CALDERON INTRODUCES ENERGY REFORM

UNCLAS SECTION 01 OF 05 MEXICO 001072 SIPDIS SENSITIVE SIPDIS STATE FOR WHA/MEX, WHA/EPSC STATE FOR EB/ESC MCMANUS AND IZZO USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD USDOC FOR ITS/TD/ENERGY DIVISION TREASURY FOR IA (ALICE FAIBISHENKO) DOE FOR INTL AFFAIRS ALOCKWOOD, AND GWARD E.O. 12958: N/A TAGS: ENRG EPET ECON MX SUBJECT: CALDERON INTRODUCES ENERGY REFORM REF: A. MEXICO 209 ¶B. MEXICO 531 Introduction and Summary -------------- ¶1. (U) Secretary Kessel delivered in the evening of April 8th the Administration's energy proposal, signed by President Calderon, to the "secretario tecnico" of the Senate, Victor Orduna Munoz. The proposal will be presented to the full Senate on April 10 and will be sent to the Energy, Finance, and Legislative Studies Committees for analysis and approval. After being approved by the Senate, the bill would have to be sent to the Chamber of Deputies. PAN coordinator in the Chamber of Deputies, Hector Larios, said that there wasn't a 100% consensus on the reform, but that approval was feasible. According to him, Calderon will submit changes to Pemex fiscal regime on April 10 to the Chamber of Deputies. The proposal includes five main changes to secondary laws. These changes are discussed in detail beginning in para 12. and track relatively closely with the proposed changes suggested by our sources in refs A and B: ¶A. The "Organic Law" of Pemex (Pemex founding statutes) (see paras 9-14 below). ¶B. The "Organic Law" of the Federal Public Administration defining government operations (defining the role of the Energy Secretariat)(see para 15 below). ¶C. Reforms to the Energy Regulatory Commission (CRE) law on pricing (see para 16 below). ¶D. Reforms to regulations of Article 27 of the Constitution reserving oil production and refining for the state. (see para 17-18 below). ¶E. Creation of an "Oil Comission," which will support the Energy Secretariat in developing policies. The commission will have five commissioners appointed by the President (see para 19 below). At 9:30 p.m. April 8 Mexican President Felipe Calderon gave a political speech on national television to explain the proposal. He stressed several times that Pemex will not be privatized and that Mexican oil will continue to be owned by Mexicans. He said that his energy proposal was only aimed at strengthening Pemex. Calderon used information included in the government's diagnostic several times during his message. End Introduction and Summary. Summary of President Calderon's Message -------------- ¶2. (U) Calderon started his speech noting that the government will act with patriotism to take advantage of oil resources. "Pemex will continue to be the property of all Mexicans and will not be privatized. Pemex is a national symbol." Pemex is losing competitiveness. He said that a few years ago Pemex was the sixth most important oil company in the world and currently it is the eleventh. This is the result not only of its financial problems, but also of its lack of technology and operational capability. Reserves are declining. Mexico's remaining proven reserves would last a little over nine years at current production rates. Output has declined and Mexico has stop receiving the equivalent of USD 9.4 billion annually. With these resources, Calderon argued,the government could have dramatically increased the budget for the popular social program "Oportunidades." The lack of refineries has meant that Mexico has had to increase gasoline and fuel imports. Currently, he reported, 4 out of 10 liters of gasoline are imported. Calderon praised Pemex employees work. He reminded the audience that that more than half of Mexican reserves are located in deep water. The proposal seeks to guarantee that Mexico has oil for future generations. The proposal will strengthen Pemex. He repeated that Pemex will continue to be a state-run company,and the initiative does not propose changing the Constitution. ¶3. (U) He listed the six pillars of his proposal: MEXICO 00001072 002 OF 005 ¶1. Provide Pemex with more management and financial autonomy over ten years. Pemex will have more freedom to manage its budget and debt to invest its resources in new projects. In particular allow it to reinvest profits to strengthen the business. ¶2. Create a special regime for Pemex that will allow it to award contracts without following traditional government procurement rules, giving the firm greater access to technology and improving its ability to operate. ¶3. Reduce gasoline imports. Private companies will be allowed to build and operate refineries on behalf of Pemex. Payment will be on a fee-for-service basis. The construction of refineries will generate more jobs, will trigger economic development in the states where they are built, as well as strengthen the petrochemical industry, and produce clean gasoline and cheaper fertilizers for farmers. Pemex will continue to own the oil and its products. ¶4. Improve Pemex administration. Improve its accountability and transparency to eliminate corruption. ¶5. Pemex will issue "bonos ciudadanos" (citizen's bonds) which are debt instruments which will be available to all Mexicans. The return paid by these instruments will be similar to the rate of return obtained by Pemex. The value of these individual bonds will be about 10 dollars. Individuals, pension and investment funds will be able to acquire the bonds. There will be restrictions to prevent a single entity from holding large volumes of the bonds. The bonds would not confer an equity stake. ¶6. Calderon also said that regulatory authorities will be strengthened. He will also implement measures to protect the environment when producing and replacing oil reserves. ¶4. (U) He added that the government considered the concerns and ideas of other actors while developing the proposal. Calderon also believed that the decision should not be unilateral and that the proposal should be broadly discussed and analyzed, but he urged legislators to move quickly. He also raised the fact that Cuba and the U.S. were already exploring fields that cross into Mexican waters while Mexico has been unable to explore for and produce oil in deep water. Calderon finished his message by repeating that the oil is and will be owned by Mexicans and that Pemex will