PETRÓLEOS MEXICANOS (PEMEX)

Introduction
President Felipe Calderón of Mexico announced Wednesday that the national oil company, Pemex,
had struck oil in deep water, its first success after years of exploration in the deeper reaches along the
bottom of the Gulf of Mexico. The find, deep below the Gulf’s floor and more than 8,200 feet below
the surface of the water, could add as much as 400 million barrels in potential reserves to Mexico’s
overall reserves, Mr. Calderón said at a ceremony at Los Pinos, his official residence. But perhaps
even more important than the amount is the fact that Pemex, a monopoly, found the oil on its own.
Mexican law prevents Pemex, which is officially called Petróleos Mexicanos, from forming part-
nerships with outside companies. Critics have argued that the company lacked the experience to
successfully explore in deep waters.
For Mr. Calderón, the announcement was vindication in the final months of his presidency that
the deepwater strategy was worth the gamble. Holding up a vial of light crude from the well, he said:
“What a good thing that this effort is crowned today, with a great discovery, with the realization of
a goal that we had set for ourselves.”
“Pemex Finally Strikes Oil in Deep Waters,” by Elisabeth Malkin,
The New York Times, August 29, 2012.

... the Chairman of the Mexican Stock Exchange (BMV), Luis Téllez, says oil is the country’s most
inefficient industry. Mr. Téllez believes it is therefore essential to leverage the power of the stock
market to increase the company’s competitiveness, which would allow it to capitalize on a buoyant
economy and strong investor appetite. “We were taught at school that Pemex belonged to the Mexican
people, yet there is not a single Mexican citizen who holds shares in the company.”
“PEMEX Can Be More Competitive; The Stock Market Would Boost the Oil
Company’s Value,” POR Diana Fernández, Funds Americas, March 30, 2012.

Petróleos Mexicanos—Pemex—was struggling. The national oil company of Mexico, Pemex held total reign over
the Mexican oil and gas industry. The largest company in Latin America, it employed 140,000 people, made up
3% of Mexico=s GDP, and provided nearly 40% of the funds for the Mexican government=s budget. Although
jubilant over its recent deepwater discovery (described above), production of oil and gas had been dropping for
years, and its single largest field, Cantarell, was in rapid decline.

Pemex had been a cash cow for the Mexican state, but was notoriously inefficient and corrupt. The newly
elected President, Enrique Peña Nieto, had long argued that private investors should be allowed back into the
Mexican oil and gas industry—in some way. He was feeling pressure from inside Mexico, from Mexican industry
particularly, and from outside Mexico, for example the United States, and calls for a Transboundary Agreement
for joint ownership of deepwater oil in the Gulf of Mexico. Everyone believed Pemex needed to change, but
the question was how? Juan José Suárez Coppel, General Director of Pemex, acknowledged that the company
had underperformed in the past, but that many significant changes had been made and it was now turning the
corner. Was change really needed?

Chapter 1 Mexico and Oil

Oil and Mexico did not mix, at least well, historically.

Those following Mexican President Felipe Calderón Hinojosa’s energy reform efforts would probably
respond that to talk about oil in Mexico is not to refer to a resource below ground or the country’s
geographical wealth. Instead, oil represents something largely symbolic. It is an important part of the
mythological construction of an independent nation, and it is also associated with the underworld of
corruption in Mexico. The mere mention of oil stirs up both a strong nationalistic pride and feelings
of profound distrust.1

The Mexican oil industry was one of the oldest by industry standards, with oil exploration and production
beginning in the 1870s. Led largely by American and British companies, Mexico had become the world’s second
largest producing country by the early 1920s, with a quarter of all global production. But production began to
decline rapidly, and as industry returns declined, relations between the private industry developers and Mexican
labor and government worsened. On March 18, 1938, in the midst of a major oil worker strike, President Lázaro
Cárdenas surprised the foreign oil companies operating in Mexico by expropriating the entire oil industry.2

Mexican oil was the property of the state according to the Mexican Constitution of 1917. Article 27 of the
Constitution granted all permanent and complete subsoil rights to the government.3

Article 27. Ownership of the lands and waters within the boundaries of the national territory is vested
originally in the Nation, which has had, and has, the right to transmit title thereof to private persons,
thereby constituting private property.
... In the case of petroleum, and solid, liquid, or gaseous hydrocarbons, no concessions or con-
tracts will be granted, nor may those that have been granted continue, and the Nation shall carry
out the exploitation of these products, in accordance with the provisions indicated in the respective
regulatory law.

