Introduction

Since the commencement of the current federal administration in December 2018, there have been clear signs that Mexico's energy policy will undergo a radical change of focus to restore the dominance of the state energy companies (ie, the Federal Commission of Electricity with respect to power and Pemex with respect to oil) instead of developing the liberalised energy markets implemented in the 2013 energy reform.

During the past year, the power sector has received the most attention in this regard.(1) However, in recent months, the oil sector has regained the administration's focus and the executive branch has sent two new reform initiatives to Congress which seek to modify the applicable legal framework.

Other actions that the administration has taken in the oil sector thus far are as follows:

  • Just a few days after the commencement of this administration's term, the National Hydrocarbons Commission, following a direct order issued by the Ministry of Energy (SENER), cancelled pending public tenders for Bid Rounds 3.2 and 3.3, which would have awarded 37 licensing contracts for conventional fields (Bid round 3.2)(2) and nine contracts for unconventional fields (Bid Round 3.3).(3)
  • Shortly after, the administration announced its intention to increase Pemex's production, but also postponed and later formally cancelled future tenders for farm-outs. The cancellation came just a few days after Pemex bonds were downgraded by several credit rating agencies.
  • Similarly, the migration of contracts to product sharing and licences was also cancelled.
  • Later, in mid-2020, Pemex suspended contracts with numerous suppliers and service providers to reduce expenses.
  • At the end of 2020, SENER eliminated the possibility of granting import and export permits for 20 years, limiting their duration (to one to five years) and tying their granting and renewal to the energy policy objectives which apply at the time of the request.
  • In late March 2021 the president issued an initial reform of the Hydrocarbons Law and in mid-April 2021 the president's party, Morena, presented a second reform. Both reforms were quickly approved; the first entered into force on 5 May 2021 and the second on 20 May 2021.

First reform

The first reform included the following main modifications.

Suspension and taking over

New grounds to suspend permits were included, granting both SENER and the Energy Regulatory Commission (CRE) authority to suspend permits when they consider that there is an imminent danger to national security, the energy sector or the national economy.(4) The authority which issues the corresponding permit will take control of the administration and operation of the permit holder for the continuity of its activities to protect the interests of final users and consumers. If, during the suspension, the permit holder does not remedy the causes of the suspension, the permit will be revoked. The reform also eliminated the possibility of authorities contracting private entities when they perform this takeover, which means that the CRE or SENER can hire only Pemex to carry out these activities.

Additional storage requirements for permits

Permit holders must prove compliance with determined storage capacity requirements established by SENER. This new requirement applies to storage, distribution, transport, commercialisation and other activities regulated by Chapter 3 of the Hydrocarbons Law and its regulations. The transitory articles of this reform also established the competent authorities' obligation to revoke the permits of permit holders which contravene the storage requirements.

New grounds for revocation

Both SENER and the CRE were granted the authority to revoke permits based on the following additional grounds:

  • the performance of regulated activities proven to have been made with hydrocarbons acquired illegally or through the commission of the crime of contraband of hydrocarbons, as determined by a final resolution of a competent authority;
  • a reiterated failure to comply with requirements of quantity, quality and measurement of hydrocarbons; and
  • the modification of the technical conditions of systems pipelines, installations or equipment without proper authorisation.

Change of afirmativa ficta rule

The afirmativa ficta rule applied to requests to assign rights under a permit and established that if the competent authority failed to issue a resolution within 90 days of a request, the authorisation was considered granted. Following the first reform, such a request is considered denied.

Second reform

The second reform modified the 13th Transitory Article of the Hydrocarbons Law by removing the CRE's power to regulate, asymmetrically, Pemex first-hand sales of hydrocarbons. This article was conceived to limit Pemex's predominant role in the market and allow other participants to compete in the market under similar conditions to Pemex. The reform was pushed under the argument that the transitory dispositions of said provision have lost their purpose since private investors have already managed to secure a sufficient market presence, creating unfavourable conditions for Pemex to compete. However, congresspeople who opposed the bill argued that for such an argument to be true, Pemex must no longer be considered a dominant economic agent in Mexico. This has not yet happened as Pemex still supplies approximately 83% of the gasoline and 73% of the diesel in the Mexican market.