not be privatized, but strengthened. Responses -------------- ¶5. (U) Both former Economy Secretary Luis de la Calle and Economist Ernesto Cervera speaking on television said after the debate that the proposed reform was "what was feasible and possible" and not "what the country needed." De la Calle said that it was a good step forward, particularly the fact that Calderon tabled the reform and that he understood the country needed a broad debate. De la Calle said he expected many of the issues, if passed would be challenged before the Supreme Court of Justice, though Administration officials told Emboffs last year that they would worked with the court to study the constitutionality of reform measures before introducing them. De La Calle thought though that a challenge was positive because it helped the democratic process. He also commented that more than an energy reform, Calderon's reform was a political reform, because of all the negotiations it required. ¶6. (U) AMLO Economic Advisor Mario di Constanzza complained about the possibility of Pemex directly entering into service contracts and the private sector's participation in refineries. He said the PRD has always been afraid of the creation of more monopolies as it has happened before with the financial and telecommunication sectors. He also said that the Frente Amplio Progresista had drafted and distributed and alternate proposal, which didn't include private participation but steps to correct and modernize Pemex. When asked why they had not sent it as a formal proposal to Congress rather than complaining, he said that their experience is that nobody cares about their proposals and the other parties do not even think of discussing them. MEXICO 00001072 003 OF 005 ¶7. (U) About "removing" Pemex from public finances, all comentators were disappointed that Pemex' fiscal regime would be modified in a ten-year period. This seemed too long to continue with the status quo before Pemex could use its own resources for projects. However, they all agreed that since there has not yet been a broad tax reform, public finances would still have to depend on oil revenues through the medium term. They mentioned the importance of implementing taxes on consumption. Political Parties' Reaction -------------- ¶8. (U) PRI leader Beatriz Paredes said her party had committed to carefully review and analyze the proposal. AMLO said that the proposal intended to privatize the sector by allowing private capital in refineries, but said that protests would not begin immediately. April 10 Senate PRI leader Manilo Fabio Beltrones called for a series of open fora between experts and political leaders to debate the proposals. Beltrones also suggested that PRI would make some changes to the proposal. Summary of Energy Reform -------------- Pemex Organic Law -------------- ¶9. (U) To improve corporate governance and strengthen the Pemex board of directors, legislation proposes adding 4 professional (independent) counselors. The number of union members (5) and government officials (6) will remain unchanged. The board of directors will be independent. Professional board members will be appointed by the President of Mexico to staggered eight-year terms beginning on January 1, 2009. The appointment could be extended for an additional period. These board members must be Mexican and must have experience in the sector. Two of them would be considered representatives of the State and will be full-time. The other two will be part-time members. Any decision made by the board would have to have at least two votes from the professional counselors. If not, the decision would be approved by simple majority in a following session. The quorum required to vote any decision will be eight members of the board (Comment: thus, under this proposal the government plus two of the professional counselors could outvote the union, and perhaps unsurprisingly, the PRI opposes having the President nominate the professional members). To make the Board's decision even more transparent, Calderon proposed the creation of an Auditing and Transparency Committee, the Strategy and Investment Committee, and Salaries Committee. The board has the power to create more committees as necessary. The President will also designate a commissioner, who will be responsible for reporting information on Pemex activities, and for protecting the interest of the owners of the citizens' bonds. The law also includes mechanisms to sanction the members of the board, regardless if they are independent or government officials or members of the union. ¶10. (U) The legislation seeks to provide Pemex with financial autonomy from the government. Pemex will be allowed to propose its debt schemes to the Finance Secretariat (Hacienda),which will have to approve them. SIPDIS However, Pemex will be able to determine its own foreign currency or foreign capital market financing without having to obtain Hacienda's authorization. Hacienda will; however, have the authority to prohibit any of Pemex' financial decisions if they threaten the country's macroeconomic stability. ¶11. (U) Pemex will be able to sell bonds directly to Mexicans. The bonds could be obtained by any Mexican citizen either directly or through financial intermediaries. These bonds will not grant holders any equity, and their return would be tied to the firm's performance. ¶12. (U) Pemex will be able to use additional revenues it generates without Hacienda's authorization as long as the decisions do not interfere with the government's balanced-budget target. MEXICO 00001072 004 OF 005 ¶13. (U) To improve Pemex's ability to enter into contracts and procure supplies, Calderon proposes a mixed scheme that will distinguish substantive operations (exploration and production) from other less-substantive activities. The first will be exempted from the requirements established in the Acquisition, Leasing and Public Services Law which had made Pemex's contracting extremely unweildy. The Board of Directors and the Auditing Committee would decide to grant contracts (for operations including exploration and production activities) either through public bidding, direct award or limited invitation. For exploration and production work there would be a clause in the contract that allows the amount to be paid to be determined