The nationalization of 1938 gave the Mexican government exclusive rights over the exploration, develop -
ment, production, and refining of hydrocarbons. Two months following expropriation, President Cárdenas created
Petróleos Mexicanos (Pemex), making it the organization responsible for all of these upstream oil and gas activities.

Even after expropriation, Pemex continued to use private contractors to fill the void in needed technol-
ogy, capital, and operational execution. Much of this work was performed under risk-service contracts, where
contractors were paid, in part, with percentages of production.4

This era ended with the administration of President Ruiz Cortinas in 1958. The Petroleum Law of 1958
expressly prohibited contractor compensation in anything but cash. Contractors could not be paid on the basis
of percentage of production, participation in production or sale, or the result of exploration activities. This elimi-
nated the use of risk-service agreements. The law of 1958 extended Pemex=s exclusive rights over hydrocarbons
to the downstream, the manufacture and sale of petroleum products.
Over the next 25 years, Pemex grew as a domestic bureaucracy, expanding its production and refining
activities with varying levels of success. Pemex was increasingly seen as an organization representing Mexico=s
sovereignty and future prosperity, in many ways an embodiment of “the people=s struggle” against repression.
The organization and its bureaucracy continued to grow, expanding employment, compensation, often more
under the control and influence of labor than the federal government.

With the surge in global oil prices in 1973-1974, Pemex came under new pressure to expand production,
which it could not do without finding and developing new fields. Despite a renewed emphasis on exploration,
the single largest discovery was made by accident. In 1976, a fisherman by the name of Rudesindo Cantarell
noticed an open water oil seepage in the Bay of Campeche. Only after repeated complaints about the oil seepage
damaging his fishing was he able to gain Pemex=s attention, leading to the discovery of one of the world largest
producing oil fields, Cantarell. Oil production boomed; Mexico moved from 1% of global production in 1973
to more than 5% in 1982, nearly 3 million barrels per day as illustrated in Exhibit 1. And like much of Mexico=s
history, oil production had been characterized by the Presidential regime of the day.
But Cantarell proved a mixed-blessing. Cantarell=s booming revenues initiated an era of oil revenue de-
pendency by the Mexican government, often termed a petrocracy, a state whose leadership becomes increasingly
disenfranchised from its own people.5 Many analysts believe this era of readily available oil revenue allowed
Pemex to become complacent and, eventually, ineffective. The Mexican government increasingly relied on the
company for its income, as did a large part of the Mexican population.

