Politics, Business & Culture in the Americas

Incentive-Based Contracts in Mexico’s Oil Sector

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Mexican President Enrique Peña Nieto’s plan to reform state-owned Petroléos Mexicanos (PEMEX) has attracted the attention of many analysts. Since President Lázaro Cárdenas nationalized the oil sector in 1938, no president has been able to push for reform to allow for foreign ownership of petroleum assets.

Peña Nieto sees allowing foreign investment to be critical to turning around PEMEX, which has suffered from declining production in recent years. PEMEX was producing 3.4 million barrels per day in 2003 and production slipped to 2.5 million barrels per day in 2012.

While the debate for energy reform continues, an oil auction for six blocks in the Chicontepec basin is set to take place on July 11, with multinational oil companies such as Repsol, Schlumberger and Halliburton set to make bids.

This is possible due to a 2008 reform that allows for limited private investment in the sector through incentive-based contracts. When it passed, then-President Felipé Calderón was quick to accompany the reform with a firm disclaimer: “I want to make clear that oil is and will continue to be exclusively Mexican property. PEMEX is not being privatized. Oil is a symbol of the nation’s sovereignty.”

The 2008 reform was criticized for setting up more bureaucracy in the energy sector.  It created two regulatory bodies—the National Hydrocarbons Commission and the National Energy Council. The former regulates the exploration and production of hydrocarbons and the latter serves as a supervisory body for all federal agencies in the energy sector.  

In the 2008 reform, foreign involvement in production is included in the contracts section, where it states that “private parties are permitted in areas of the oil and gas industry that are not exclusively reserved to the state.” Nevertheless, production-sharing agreements were deemed non-permissible, and the only acceptable arrangements were incentive-based contracts. These contracts allow PEMEX to acquire know-how from private companies while maintaining claim to their reserves.

The first round of incentive-based contracts was awarded in August 2011 when Petrofac, a British company, received the rights to drill in the Santuario and Magallanes fields. A second round took place in June 2012. The contracts are attractive to foreign investors since they include terms that companies must be paid in cash and are awarded bonuses for completing work early, but get no cut of the profits.

The incentive-based contract scheme remains a legacy of what were then considered watered-down energy reforms. While the reforms have limited scope, they are allowing some foreign participation in the oil sector, which is critical to boost PEMEX´s declining production. While full reform would require a change to Mexico’s constitution, incremental gains that allow for investment, expertise and technology transfers are vital to boost Mexico´s energy sector. 


Christian Gómez, Jr. is a contributing blogger to AQ Online. He is director of energy at the Council of the Americas. Follow him on Twitter at @cgomezenergy.

Tags: gas, Mexico, oil, Pemex
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