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Mexican officials have closely examined Colombia's successful energy model--which does not employ local content requirements. (Photo: Colombia's Mining and Energy Ministry)
Wednesday, May 7, 2014

Mexico Energy Reform: Local Content?

Mexico's energy overhaul should include no or little local content rules, experts recommend.

Inter-American Dialogue

One of the most contentious aspects of Mexico's energy reform is whether or not secondary laws should set specific local content requirements for international oil companies operating in the country. Similar measures have been put in place in other countries, such as Brazil, in an effort to support and develop domestic industry, while other countries, such as Colombia, choose not to use them. Are local content rules a good idea for Mexico to include in its energy reforms? How do local content rules vary across the region, and what have been their consequences for energy sector investment and development? How much do they help local industry, and what are the drawbacks and pitfalls of such requirements? 

R. Kirk Sherr, president of Clearview Strategy Group: Mexico enjoys numerous advantages that create a solid foundation for the implementation of national content policies including a strong industrial base, deep North American trade ties created by NAFTA, a free-trade agreement with the European Union and proximity to Texas. However, the implementation of national content rules also will coincide with new competition for Pemex and new energy regulatory bodies, leading to complex and unknown outcomes for investors. Thus, a 'light touch' on mandatory national content percentages ultimately may be the best approach. This is particularly true considering that the effectiveness of national content policies internationally has been mixed--and even in Latin America there has been marked difference in national content rules (and results) between country markets like Colombia and Brazil. Thus, Mexico must weigh carefully the cost/benefit of the policies it chooses and the timing of their implementation. Mexico imports tens of billions of dollars (and still growing) in natural gas and refined products per year to meet its demand. Addressing these energy import costs will be another important objective of the energy sector changes, meaning investment must be attracted not only to upstream projects, but also to infrastructure and refining. And all of this is occurring in a worldwide environment where energy investment opportunities are increasing due to new offshore and unconventional developments. Rather than mandating a high percentage of national content, perhaps focusing on other mechanisms to develop the sector-especially related to education, domestic technology centers, and skills development and training-may produce the desired investment results more quickly. 

John D. Padilla, managing director of IPD Latin America: Historically, government-imposed local content requirements have distorted markets. Such would be the case for Mexico's energy sector. Mexican companies clearly want to vigorously participate in Mexico's energy sector opening. And they should. It's good for the Mexican economy and the sector as a whole. Foreign investors will want strong and competent local partners and will prefer to purchase locally when able. But Mexican companies will also need to become world class. Their products and services can't just be good enough for Mexico; they have to be good enough for any market in the world. Mexican companies have billions of dollars to invest. Alliances, mergers and acquisitions will certainly evolve naturally, given the size of the prize Mexico's energy sector opening represents. Artificial local content requirements won't stimulate economic activity or aid Mexican companies in the long run. Certainly not in the way that a more focused national content strategy could. The delays (and their impact) in Brazil's pre-salt development that came as a result of national content requirements speak volumes. Because Mexico is a NAFTA member, Mexican companies have a tremendous market beyond Mexico. Those companies that truly develop world-class energy sector products and services will also benefit from Mexico's 12 free trade agreements, which provide access to 44 countries. Fortunately, the Peña Nieto administration appears to be looking at national content on a case-by-case basis, rather than a generic, prescriptive one. And, as a signatory of NAFTA, Mexico is fairly limited in its ability to implement a strictly prescriptive solution. Essentially, Congress' national content debate comes down to how dynamic and global Mexico wants its energy sector to become. 

Danielle Valois, partner at Trench, Rossi e Watanabe Advogados in Rio de Janeiro: Local content rules are a good idea provided that the rules are clear and they incentivize both the local government and the companies to heavily invest in education and research and development in Mexico. Many Latin American countries have been studying efficient formulas to increase the local content percentage of the goods and services supplied in connection with their upstream activities. The Brazilian local content policy seems, however, to be the most detailed and evolved one within the region, having substantially increased the number of foreign companies with investments in R&D activities in the country. The Brazilian local content policy has been clearly incentivizing players with serious and solid plans for Brazil to establish R&D labs and manufacturing facilities in the regions with higher demand for oil- and gas-related services and goods, which is already a great benefit for our country. In the long run, however, I believe that our capacity to (a) absorb the demand for oil- and gas-related services and goods expected to be generated by pre-salt and shale gas development and (b) qualify our local manufactures to compete internationally could substantially increase upon the combination of the existing (and increasing) investments in R&D by private companies and the required investments by federal, state and municipal governments in fundamental education. With investments in R&D and education, the quality and price of our locally-produced services and goods should become more competitive and our local content policy would more effectively benefit the evolution of our country, eliminating the risk of the creation of a market reserve which is always harmful to the economic environment.

David Shields, independent energy consultant based in Mexico City and editor of Energía a DebateCountries like Brazil and Norway, which have been role models for the Mexican oil industry, achieved tremendous growth for their domestic suppliers as they developed their oil industries. In Mexico, oil industry reform will probably be looked upon by many as a failure if it does not create prosperity for domestic industry suppliers. Mexico was probably overzealous in the 1990s in opening up its oil services to foreign contractors and suppliers, to the detriment of local companies, even though the industry remained closed to foreign oil majors and oilfield operators. NAFTA included provisions for Pemex to open up its public tenders to a gradually increasing role for U.S. and Canadian firms. Companies such as Halliburton, Bechtel, Precision Drilling and Schlumberger thrived. They, rather than local companies or Pemex itself, dominated Mexico's oilfield services. Mexico now wants to apply local content rules as part of its energy reforms, especially in low-technology and labor-intensive activities. But it is still the limits and restrictions established years ago in the government purchases chapters of its free-trade agreements that oblige Mexico to keep its oil-industry tenders open to foreign participation in all senses. It is foreseeable that the energy and economy ministries will now seek ways around these restrictions, so that Mexican companies can have a greater role in contracting and subcontracting. How this will be achieved is not yet clear, but new rules on local content are awaited among the enabling laws of the energy reform, which are expected to be passed by this summer. 

David L. Goldwyn, president of Goldwyn Global Strategies LLC and former U.S. special envoy and coordinator for international energy affairs: Achieving energy reform in Mexico is a daunting political challenge. President Peña Nieto was able to overcome the first hurdle with the approval of constitutional reform allowing foreign investment in the oil sector. The next hurdle involves the secondary laws, which will make the reform a reality. The discussion about local content requirements is ultimately a discussion about striking the right balance. The government must balance the need to incentivize foreign investment with the need to demonstrate that the reform will not just bolster the macroeconomic figures of the country, but also create jobs and opportunities that directly benefit the Mexican people. Promoting a local content requirement may indeed help Mexico achieve this balance. The key, however, is that any local content requirements are flexible enough so as not to exceed Mexico's domestic capabilities, especially considering that the introduction of new, non-domestic technology is one of the reform's chief goals. In my conversations with Mexican officials they have made clear they closely examined Colombia's successful energy model--which does not employ local content requirements--in shaping Mexico's reform. Similarly, they have learned well the lessons taught by Brazil's overly stringent content rules, which have suppressed growth and proven to be self-defeating. While the right answer for Mexico may involve some measure of local content requirements, I am confident the nation's leaders will not enact requirements so strict that they undermine the very goal of the reform.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

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