For the first time in 50 years, the Mexican government is planning to invite oil and gas companies to participate in international tenders for developing Mexico's onshore natural gas fields. The process will start in mid-2002 with a dozen production blocks in the Burgos basin of northern Mexico (Fig. 1). The concepts and terms of the proposed contracts are still under discussion and development.
A growing gas need
Pemex estimates that gas demand in Mexico, primarily for meeting the needs of the electric power industry, is growing far faster than domestic gas supply, and demand is expected to reach almost 9 bcfd by the end of the decade, up from the current 4.3 bcfd (Fig. 2).
Most Mexican gas demand is supplied by domestic production, with only a small volume imported. However in the coming decade, an anticipated supply-demand gap of 7 bcfd will require Mexico to import natural gas from the US via pipeline, import liquefied natural gas, or increase domestic gas development and production.
Because imports of LNG or US gas would be very expensive, development and utilization of its own domestic gas would be best for the Mexican economy. Pemex is therefore trying to boost investments in gas development and debottleneck the development process.
It plans to do this by initiating Multiple Service Contracts (MSCs) (Table 1) with the goal of successfully reducing the necessity for imports (Table 2).
The purpose of this article is twofold:
- To recapitulate information in the public domain about the concept of MSCs that the administration of President Vicente Fox is proposing.
- To situate the political debate around the MSC concept in a broader understanding of Mexican politics and policies.
Fox's new ideas
The Fox administration is proposing several new ideas for the Mexican energy sector:
- The fiscal relationship between Petróleos Mexicanos (Pemex) and the federal government should be modernized to allow Pemex to reinvest in capital projects.
- Pemex's gasoline stations should be allowed to sell all brands of motor oil, not just the Pemex-sponsored brand Mexlub.
- International companies should be allowed to invest in retail LPG distribution.
- Regulations for investments in LNG terminals should be transparent and should match international standards.
- Independent power producers should be allowed to sell directly to end-users any power not bought by the Federal Power Utility (CFE).
- Oil and gas companies should be invited to participate as bidders in international tenders for the development of dry-gas fields on a nonrecourse financing basis.
The trend of these ideas is clear: the Fox administration is looking toward a future in which the energy sector in Mexico will enable the private sector to have a substantial and meaningful role alongside the state-owned energy companies.
MSCs
The initial framing of the idea of the MSC was presented in a joint session, sponsored by Mexico's Ministry and Pemex, that was held in the Hotel Nikko in Mexico City Dec. 6.
At the end of the presentation, it was announced that there would be an international conference early in 2002 and that more information would be provided on a timely basis on Pemex's special website www.msc.pemex.com.
The information provided here derives mainly from that presentation as well as from the briefing on the subject of MSCs delivered by Pemex CEO Raúl Muñoz Leos and his senior staff to the Senate Energy Commission Dec. 5.
Contractual framework
The concept of a public works project is being applied to the industrial activity of hydrocarbon production in onshore gas-prone fields.
The idea is to manage MSCs like any other major public works project, with an international public tender in the initial round of some 8-10 blocks in the Burgos basin. Each block will consist of 30-50 sq km and will be configured to contain internationally certified, proved reserves of natural gas.
The initial contract for the development of a tendered block will be for 3 years. Successful operations will permit both sides to extend the contract progressively to a maximum of 20 years.
The sixth article of Mexico's Oil Law of 1958 allows Pemex to hire anyone as contractors for any purpose that would enhance the efficiency of its operations, provided that three conditions are not contravened:
- The contractor is not paid by any formula that computes payment as a function of commercial hydrocarbon production.
- The contractor does not acquire an interest in the hydrocarbons produced.
- The contractor is not paid in kind.
The proposal of the Fox administration is to find a contractual vehicle that would meet these strict conditions but still be attractive enough to international oil and gas companies that they would be willing to compete in international tenders, come to Mexico, and invest their capital in gas-prone plays such as those found in the northern Burgos basin [see map].
The contract treats the development of an oil or gas field as a public works project, and, for this reason, it generates no equity rights for the operator.