As illustrated by Exhibit 1, production largely stagnated between 1980 and the mid-1990s, and became
increasingly intertwined with presidents and politics. Little reinvestment was made by Pemex (and the Mexican
government), with the focus shifting to maintaining production. Cantarell was already showing signs of decline,
so in 1996 a major nitrogen injection project was initiated to boost production. Although successful in the
short-term, it was thought to have accelerated the eventual depletion of the field. Cantarell=s production began
to decline quickly, and Mexican oil production peaked in 2004. (In 2004, Cantarell had accounted for 63% of
Mexican production; by 2008, it had fallen to 43%.) In the years that followed, the government=s revenues were
partially sustained by rising oil prices, but falling production now posed a looming threat.
Mexico=s crude oil production today is predominantly Mayan crude (60% of total production), a heavy
crude of high sulfur content. This requires more specialized and higher-cost refining technologies, which explains
why most of the heavy crude is exported to refineries on the U.S. Gulf Coast. Oil production does include two
lighter oils, Isthmus and Olmeca, which are refined domestically and used predominantly for domestic consump-
tion. Crude oil production is approximately 25% onshore and 75% offshore today.
Chapter 2 Natural Gas
Historically of lesser development and value, natural gas has been a poorer sibling to oil until recently. Private
participation is allowed in the downstream, unassociated natural gas, and has been since 1995. Pemex is the
exclusive natural gas pipeline and gas distribution operator in Mexico, including 10 different import pipeline
connections with the United States. Recent shale gas discoveries and developments (largely the Eagle Ford for -
mation of northern Mexico and southern Texas) have revived interest in gas development, along with growing
demand. The EIA estimates that Mexico may have 680 trillion cubic feet of shale gas reserves which would rank
Mexico fourth largest globally.
Mexico was one of the few countries that continued to use fuel oil and diesel for electrical power produc -
tion. Natural gas costs and environmental concerns have, however, now driven natural gas to a greater share of
electrical power, as well as increased the use of coal. Much of the latest electrical generation facilities are using
liquefied natural gas (LNG) which is imported to Mexico on both coasts. The Altamira LNG receiving and re -
gasification facility on the Gulf Coast (a joint venture with Shell and Mitsui) began operation in 2006, supplying
the CFE (Comisión Federal de Electricidad), the Mexican state monopoly electrical power producer, under a
15-year contract. The Costa Azul receiving and regasification facility on the Pacific Coast near Ensenada started
up in 2008, and supplied natural gas to commercial developments in northern Mexico. Nigeria provided 75%
of all LNG, followed by Egypt and Qatar.

Pemex=s declining production was a direct result of its inability to find and book replacement reserves. The
company had invested little in exploration for decades, and the two most promising areas for future develop-
ment, the onshore Chincontepec Basin and deepwater Gulf of Mexico, had seen little exploratory drilling. The
problems in future oil were thought to lie within Pemex today.

Chapter 3 Pemex
A few companies preserve the great tradition of state-sponsored incompetence and overmanning.
Venezuela’s Petróleos de Venezuela, which is central to the patronage machine of the country’s
president, Hugo Chávez, is an obvious example. More surprisingly, so is Mexico’s Pemex, which has
successfully resisted numerous attempts to reform it.
“State Capitalism’s Global Reach: New Masters of the Universe, How
State Enterprise Is Spreading,” The Economist, January 21, 2012.

Pemex had been founded and run for 40 years for the express purpose of supplying the country=s domestic oil and
gas needs. This was distinctly different from most NOCs which were created to produce domestic hydrocarbons
for export and national earnings. Starting in the 1970s, however, Pemex, too, moved in this more traditional
direction; it became an export-earning vehicle for the Mexican federal government.

Chapter 4 Governance and Management

Pemex operated as a governmental bureaucracy, charged with administrative and operational duties, but lacking
in financial and legal independence. The Mexican federal government maintained control over the company=s
budget, budget modifications, and any investments it wished to make. Organizational governance came from a
collection of parties, complicating the identification and pursuit of a singular corporate strategy.

Although a part of a complex web of intergovernmental structures and relations, Pemex was officially regu -
lated by the Ministry of Energy, but held largely accountable to the Federal Income Tax Authority of Mexico —the
Hacienda. Pemex paid all its net revenues, all income beyond current direct costs and general administrative
expenses, to the Hacienda. Without the ability to control its own financial resources, the company was unable to
undertake investments it believed necessary strategically for the future. This meant that for many years investment
was largely confined to production, not exploration, refining, or petrochemicals. In the words of one analyst.
Pemex=s manager[s] are effectively stripped of much of the responsibility and accountability that comes with running
such a large company—they are unable to pursue an optimal investment strategy because they have neither the capital
resources nor the autonomy to make intrinsically risky investment decisions on commercial merits.