after the contract is signed, giving Pemex a flexibility it did not previously have, as many operations such as drilling can involve a significant change of scope during the execution of a contract. Pemex will also be able to pay companies based on their performance. ¶14. (U) The proposed financing changes changes will be implemented over a ten-year period because the government acknowledges that the recent tax reform was not sufficient and public finances still rely on oil revenues. The gradual implementation will also prevent states and municipalities from significant short term revenue swings. Most of the states' resources -in some cases more than 95%- come from federal transfers and not from local taxes. Changes to Pemex' contract requirements will be implemented immediately. Pemex will be able to channel from 10% to 90% its own revenues to investment projects gradually. Pemex' subsidiaries will continue to operate as usual until the Executive issues a decree. Federal Public Administration Organic Law -------------- ¶15. (U) With these modifications Calderon seeks to strengthen the Energy Secretariat (SENER) as the agency responsible for establishing, conducting and supervising the energy policy; for fostering the participation of the private sector where applicable, for creating regulations to protect the sector's security, for regulations to exploit oil resources, for the elaboration of medium and long term plans to exploit oil resources, for fostering the use of alternate energy resources, and for issuing an opinion on the feasibility of Pemex investment proposals. Energy Regulatory Commission (CRE) Law -------------- ¶16. (U) The government will continue to control the first-hand sale of oil related products. The existing Energy Regulatory Commission (CRE),which now only regulates electricity and natural gas prices, as well as aspects of natural gas and gas liquids (LPG) transport and storage, would be given additional authorities. The newly empowered CRE would work to foster investment to complement the government's investment in the distribution, transportation, and storage of petroleum products. This reform will help Pemex to expand and maintain its pipeline and distribution network with private investment so that Pemex can channel more resources to oil and natural gas exploration and production. Following the reform the CRE and not Hacienda would determine the price of refined products until effective competition conditions existed or as determined by the Executive. This would permit development of a petrochemical industry, now impossible because of the Finance Ministry's control of hydrocarbon pricing. The CRE would also create the contract models for private participation in the petrochemical industry and be able to propose changes to energy laws. Five commissioners will be appointed to staggered five-year terms as opposed to the concurrent terms they now serve. Reform of Constitution Article 27 Implementing Regulations -------------- -------------- ¶17. (U) The Administration's reform also proposes several changes to implementing laws of Article 27 of the Mexican Constitution. On the downstream side, third parties will be allowed to provide transportation, distribution, and storage MEXICO 00001072 005 OF 005 services to Pemex. Oil products will continue to be owned by the government. Private capital would be permitted in oil refining activities, but through a processing fee scheme in which ownership of the hydrocarbon would remain in government hands. The private sector would be allowed to build and operate refineries, and own the pipelines, facilities and equipment. ¶18. (U) On the upstream side, the reform would allow the government to sign international agreements to develop transboundary wells. SENER would be able to direct Pemex to specific areas to explore and develop. Article 6 of the regulation gives Pemex the authorization to hire the services of individuals or companies to explore and develop resources (these services could include maintenance of facilities, technical analysis, drilling of wells, and three dimensional seismic). The payment for the services would be in cash but not through a percentage or share of production. SENER would have to grant a permit for the areas to be explored and developed. (Note: Calderon acknowledges that for many years Pemex has been using contracts with private companies, but he wanted to make article 6 more specific to prevent legal challenges and provide companies with more legal certainty: one is that Pemex keeps control over exploration and production, and second that risk contracts would remain illegal.) The Administration, by decree, would establish blocks which could be developed to guarantee future oil supply. Additional regulations would help to guarantee that private companies provide good service in oil transportation, storage and distribution, measures to prevent the creation of monopolies, and mechanisms to guarantee energy supply and national energy security. Oil Commission Law -------------- ¶19. (U) Following the lead of Norway, the UK, and Brazil, Calderon proposes the creation of a technical and specialized Commission to support SENER in overseeing energy regulation, exploration and production activities, and technical analysis, determining oil reserves and production volume, and in the evaluation of areas to be developed. The Commission would evaluate the exploration and production projects submitted by Pemex. The Commission would also grant the permits to perform the projects or works. The commission would depend on SENER, but would have administrative and operational autonomy. The president would appoint five commissioners proposed by SENER (the PRI specifically opposes this provision). Comment -------------- ¶20. (SBU) Though the proposal is barely 24 hours old, we believe that this very token resistance is a sign that much of the package was negotiated before hand, nevertheless, initial comments by PRI leaders indicate that some additional negotiation remains. Beltrones fora, however, (see para 8) are likely designed as a sop to placate the PRD before a vote is held. Visit Mexico City's Classified Web Site at http://www.state.sgov.gov/p/wha/mexicocity and the North American Partnership Blog at http://www.intelink.gov/communities/state/nap / GARZA