Compensation
How then will operators be paid? The operator is compensated by formulas and tariffs that must, by the current law, disconnect him from the market price of the production. The successful bidder will receive payments in three forms:
- Reimbursement for operational costs associated with commercial production. The successful bidder will not be reimbursed for costs associated with dry holes or noncommercial production. Reimbursement for activities associated with commercial production will be made on a schedule of standard costs that will be part of the contract for services. Where the company is able to perform an activity below the standard cost, it will nevertheless be paid at the full value of the standard cost.
- Reimbursement for invested capital associated with commercial production. On the basis of successful commercial production, a contractor will recover his invested capital, plus interest, during a 5-year period in equal monthly installments.
- A profit margin that is competitively set. The contractor will propose a rate for his return on capital invested that will constitute his profit margin.
Bidding
The concept presented on Dec. 6 was that bidders would organize themselves into consortia of international companies with Mexican partners. Mexican companies are expected to provide capital, expertise, or in-kind services.
The leader of the consortium will be an international oil and gas company with a track record of successful operation of dry-gas fields.
The consortium must demonstrate that it has the financial resources necessary to fund all investment requirements up to the point of successful commercial operations. Progress payments typical of turnkey contracts will not be made under the terms of MSCs.
The definition of the concept of the tendered service is still under development. Elements of the service to be competitively evaluated in an MSC tender include a work program for the tendered block, Mexican national content, and technology transfer to Mexican companies.
The approximate schedule for 2002 visualizes an orientation conference sometime in the first quarter, the publication of the first round of tenders in the second quarter, bidding and awards in the third quarter, and the beginning of operations by the successful bidders in the fourth quarter.
Political discussion
The topic of the MSC has become the latest focus of confrontation and theatrics between the Fox administration and the opposition-controlled Congress.
The story at the level of party politics is the same in any country where the system of government permits the executive branch to be controlled by one party and the legislative branch by another. For whatever pretext, the opposition party in the congress will seek instinctively to confront the president or prime minister, if not for substantive issues of public policy then for lapses in personal conduct.
In Mexico's political culture the PRI (Institutional Revolutionary Party), as the majority party, had been in power for 6 decades--during all of which time PRI members of Congress had been prohibited from criticizing the president of Mexico. At last freed from this constraint by the election of the first non-PRI president, Fox, the PRI has led the opposition on most matters of public policy.
Two Senate committees have issued strong views about Fox's proposed energy policies in general and about the MSCs in particular. One of these is the Committee on Constitutional Issues led by Manuel Bartlett, a former PRI Interior Minister and presidential candidate in 2000. The other is the Energy Committee led by Senator Juan José Rodríquez Prats of the PAN (National Action Party, the party of Fox).
On Dec. 5, Pemex CEO Muñoz Leos and his senior staff made a special presentation on the rationale for MSCs to the Senate Energy Committee. On that occasion and afterwards, Pemex was asked to submit copies of the proposed MSC contracts to the Senate for review.
Pemex on Dec. 30 took the view that, as the terms and concepts of the MSC were still under development, and consultations with private companies were still in progress, it is premature to submit any preliminary version of an MSC contract.
On Jan. 14, a major Mexico City daily, El Universal, reported that the two committees had agreed on the position that the award of any contract of this nature should be conditioned on the Senate's prior review of its terms and conditions. The legal effect of such an agreement on Pemex's ability to negotiate contracts and issue MSC tenders, however, is not yet clear.
The controversy over the MSC started much earlier. One representative example of public discussion is an extended interview published in the Mexico City press on Nov. 19, 2001, in which Víctor Rodríguez, an advisor to the Senate Energy Commmission, criticized the MSC concept on multiple grounds.
Electric sector analogy
Rodríguez, who is also a professor of engineering at the National University, has led the questioning about the MSC, and most similar comments voiced by legislators, academics, or columnists derive from his ideas.
One of his comparisons seems accurate: the MSC concept may be compared with the legal figure of the IPP whose legal identity is defined as a contractor to the CFE and whose commercial activity as a power generator is limited to selling all of its power to the state electric utility. In the same way, an oil and gas company operating under an MSC would be a contractor to Pemex; unlike the IPP, the operator in an MSC would never have title to the gas he produces.