Although not a regulator, the Ministry of Public Functions (SFP), the government organization which
had oversight over the external auditing of all public entities, had immense influence over the daily operations
of Pemex. The internal controllers required by SFP had authority over much of the internal spending of the
company, in addition to influencing organizational structures and reporting lines of authority. Although only
created in the mid-1980s, it had grown highly bureaucratic.

Pemex=s internal stakeholders were exceedingly powerful and politically insulated. Power was held officially
by a director appointed by the Mexican President every six years—like Mexico=s presidency itself.8 The organiza-
tion was governed by a board of directors consisting of members of the President’s cabinet and industry union
leaders.9 The six-year terms meant that leadership focused on strategies, tactics, and projects possessing relatively
short-term outlooks—and results.

The union, the Oil Workers= Union of the Mexican Republic (STPRM), was powerful and largely im-
movable. The union had resisted significant organizational change over time, protecting the roughly 140,000
employees of Pemex. (The union had lost one major employment fight under President Carlos Salinas in the late
1980s, when Pemex employment had dropped from 220,000 to 120,000, but 20,000 of that had been regained
in the following years.) The union was also the subject of increasing debate over the corruption thought to be
rampant throughout the organization. Three of the union=s general directors had ended their administrations
in recent years under indictment. The union maintained its stranglehold on much of the Pemex organization
through hiring—the union controlled most new hiring (termed “filling spaces”), not management.

The union had not fought the increasing use of outside contractors for many oil field and natural gas pro -
duction services. In many cases, union members or Pemex management had business interests related to many
of the contracting companies.

The oil industry nationalization of 1938 (expropiación petrolera) had created two separate entities, Pemex
Production and Pemex Distribution. Several years later, they were merged to form a single all -encompassing
national monopoly, an organizational form preserved for 50 years. In 1992, the company had been reorga-
nized into four main operating units (exploration and production, refining, gas and basic petrochemicals, and
petrochemicals), along the same organizational lines seen in other major international oil companies. A fifth
organization, PMI Comercio Internacional, conducted all international trading activities, including t he sale of
exported crude oil and the purchases of imported natural gas and petrochemical products. In 1995, in a major
restructuring, most of the natural gas exploration, development, production, and processing was outsourced to
a series of major contractors.

Chapter 5 Oil Production

The single issue which dominated the debate over the need for change in Pemex was declining production. As
illustrated by Exhibit 2, Mexican oil production was defined by five distinct basins:

1. Tampico-Misantla Basin. The oldest producing area, onshore, and, although some enhanced recovery had
been successful in recent years, largely depleted.
2. Mesozoic Chiapa-Tabasco Basin. Located onshore in the southeast coastal zone, the MCT basin collective
combined a number of large and producing fields. The second oldest production area in Mexico, production
had continued to decline despite continuing investment in enhanced recovery.
3. Ku-Maloop-Zaap Basin. An offshore basin located northwest of Cantarell in the Bay of Campeche, it was
made up of three producing fields. Now the largest production area in Mexico, it was the focus of intense
production investment.
4. Cantarell Field. Cantarell=s role in Mexican oil production had been dramatic, as it had doubled production
within three years of start-up. But its decline was now equally dramatic, despite massive investments in the
past 15 years in secondary recovery processes, including nitrogen injection.
5. Other Offshore Fields. Mexico=s oil production future, this was a collection of relatively shallow water de-
velopments. Further offshore, deepwater, was believed to be the true “treasure” awaiting Mexico. Finally, in
August of 2012, a significant deepwater discovery had been made. But further deepwater exploration and
development would require massive increases in capital, technology, and knowhow.

If Cantarell spoke of Mexico=s oil producing past, no other field spoke more about the complexity of its
present than Chicontepec. The Chicontepec field, located northwest of Mexico City (onshore), was originally
believed to hold half the reserves of Saudi Arabia. The field=s complexity and the heavy crude quality (categorized
as tight oil or unconventional), had, however, proven daunting. Despite investing more than $9 billion in the
field over the 2007-2011 period and 2,100 wells, the area was still producing less than 70,000 bpd. Pemex E&P
leadership had come under extreme criticism over its competency. In 2011, Pemex E&P had finally reduced its
estimates of probable reserves at Chicontepec by 30%, from 9 billion to 6.5 billion barrels.

