Mexico Dreams Face Test After Opening to Investors

MEXICO CITY — Aug 7, 2014, 1:29 PM ET

By E. EDUARDO CASTILLO Associated Press

Mexico has passed laws to open its oil, gas and electric industries to private and foreign investors after 76 years of state control. Now comes the hard part.

Experts say Mexico's hopes for tens of billions of dollars in outside investment, and possibly a shale gas boom like the one occurring across the border in Texas, hinge on being able to design the kind of tenders, contracts and concessions that would actually prove attractive to companies that already have their hands full drilling in deep sea waters and hydro-fracking elsewhere.

On that question hinges Mexico's hope for an industrial boom.

Mexico says it is stepping into new era following the approval of the final bills late Wednesday. The country has been pinning its hopes on becoming a low-wage manufacturing center, but growth has been limited by unusually high electricity rates and the need to import massive quantities of natural gas at high prices.

Mexico's oil and gas production peaked in 2004 at 3.4 million barrels a day. It has fallen steadily since to the current 2.5 million barrels. With the reform, the government hopes to increase that to 3 million barrels by 2018 and 3.5 million by 2025, by attracting private companies with the expertise and technology to exploit the country's vast shale and deep-water reserves.

The first contracts and concessions for drilling blocks are expected in 2015, and the government hopes to draw more than $10 to $15 billion in private investment in the industry per year.

But those hopes are running up against hard realities: the Mexican government and the state-owned oil company have little experience at putting out attractive contracts for bid, or at managing them with clarity and transparency.

"When the contracts are drawn up and bidding is opened, that will be the acid test for the energy reform," said Alfredo Coutino, Latin America director for Moody's Analytics. "Investors aren't convinced by industry openings; investors are convinced by what is put down in black and white" on contracts.

Mexico had struggled for about a decade to push more limited openings, like incentivized contracts that paid foreign contractors bonuses for performance. But those drew little interest because the oil firms weren't allowed to book reserves or take a percentage of the oil or gas they produced, or a percentage of profits. Now, they will be able to do so.

Carlos Capistrani, chief economist in Mexico for Bank of America Merrill Lynch, said "What we perceive is that there is significant demand among companies that want to come into Mexico to take advantage of this reform," but he noted that doesn't mean "they're literally going to jump and we'll see this investment immediately."

Instead, it will take time: An increase in production may not be seen for several years, in part because companies with expertise in hydro-fracking and deep-sea exploration are busy with projects in the United States.

It remains to be seen whether Mexico can assign such complex contracts without the kind of kickbacks, favoritism and insider deals seen in the past. The law creates a national oil commission to take such decisions out of the hands of Pemex, the state-owned oil company.

Marcos Avalos, an economics professor at Mexico's Ibero American University, said the biggest challenge will be "to make it transparent, to ensure transparency in (bidding) decisions, to make them (regulators) make their methodology and decision-making processes public, so they can be evaluated."

Avalos noted that Mexico's relatively new and untested regulatory agencies are going to be up against a few, big, sophisticated players, international oil companies with a long history of bidding around the world.

"I have my doubts about the institutional framework, the economic regulatory power," said Avalos. "I don't see how we're going to regulate these monsters."