Implications

With regard to the first reform, numerous specialists and organisations have praised the intention to fight fuel theft and contraband and consider that particular part of the reform (ie, the new grounds for revocation) to be positive. However, most of them also consider that the rest of the reform's provisions will harm the industry – in particular, the provisions regarding suspension and taking over, as well as the storage capacity requirements, since they are unclear and grant the state a dangerous discretion to take over privately owned assets.

As regards the second reform, there is a general consensus that the open market has not evolved sufficiently to eliminate the asymmetrical regulation to which Pemex was subjected, so the reform unnecessarily favours Pemex in a market which it substantially controls, effectively raising economic barriers which obstruct the entrance of new market participants; this is to the detriment of competition and the best interests of final users and consumers.

Civil groups such as the Mexican Business Coordinating Council have classified the reforms as a change of rules for investors which threatens:

  • legality;
  • private property;
  • international commitments;
  • the environment; and
  • public health.

On its part, the Federal Competition Commission, before the reform was approved, warned that many of the reforms' terms would:

  • affect competition;
  • increase the price that families and companies pay for final goods; and
  • generate legal uncertainty.

There has also been a generalised discontent among investors in the sector. On 5 May 2021 the president and CEO of the American Petroleum Institute sent a letter to US cabinet officials "encouraging" them to engage diplomatically and take action on this matter, in order "to urge the Government of Mexico to uphold its [US-Mexico-Canada Agreement (USMCA)] commitments to treat U.S. investors and U.S. exporters fairly", stating that there had been continuous efforts by the Mexican president to undermine the USMCA and discriminate against US investors. A similar letter was sent to the Trump administration in June 2020.

Defence mechanisms and future of reforms

In a similar manner to what happened with the reforms carried out in the electricity sector, these reforms are considered to breach the Constitution and federal laws as they go against the open and free competition regime established in Articles 15 and 28 thereof with respect to:

  • the refinement, treatment, import, transport, storage, distribution, commercialisation and public sale of hydrocarbons;
  • the principle of legal certainty, and
  • federal competition laws.

Therefore, at least parts of these reforms will likely be challenged, suspended and eventually nullified by the courts.

As of 17 May 2021, two federal judges had already suspended, with general effect, the application of the most controversial provisions of the first reform to the Hydrocarbons Law until the challenges procedures against it are finally resolved. Similarly, the restrictions on imports and exports listed above have been suspended by a federal court. The minority parties in the Senate have also indicated that they will challenge the reform before the Supreme Court.

Likewise, there is a consensus among specialists that the reforms imply a breach of investment protection treaties (against principles of the minimum standard of treatment and the prohibition of indirect expropriation), free trade agreements (against provisions of non-discriminatory treatment in trade, state-owned enterprises and monopolies) and maybe even human rights treaties (due to the possible violations of property rights and the right to a healthy environment). Thus, foreign investors may resort to investment arbitration claims against Mexico, tariffs may be imposed under trade agreements and there could also be state versus state disputes regarding this matter.

Comment

Considering all of the above, the challenges to these reforms are likely to continue and the diplomatic pressure will gradually increase. These challenges seem likely to succeed and the reforms are expected to be at least partially annulled. However, it is unlikely that this administration will change the course of its energy policy in the short term; only a considerable defeat in the mid-term elections on 6 June 2021 could have a significant impact in this respect. However, the polls suggest that this is unlikely.

Endnotes

(1) For further details please see:

(2) These had an expected investment of approximately $89 million per conventional field.

(3) These fields were expected to receive investments of approximately $2.3.

(4) The suspending procedure includes prior notice to the permit holder indicating the motivation for the suspension so that it may present arguments and evidence against the suspension within the following 15 calendar days. The authorities will then have the same timeframe to determine whether the suspension will be sustained.