Chapter 6 The Downstream

Unfortunately, Pemex=s shortcomings were not limited to oil production. Refining was also critically underper-
forming. So little capital and effort had been devoted to the refining infrastructure in Mexico that for the past
two decades much of the heavy oil produced in Mexico (roughly 50% of all Mexican production was classified as
Mayan crude, a heavy oil which required specialized refining) was exported to refineries along the U.S. Gulf Coast
for processing. The products of that crude refining, particularly gasoline, were then imported —reimported—by
Pemex for sale in Mexico.10

Mexico=s six operating refineries were also inefficient by international standards, much of it a result of cor-
rupt hiring practices. Whereas a standard refinery of 200,000 bpd capacity might typically employ 800 workers
(four shifts of 200), a Pemex refinery would average 4,000.

Pemex leadership had repeatedly and publicly noted over the years that, although it was interested in reinvest -
ing in technology to gain increasing efficiencies in refining, it did not expect to generate profits or returns from
refining, and it had no real intention in investing large quantities of capital in building new refineries. Mexico=s
neighbor to the north, the United States, had enormous refining capabilities within Mexico=s effective reach.
Investment itself, in any stage in the value chain, had been inadequate throughout Pemex=s life span. All
investments had to be approved by the Hacienda, and it had been more keen on collecting capital from Pemex
rather than redeploying it to build Pemex. As Cantarell=s production decline became increasingly imminent, a
major investment in nitrogen injection had finally been undertaken in 1996 to sustain its production (enhanced
oil recovery, EOR). Investment in new exploration had been near-zero for decades, but in 2003, as Cantarell=s
future decline approached, new capital was finally approved for exploration efforts. Those efforts, however, had
borne little fruit.

Pemex=s monopolistic hold on the oil markets of Mexico extended all the way to the gasoline pump. Pemex=s
refining subsidiary provided 100% of all the gasoline, diesel, jet fuel, and fuel oil (used heavily in Mexico for
power generation), either through its own refining operations or its purchases internationally. The 7,000 gasoline
stations in Mexico were nearly all concessions (franchises). These gasoline stations were licensed by Pemex but
owned by private operators. The operators purchased all inputs from Pemex and paid the firm a concession fee
on their sales. This gasoline station infrastructure was often characterized as highly corrupt (both i n reported
income and quality of gasoline sold), and as the most visible point of contact with the Mexican public, highly
destructive of the company=s reputation.

The various petrochemical products of Pemex and their prices in Mexico were complicated. Gasoline is
not subsidized, and the price of gasoline throughout Mexico reflects most of its actual costs, allowed to fluctu -
ate with market conditions. Fuel oil and natural gas sold to the country=s electricity providers (also government
owned), are heavily discounted/subsidized.

Chapter 7 Creative Solutions

Mexican law=s prohibition against private interest in hydrocarbons, combined with Pemex=s inability to control
its own cash flows, led to significant underinvestment. Two specific structures, multiple service contracts and
Pidiregas, were created within the Mexican legal system to attempt to fill that void.

Multiple Service Contracts (MSCs). In the late 1990s, the multiple service contract was introduced to allow private
companies to contract with Pemex to provide a long-term combination of activities and services for natural gas
production.11 The MSCs, many of which were 20 years in length, allowed both foreign and domestic companies
to contribute services and technology which Pemex did not possess. Contractors would provide everything from
seismic to drilling services. Regardless of the activity, contractors could only receive cash payment based on the
unit prices for the work performed and the services rendered; returns could not be tied in any way to produc-
tion volumes or values.
After extensive use but increasing debate over their constitutionality, MSCs were suspended in 2005. The use of
the MSCs also represented the general tendency to outsource most of the natural gas industry in Mexico over
the 1990-2008 period. This has been somewhat reversed with the rise of oil prices in recent years combined with the
rapid development of shale gas resources.