To situate the political discussion of the MSC, it is important to review the history of the discussion of the IPP legislation of 1992 and its implementation in 1993. Policymakers of the administration of Carlos Salinas de Gortari discovered that, in order to change regulations to permit private investments in electric power generation, it was necessary to specify the meaning of a term in the Constitution that had never previously been defined.
The term in question was "public service." The Constitution required that the activities of electricity generation and distribution for public service be reserved for the state. The language had to be changed to specify that electric power generation under contract by a state-owned company did not violate the restriction of public service.
This felicitous modernization of the law and the Constitution in 1992-93 is not currently an option for oil and gas law for the Fox administration, given that, unlike the earlier period, the government does not command a majority vote in the Congress.
Exclusivity
One point of questioning is whether or not the concept of the MSC violates the Constitutional restriction that the State has the "exclusive" responsibility to develop Mexico's hydrocarbon resources.
The idea that a private contractor would have responsibility for operational decisions in Mexico's gas fields would seem to violate the concept of state exclusivity. Closer inspection, however, leads to the conclusion that the teeth of the concept of exclusivity is in the requirement that no hydrocarbon production be carried out by private parties for their own account.
As the MSC specifically defines the role of the operator as a contractor without legal interest in gas production, the exclusivity requirement is met.
Another point of criticism Rodríguez made is the MSC's implicit premise that only by increasing gas supplies can Mexico meet future demand for its growing electric sector. He estimates that some 8,000 Mw of additional power may be squeezed out of cogeneration projects at Pemex's refineries and other facilities.
Coupled with a policy of fuel diversification and efficiency controls, much of the projected natural gas "supply deficit" disappears.
Constitutional issues
The argument here is that conceiving of a contract in which oil and gas operating companies will participate in the operation of gas fields is a violation of the spirit of the Constitution. The matter is presented as a "disguised privatization" of the state-owned oil company.1
This argument boils down to the premise that Mexico is a country that, regardless of other arguments or considerations, is one that excludes operators from its oil and gas fields. Any contract that would propose otherwise violates not only legal and Constitutional norms but public sensitivities as well.
An argument about public sensitivities is quite different from one about legal and constitutional strictures. Here, critics of the concept of an MSC have a point, but not a legal one: To date, the Fox administration has done little to build public support for the concept of an MSC in ways that address public sensitivities.
Given the reversals that his predecessor, Ernesto Zedillo (1994-2000) suffered in the matter of unsuccessful attempts at petrochemical privatization, a prudent course would seem to be giving full attention to winning the Mexican public over to the idea that the law, the Constitution, and Mexican history are all compatible with the ideas inherent in the MSC.
These arguments in favor of the MSC have been of the technical kind made by engineers, lawyers, and economists. It is doubtful that the sum of these arguments will have the force to meet the passion generated in a civic culture that has just evicted a political party from 6 decades of uninterrupted power and that is now free to criticize openly any governmental measure irrespective of its merits.
Industry issues
It remains to be seen whether the Fox government can craft a public-works type contract that will interest international operating companies whose unspoken corporate culture thrives on the direct relationship between success in the ground and reward in the bank.
In its present political position the Fox government is completely blocked from offering those terms of reference, so it is not out of naiveté or ill will toward oil companies that it refrains from doing so.
For such a contract to attract international oil and gas companies, the exact nature of the competition must be made transparent.
Are companies competing over development strategies, technologies, Mexican content, capital budgets, or rate-of-return requirements? Is the object of the bid the development of existing fields or identified prospects? Is a bid also supposed to compete for the development of undiscovered resources that are presumed to exist?
It may be of some concern to some international companies who might be interested in participating in international tenders that Mexico lacks an upstream regulatory authority of the kind that exists in Norway that would create a buffer between Pemex and the contractor and that could serve as an umpire of the rules.
Still, the new ideas for the Mexican upstream are innovative, and the Fox government should be given the benefit of the doubt while the process of crafting an attractive MSC framework is in progress.
Reference
- Proceso, Jan. 6, 2002.
The author
George Baker is a petroleum analyst and director of Mexico Energy Intelligence, an industry newsletter service. He is the author of Mexico's Petroleum Sector (PennWell, 1984) articles listed at www.energia.com, and numerous articles since 1981 for Oil & Gas Journal and its affiliate Spanish-language bimonthly magazine, Oil & Gas Journal Latinoamerica.
