$8-Billion Debate Flares in Mexico

A constitutional battle is forming over a new plan by Mexico’s state-owned energy monopoly to attract as much as $8 billion in foreign investment to develop natural gas reserves. Its outcome could have a profound effect on Mexico’s energy future and the North American industry in general.

Petroleos Mexicanos, or Pemex, says the investments will be crucial in dealing with rising domestic demand for natural gas, as the country seeks to achieve energy self-sufficiency and even become an exporter to the U.S. and other consuming nations.

But opponents say proposed new energy contracts violate constitutional sanctions--and Mexicans’ historical sentiment--against foreign involvement in energy.

“The danger of a privatization is real,” said Sen. Oscar Caton, one of several opposition-party critics who vow to fight a Pemex proposal unveiled this month and supported by the administration of President Vicente Fox.

Although Mexico has become the world’s fifth-leading producer of oil, it has lagged in developing what are believed to be potentially huge deposits of natural gas.

With demand rising and capital scarce, Pemex is proposing a new type of contract that would lure foreign investment by granting energy companies total control over gas-drilling projects for up to 20 years. If successful, open bidding in the spring would be the first of several rounds that could generate $50 billion for Mexican energy projects by 2010.

The so-called multiple-services contracts would give giants such as ChevronTexaco Corp., Royal Dutch/Shell Group and El Paso Corp., all of which are believed interested in the deals, the most extensive access to Mexican energy fields since the country expelled foreign oil companies in 1938.

Officials at Pemex say the contracts are legal and simply would expand on or lengthen the terms of existing contracting procedures. The agreements would be structured so that outsiders would not own the oil or gas they produce but be paid by Pemex according to how much they can produce and how efficiently, enabling them to profit handsomely if they can beat the state-owned company’s own cost benchmarks.

Pemex previously has granted contracts for drilling, seismic studies and other oil-field services but until now has maintained strict management control over energy sites. The new contracts would allow the multiple-services contractors to take control of entire blocks of territory where gas is thought to be and then manage production from exploration and extraction to delivery to Pemex.

Fox took office a year ago as a can-do, pro-business leader intent on opening Mexico’s energy to outside investment.

But oil and gas are highly politicized--and constitutionally restricted--commodities in Mexico; Article 27 of the Constitution says only Mexico can develop hydrocarbons on native soil. So like his predecessors, Fox has had to tread lightly in forging any policy that affects Pemex, given its place in the Mexican psyche as a source of national pride and a bulwark against foreign incursion.

Nevertheless, Pemex and Fox’s handpicked chief executive, Raul Munoz Leos, say they have no choice but to open development of the Burgos natural gas field in northern Mexico to all comers if the country is to meet escalating demand.

Mexico’s daily consumption of gas will double from current levels to 9 billion cubic feet in the next decade, driven mainly by a new generation of gas-burning power plants across the country, the government says. Absent outside investment--Pemex says it lacks the funds for costly new drilling--Mexico would have to import more than half its gas by 2007, analysts warn.

Burgos is rich in “non-associated” or “dry” natural gas, meaning deposits not found with crude oil. Although Pemex is a successful developer of oil, it is not considered an efficient producer of dry gas and could use outside technology in developing it.

“The situation is critical,” said Luis Labardini of Marcos & Associates, a Mexico City energy consulting firm founded by former Pemex Chief Financial Officer Ernesto Marcos. “The Mexican government cannot make the kind of investment it has to, nor does it have the expertise to develop, non-associated gas.”

But congressional opponents say the Fox government is exaggerating Mexico’s energy needs and is engaging in semantics to sell the notion of foreign investment. In their view, the contracts amount to something the constitution forbids: foreign control over energy production.

The Mexican Senate voted Saturday to review the contracts, claiming the right to decide on their use.

Caton and other leaders of the opposition Institutional Revolutionary Party, known by its Spanish initials PRI, and members of the Democratic Revolutionary Party, or PRD, have come out against the contracts.

Sergio Benito Osorio, the PRD’s coordinator of Senate advisors, said the Fox government and his conservative National Action Party, or PAN, could be on a collision course with opponents if they pursue the contracts.

“We could see a constitutional shock of Congress on one side and the executive branch on the other,” Osorio said.

Multiple-services contracts are not universally favored by foreign oil companies, because the firms cannot book the oil and gas reserves they find on their balance sheets. Accountants and Wall Street analysts use reserves to forecast energy companies’ earning potential and stock trends.

Still, a conference held by Pemex in Mexico City this month to unveil the new contracts drew about 200 top energy executives from around the world. Some see the contracts as an invaluable means of getting a foot in the door in Mexico in advance of a hoped-for further liberalizing of investment policies.

One executive who attended, Ali Moshiri, president of ChevronTexaco’s Latin America operations, said the contracts being floated by Pemex have been used similarly or are under consideration in other countries that have constitutional prohibitions on foreign energy investment, such as Iran, Kuwait and Venezuela.

Although his company is evaluating the Pemex concept, Moshiri said ChevronTexaco may be interested if it can obtain a big enough contract, one that might pave the way for an investment of $1 billion or more.

“We always work within the legal framework of a country,” Moshiri said. “We are prepared to commit to a major expenditure to increase Mexican gas production by 1 billion cubic feet or more daily.”

If successful in opening the Burgos field and other sites to development, the Pemex contracts would be bullish for the oil industry. The deals also might work to increase gas supplies for the energy-hungry U.S. once the fields are fully integrated with the North American pipeline grid, analysts say.

The future of the contracts will hinge on Fox’s ability to marshal political support and to persuade his nation that it needs to open the doors to more outside investment. Those issues, as of now, are far from resolved.