Pidiregas Projects. The Public Debt Law of 1995 created a new category of long-term contingent public debt to
support priority infrastructure projects, the Deferred Impact Status Projects, or Pidiregas Projects. First a project,
for example a gas development project, would have to be approved by the government as a priority project. It
could then be financed purely through debt (bank loans or security issuances), which would remain off -balance
sheet until the project was both complete and operational to the degree that it could begin to generate its own
cash flows for its own debt service. Although the debt was to be serviced by the project=s own returns, it was
guaranteed by the issuing entity, Pemex.

Pidiregas quickly became the preferred financing vehicle for the capital needed by Pemex. Between 2000
and 2008, roughly 70% of all new investment by Pemex was funded through Pidiregas (Appendix 3).

Chapter 8 Mexican Politics

In Mexico, ultimately everything and nothing came down to politics. Although long dominated by a single political
party, the PRI (Partido Revolucionario Institucional), most Mexicans did not trust political parties to represent
their interests. The Mexican government, Pemex, the STPRM, all were instruments of the ruling political party
in Mexico. The PRI=s 70 years of dominance had been broken in the elections of 2000 when a second political
party, the PAN (National Action Party), for the first time gained power.

Under the Mexican constitution, elected officials could not serve consecutive terms, including presidents.
As a result, Mexico was a country governed for the moment.

“We have engineers; there just has not been investment,” argues Rogelio Ramirez de la O, an
economist who has served as a consultant to the PRD [another Mexican political party, Partido de
la Revolución Democrática]. “The management strategy for Pemex, which proved to be a popular
one throughout several presidential administrations, in the end ‘feudalized’ Pemex. Changing this
should not be an ideological issue. We must recognize that the strategy did not work and reverse it.
This can be done by rebuilding Pemex’s capacity and returning to the capital markets. Then Pemex
can attract investment.”12

The result was a political-economic system which was often characterized as short term in focus and not
trusted by civil society. As noted by Horacio Boneo, an Argentinean official who headed a team of United Na -
tions election observers in Mexico in 1994, “Mexicans have a distrust gene.”

Chapter 9 Reforma Energética

 The oil is ours, let’s go for it.
Public Slogan for 2008 Oil Industry Reform

President Felipe Calderón, fearing that Pemex and Mexico were facing an oil collapse, initiated a firestorm of
debate with reform efforts in the spring of 2008. (Calderón was uniquely qualified to assess the situation, as he
served as secretary of energy in the previous president=s administration.) Privatization, in some way, was to be a
part of the process, and it extended from exploration efforts in the upstream to the refining and petrochemical
industries in the downstream.

In the upstream, reserves were not being replaced. Proven reserves were now estimated at only 9.2 years,
given current production. And production itself was declining, having peaked in 2004; 23 of the country=s 32
largest producing fields were in decline. The downstream was in many ways worse. Refining was by all accounts
atrociously inadequate and inefficient. Mexico was producing roughly one-third the amount of oil as that produced
in the U.S., yet had six refineries operating compared to 149 in the United States. Mexico was now importing
(re-importing to be exact) nearly 40% of its refined product needs.

In October 2008, the Mexican government finally passed a package of administrative and operational
reforms to Pemex in an effort to revitalize the organization and its performance. The final package was moder -
ate at best, the result of a tumultuous political fight. The reforms of 2008 were a reform of Pemex—termed
the Pemex Law—rather than a revision of Mexican energy law. The 2008 Pemex Law continued to explicitly
prohibit the use of standardized oil industry contracts like concessions or production-sharing agreements, or
allow private firms to book reserves or take equity interests in hydrocarbon business activities. The 2008 reform
had three key components:13

