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Subjects in Mirror Are Closer Than They Appear: Mexico and Brazil Switching Sides in Oil & Gas

Subjects in Mirror Are Closer Than They Appear: Mexico and Brazil Switching Sides in Oil & Gas

shutterstock_27488632 (2) InsightOver the past decade, Brazil and Mexico have seen increasingly divergent policies in the energy sector in both countries. Whereas Brazil moved from a competitive, highly-functioning privatized national oil company to a covert nationalization of Petrobras in the Lula administration; Mexico is in the process of implementing a private market for oil & gas after 77 years of a national monopoly.

Earlier this month, however, the two countries enacted their own version of Parent Trap. Whereas Brazil is considering a bill that undoes a lot of the regulatory damage caused by the Pre-Salt bill; the Mexican Ministry of Finance proved that rent-seeking behaviour still exists, despite many liberal-leaning reforms over the last few years.

Mexico?s Energy Evolution

Mexico?s energy reform represents a historic opportunity to revitalize the country?s troubled energy sector and strengthen its overall economic productivity. Since the approval of the country?s energy reforms in 2013, most of the policy-oriented efforts of President Enrique Pe?a Nieto?s administration have focused on establishing the regulatory and institutional infrastructure for the new energy sector.

While Mexico has significant oil and gas reserves, the past few years has seen a decline in oil production of 25 percent (from 3.3 million bbl/d in 2004 to 2.5 million bbl/d in 2013). After years of contentious deliberations, the Mexican Government amended the Constitution in 2013, opening the oil and gas market to private foreign and local investors for the first time since 1938. The changes aim to attract much-needed investment in the industry, improve infrastructure, revitalize the national oil industry, and increase overall economic growth in the country.

In August 2014, the Mexican congress approved secondary laws that identify actionable steps for all parties when it comes to making the reforms a reality. Mexico?s energy reforms are based on lessons learned from other global markets. The administration was very careful not to impose the anti-competitive terms that were established in Brazil?s pre-salt laws. Until last week.

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Source: ?Mexican Energy Reform: Opportunity Knocks?, Deloitte, 2014

On Wednesday July 15, the Mexican CNH, the oil and gas regulator, put on a beautiful example of open government and transparency, televising the first hydrocarbon block auction in almost a century. Yet, some headlines the next day called it a failure because only two of the fourteen blocks were awarded.

Although the results were disappointing, the failure was in in the Government?s over ambition, not a lack of interest on the part of international oil companies. Surprisingly, for an administration that had been learning the right lessons from BrazilĀ“s Pre-Salt experience, the bid last Wednesday seemed like a late-night rerun of the Dilma administration.

Unbeknownst to the bidders, the Mexican Finance Ministry decided to guarantee a high cut for the Mexican government, establishing a higher than expected minimum-bid. For most of the blocks, they required a 40% cut up front of any successful exploration, with taxes still due on top of the profit on the 60% that would be awarded to the successful bidder. The minimum bid was not known to anyone until the moment of the auction itself.

Had the minimum bid been more in keeping with the market?s expectations, six of the fourteen blocks would have been awarded. Such was the market?s interest that of the seven bidders, there was one consortia of two mid-sized, highly respected international exploration companies (Murphy and Petronas) and one major oil company, Statoil for what shallow water oil exploration, which would normally not attract much attention from the majors.

Easing Petrobras Pressure with Offshore Oil Bill

While the Mexican government is learning the lessons from over-reaching, the Brazilian Senate is undoing a wrong with the Pre-Salt legislation. The introduction of a bill in Brazil?s congress that would open up offshore oil to private operators and more private investment, could dramatically shift the outlook for Brazil?s hydrocarbon exploration. Just as Mexico has benefited from their understanding of the mistakes in Brazil?s oil & gas reforms, Brazil is now looking at the Mexican model to ease the pressure on Petrobras, the struggling state energy corporation in Brazil. The bill, which comes in the wake of the Petrobras ?Car Wash? scandal, is an interesting turn of events in Brazil, especially in relation to the energy reform initiatives officially launched by the Mexican government in 2014. As Mexico?s energy reform goes into the early stages of implementation , Mexico provides a valuable early case study for potential investors interested in the Brazilian energy market.

Under the current 2010 law, Petrobras requires a 30 percent stake in each of the pre-salt oil fields and acts as the sole operator. The proposed legislation, introduced by Senator Jose Serra this past March, would remove these requirements, opening up offshore oil to more private investment and multiple operators. All oil concessions must be initially offered to Petrobras, but if the company is unable to fulfill its investment, then private companies are allowed to invest and act as the main stakeholder.

Earlier this month, the bill was sent to the floor of the Senate to be voted on, the last step in the legislature process before it enters the House of Representative. Government-oriented parties requested two amendments, one of which was the removal of the urgency-clause with the aim for slowing down the process. Other senators also recommended creating a Special Commission comprising of 27 members, to discuss the proposal of the bill. The creation of a commission has been approved and it will have 45 days to debate the bill and present their decision.

The iterative nature of Lessons Learned

Despite a weak start, there is reason to believe that the Mexican government is open to learning from its mistakes for the next phases of the energy reform and will make the necessary changes in both the minimum bid and the contract, which has been a thorn in international oil companies? side. As Mexico increasingly gets it right and international investors point to its case as an example for Brazil to follow, the opposition in Brazil will gain ground and might succeed in forcing the PT?s hand in Pre-Salt exploration.

Lest that scenario seem unlikely, the cherry on the cake is that low oil prices and Petrobras-related problems means there are a number of Brazilian companies in oil & gas, shipbuilding and related industries suffering financial hardship as a consequence of both. Facilitating the acquisition of struggling Brazilian companies, modern bankruptcy laws in Brazil (introduced in 2005) allow the separation of assets from liabilities when an investor purchases a distressed asset. Negative market sentiment and currency depreciation have combined to dramatically reduce asset values. Infrastructure conglomerates involved in the ?Car Wash? investigations are being forced to de-leverage by selling off subsidiaries and assets in a buyers? market. Such factors can lead to excellent opportunities for investors looking for a bargain in Brazil. With presence in both markets, Speyside Corporate Relations can help companies understand the iterative policy reforms that Brazil and Mexico are undergoing, offering in-depth local knowledge in either market.

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Ian Herbison

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