutional structure has 2 new agencies (ASEA and CENAGAS), 2 stronger regulators, and a financial tool: The Mexican Oil Fund The new model broke that vertical integration with the National Center for the Control of Natural Gas, but also strengthened both regulatory agencies, CRE and CNH, with more people and more technical resources. It also created a new environmental agency, the Agency for Industrial Safety and Environmental Protection. I would like to focus now on the role of these new institutions and the objectives to have a more competitive environment. National Center for the control of Natural Gas

Mexico changed the Constitution and created new laws 3 articles of the Constitution 21 secondary laws 25 new regulations Administrative actions Private companies + PEMEX ASEA CRE CENAGAS CNH But first I must point out that To launch the Reform the government had to make changes in 3 articles of the Constitution, enact 21 secondary laws and create 25 new regulations and numerous administrative actions. The Mexican Oil Fund

Petróleos Mexicanos: PEMEX Accumulated labor debt (more than 1 thousand billion MXN) Fewer employees, increase productivity Refineries Increase operational efficiency Invest to revamp refineries Farmouts to get new partners Low oil prices Low efficiency PEMEX Pemex was being squeezed by two sides. Upstream, there were low oil prices. And even before that, investments were not sufficient to get the technical and financial resources that it needed. Downstream, Pemex’s refineries are inefficient. At this time, it is undergoing a process with the unión to renegotiate contracts and lower costs. For this process it is getting financial help from the government In addition, the Company is having farmouts to get new partners to be able to increase its efficiency

CNH: National Commission for Hydrocarbons Regulates exploration and production Tender processes Round Zero: 83% 2P reserves + 21% prospective resources Round One: 4 Tenders, 3 concluded 30 contracts for exploration and production Onshore and shallow waters, 7 billion USD investment 4th Tender in process (Deep waters): Dec 5th Round Two: 15 contracts (shared production) shallow waters in the Gulf of Mexico, Areas nominated by the industry, begin production in 2020 2nd Tender: 12 contractual areas with proven potential near facilities 10 with infrastructure (dry and wet gas) Regulates exploration and extraction. According to the law, it can choose from a variety of contracts or a combination to maximize government revenue en efectivo, para los contratos de servicios; II) con un porcentaje de la utilidad, para los contratos de utilidad compartida; III) con un porcentaje de la producción obtenida, para los contratos de producción compartida; IV) con la transmisión onerosa de los hidrocarburos una vez que hayan sido extraídos del subsuelo, para los contratos de licencia, o V) cualquier combinación de las anteriores. maximizar los ingresos para lograr el mayor beneficio The Finance Ministry defines the fiscal terms of the contracts and the tenders and the Ministry of Energy must design the type of contracts and the technical guidelines for the process Steps: Round Cero: The State guaranteed fields to Pemex according to financial and technical capabilities = 83% of 2P reserves and 21% of prospective resources Round One: 4 Tenders, 3 already concluded with relative success Transparency, broadcasted in real time, 30 contracts for exploration and exploitation in land and shallow waters, 7 billion USD investment 4 Tender in process (most complex, Deep and ultradeep waters)Dec 5th Round Two: March 2017, 15 contracts of shared production for exploration and exploitation of oil in shallow waters in the Gulf of Mexico, areas nominated by the industry, expected to begin production in 2020 Second tender: April 2017, 12 contractual areas with proved potential near Pemex facilities, 10 with infrastructure (dry and wet gas)

Energy Regulatory Comission: CRE Regulates midstream and downstream activities (29 markets) Tariffs and regulation: structure (monopoly or competitive), maturity, and behavior (contestable) of the market Under CRE’s control Wholesale Processes Regulates midstream and downstream activities (29 markets, including 8 from the electricity sector), and including wholesale, retail, transport, storage, and distribution It regulates oil and gas activities, oil products, biomass products, throughout the value chain CRE regulates based on the structure of the market (competitive markets or natural monopolies) but also on its maturity (setting its tariffs accordingly). In addition, it observes the current behavior of activities. If it finds for instance a constestable market, then it lowers its regulation Exploration and exploitation Refining/ Processing Storage Retailers Transportation Distribution Consumption

ASEA: Agency for Industrial Safety and Environmental Protection Exclusively for oil and gas Regulates industrial safety of all facilites Issues regulations for the protection of the environment Mandatory for Pemex, CENAGAS and private companies Recently created, ASEA regulates industrial safety and environmental protection for all hydrocarbon activities (upstream, midstream, downstream)

CENAGAS: National Center for the Control of Natural Gas Breaks vertical integration Technical System Operator Owns and manages 9,000 km Regulated by CRE and ASEA Ensures a leveled playing field in capacity (first open season) CENAGAS A government utility created to break the vertical integration of Pemex, In the past Pemex had to produce, process, transport, and commercialize natural gas in the country. Now CENAGAS owns and operates 9,000 km gas pipelines of the system, acquired from Pemex and 9 compressor stations. This is a centralized planning model CENAGAS is subject to CRE and ASEA’s regulations, including the approval of tariffs Its operation ensures a leveled field for the companies. Actually this week it is having its first open season It also set a 5 year plan for the expansion of the network that has to be updated anually. Currently it has 7 awarded projects and 2 tender projects

Increased energy security Short term benefits Geological knowledge: licenses to invest (over 2 billion USD) Expansion of the national network of gas pipelines 11,000 km + additional 10,000 km by 2018 Expansion of transportation and storage of oil and liquid fuels Investments: 7 billion USD (exploration and extraction) + 13 billion USD (gas pipelines) Increased energy security Geological knowledge: permits to companies investing over 2 billion USD in the Gulf of Mexico Expansion of the national network of gas pipelines 11,000 km + additional 10,000 km by 2018 Expansion of transportation and storage of oil and liquid fuels (private sector), which will allow more competition in service stations Investments: 7 billion USD (exploration and extraction) + 13 billion USD (gas pipelines) and more than 26 billion USD with elect. gen.

Pending issues: CO2 emissions Energy demand by sector (2050)

Pending issues: CO2 emissions Primary energy supply by source (2050)

Other pending issues Subsidies and carbon taxes Regionalization 2013 Carbon tax: Correcting externalities or distorting the market? Regionalization Price liberalization (interregional subsidies) Social + environmental issues Social license: consultation + environmental impact assessment + social impact assessment + territorial occupation analysis North American Regulatory Harmonization

Thank you for listening Alejandra Elizondo Research fellow Center for Research and Teaching in Economics (CIDE) alejandra.Elizondo@cide.edu