1. New Procurement Framework. This new framework allowed Pemex to conduct a bidding process for
production-related business activities. The bidding structures were further revised in subsequent rounds
(rounds 1 and 2) to compensate contractors in full for investments. The new framework also created a new
contracting structure, the PEP (Pemex Exploración y Producción) Model Contract. The PEP Model Contract
was a service contract with the possibility of performance-based bonus payments.
2. Greater Fiscal and Operational Autonomy. For the first time, Pemex would prepare its own budget, includ-
ing the ability to commit to reinvestment and investment plans. It would also now have the independent
ability to take on additional debt (termed citizen bonds) without Ministry approval.
3. Corporate Governance Reform. Pemex=s board of directors was expanded from 11 to 15, with the addition
of four independent professional positions (with required private sector experience and Senate ratification)
added to five positions held by the union and six presidential appointments.

The Pemex Law also created a new regulatory body, the National Hydrocarbon Commission (CNH),
which would be independent of the Energy Ministry of Mexico. The CNH was charged with oversight of all
exploration and production of hydrocarbons in Mexico, along with processing, transportation, and storage of
all hydrocarbon products. The commission would consist of a five-member panel, a staff of 60, and an annual
budget of $7 million. Although the CNH was charged with oversight, it could critique and monitor Pemex
decisions, but would not control them.

Chapter 10 Bidding and Contract Awards

The first real test of the effectiveness of the 2008 reform packages was the conduct of the first two bidding rounds
for field services in 2011 and 2012. The first round, a series of contracts to explore and produce in mature fields
in southern Mexico, resulted in two blocks being awarded in August 2011 to Petrofac (United Kingdom) and one
block to Schlumberger of Houston (Schlumberger was awarded the block in October after the winning bidder
failed to comply with legal requirements). Schlumberger would charge Pemex $9.40 per barrel of oil produced,
well under the ceiling price of $12.31 per barrel Pemex had posted.

After some revision following the first round, the second round was conducted in the spring of 2012.
Pemex chose the winners on the basis of who could produce the most oil at the lowest cost per barrel. Although
16 global companies prequalified for the auction, only 12 submitted bids (including Baker Hughes, Haliburton,
Pico International of Egypt, Respol, Saipem, and Petrofac-Schlumberger). Four onshore contracts were awarded
(one to Pico, two to a consortium of Latin American companies, and one to Petrofac-Schlumberger), but the
two offshore areas were declared void because of inadequate bid interest.
 The Petrofac-Schlumberger award for the Pánuco Field was representative of the new contract. Pemex=s
explicit goal was, through a 30-year integrated incentive-based field services contract, to boost production in the
mature Pánuco Field in northeastern Mexico from 13,000 bpd to 140,000 bpd. Petrofac-Schlumberger would
invest $17.5 million in capital expenditures in the field the first two years of the agreement, and then continue
to invest capital on a per-barrel basis the following 28 years (depending on the official estimates of remaining
undeveloped 2P reserves). The companies would be reimbursed for 75% of their development expenditures
through a restrictive cost recovery schedule, but receive a tariff of $7 per barrel of incremental production.

Although Pemex was happy with the onshore contracts, the failure of the offshore block auctions was a
clear sign that the contracts were not attractive. Further bidding would be postponed until after the forthcom -
ing presidential election.

Chapter 11 Pemex 2013

The presidential election of 2012 renewed much of the debate over the future direction of Pemex, the Mexican
oil industry, and Mexico itself. Enrique Peña Nieto (PRI), the clear front-runner throughout the election, argued
that Mexico might learn much from Brazil=s success with Petrobras as a way to attract more private sector interest
and involvement with Mexican oil. Petrobras was publicly traded (though the Brazilian government retained the
controlling golden share), allowing it to raise the capital it needed for exploration and development (see Appendix
9). Although Peña Nieto did not think Pemex should go public any time soon, he did argue that greater private
participation in the industry was needed immediately, and that downstream —specifically refining—would be
Aone of the windows through which you can open up to the private sector.@14 Peña Nieto was elected president
on July 1, 2012, and was sworn into office on December 1.

The General Director of Pemex, Juan José Suárez Coppel, did not necessarily agree that Pemex needed
radical change. Through a series of international presentations, Coppel argued that the company was already
taking sufficient action to assure the future of Mexican oil, that Pemex was committing more and more capital
to E&P (Exhibit 3), and Mexico=s champion was turning the corner on replacing reserves (Exhibit 4).15

But many, both inside and outside Mexico, were not convinced. The problems and pressures in oil and gas
in Mexico continued. Those in private industry, even within Mexico, saw little light at the end of the tunnel.16

The chief executive of petrochemicals company Alpek SAB (ALPEK.MX), Jesus Valdez, said in May that
the boom in shale gas production in the U.S. and consequent drop in natural gas prices was an encouragement
for companies to expand abroad, while in Mexico the need to import feedstocks keeps projects from being carried
out. “As long as there’s no way of complementing public investment with private investment, it will be difficult
to take advantage,” he said following Alpek’s listing earlier this year on the Mexican stock exchange.

Chicontepec, deepwater Gulf of Mexico, shale gas, all needed capital, technology, and expertise, which
were clearly in short supply in Mexico. And the recent Transboundary Agreement signed with the U.S., sum -
marized in Appendix 10, only added to the growing obligations. The question faced by Mexico=s new president,
Enrique Peña Nieto, in 2013 was how to change Pemex to get his country where he knew it needed to go. As
one analyst noted, “Calderón got Mexico’s oil industry out of intensive care. Peña Nieto must get it out of the hospital
and back to a productive life.
Appendix 9. The Petrobras Model

The national oil company of Brazil, Petrobras, is often used as an example of what Pemex should become. One of the
largest publicly traded companies in the world, Petrobras has enjoyed an extended period of rapid growth and success
unparalleled among NOCs. Much younger than Pemex, Petrobras was not founded until 1958, and, even then, was not
a domestic production company, but rather a manager of the growing petroleum import needs of the industrializing
Brazilian economy.

1995 Reform. Significant change began in 1995 under Brazilian President Fernando Henrique Cardoso. For the first time
,significant change was successfully made in the Brazilian constitution, authorizing the federal government to “outsource
oil and gas activities under state monopoly to private or government-owned companies.”

1997 Reorganization. The second major step in the reformation of Petrobras was the reorganization of 1997 when
Petrobras’s business activities were separated from its regulatory role. A new agency, the National Petroleum Agency
(ANP), was created in January 1998 to regulate the domestic oil and gas industry. ANP was charged with the awarding
of all exploration and production bids for oil, natural gas, and other liquid fuel concessions, along with most downstream
activities including refining, import and export of natural gas and its derivatives, marine transportation of oil and its
derivatives, and all domestic pipeline activities of oil, natural gas, and associated derivatives. In addition to awarding
contracts in these fields, it was also charged with regulatory oversight and dispute settlement. Although officially it was
expected to maintain Brazil’s monopoly powers over oil and gas, it could grant exploration and production concessions to
any firm from anywhere, including Petrobras alone or in partnerships with others (junior or senior), including domestic
and foreign private companies.

Law 9478. Passed in 1997, Law 9478 was instrumental in the design of Petrobras’s current operating and ownership
structure. Law 9478 made it explicit that private investors could own participating shares, but could have no non-economic
rights—no voting rights—to influence corporate management or leadership. The law also set a floor on government
ownership, requiring the Brazilian government to retain 50% plus one share of all voting rights shares. This effectively
assured the Brazilian people that denationalization would not occur, but that private entities could contribute and
participate in Brazil’s oil and gas industry.

In 1999, the restrictions over share ownership, common and preferred, were removed. Investors of all kinds, Brazilian
and foreign, were now allowed to hold common or preferred shares. The domestic Brazilian market was opened further
in 2002 with the deregulation of import, export, and pricing of oil and gas products.

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