Does MSC stand for Mexico Sold Cheap? Controversial multiple service contracts in Burgos Basin whip legislators into nationalistic frenzy.

The head of Mexico's state-run oil company Petroleos Mexicanos (Pemex) stood before Congress at the beginning of August and warned that the company must be reformed to avoid deterioration and eventual collapse, restarting a debate on the possible future of the company.

Raul Munoz Leos, former head of Dupont Mexico and the oil company's first head that comes from a business rather than a political background, was originally called before a permanent congressional body to explain his most recent attempt to modernize the company through the much-debated multiple service contract (MSC) schemes.

Munoz Leos' warnings came in the stone week of the publication of the controversial new book on the state company, "Pemex: Un Futuro Incierto," (Pemex: An Uncertain Future) by respected energy analyst David Shields, and both have helped rekindle the debate on the role of politics and economics in the oil and energy sector.

The MSCs are large multi-million-dollar contracts of 20 years or more to explore the Burgos Basin gas fields in northern Mexico. At present, Pemex puts out a number of small contracts by which companies are paid to partake in portions of a larger job. For example, one company will be contracted to explore for gas, another to drill and another to transport the extracted gas from the well.

Under the MSC scheme, one company will be contracted to do all of these jobs under one agreement, thereby cutting back on the stifling Pemex bureaucracy and giving the company the freedom to choose how it wishes to find and extract the fuel. Such freedom within a Mexican gas field, even though the company in question is not permitted to directly profit from the gas it finds and extracts, is frowned upon by legislators who see such exploitation as a step toward a complete sale of Pemex.

DEMANDING AN EXPLANATION

Congress called on Munoz Leos to explain MSCs on the tail of a second round of MSC tenders. The contracts are just the second of an expected eight rounds for private companies to take part in the exploration and exploitation of the massive Burgos Gas fields.

Shell, British Petroleum, Exxon Mobil, Chevron Texaco, Total Fina and Techint are among the companies said to be participating in the tender process, and it is here, say legislators, that the Pemex boss has overstepped his mandate.

Ever since the expropriation of Pemex in 1938, the company and its independence from foreign interests has been a matter of national pride. The new MSCs, however, while not greatly different from existing contracts, have stirred up a political hornets' nest.

The Constitution does not permit the exploitation of any fuels within Mexico by any company other than that run by the state. While the Burgos basin is currently being explored by hundreds of different private companies through smaller contracts, it is the MSCs that are creating the most controversy.

By clumping hundreds of smaller contracts into a handful of large billion dollar contracts under the MSC method, Pemex saves itself from having to traverse expensive bureaucratic channels and brings in expertise that it otherwise cannot afford, Munoz Leos argued.

"There is an element of rationalization in these contracts in that you are reducing the number of contracts and so too the bureaucracy that it takes to implement them," said Shields. "But the [foreign] companies are replacing Pemex in a major oil field and that is simply not done in Mexico."

With full investment in the Burgos fields, Pemex estimates it could produce around 1 billion cubic feet of natural gas a day, comparable to the rich gas fields in southern Texas.

ESCALATING NEED

Mexico's need for natural gas has grown exponentially in the last few years, with Mexican industries forced to buy imported expensive natural gas. Some officials blame the situation on the state company's failure--whether from cash limitations or technological challenges--to better explore beneath the country's surface for untapped reserves.

Costs of electricity generation alone, due to increasing numbers of combined cycle plants in the country which use natural gas as a main fuel, have risen by an estimated 20% to 25% in the first half of 2003, according to the Federal Electricity Commission (CFE).

Such prices have lead the CFE to switch to environmentally unsound and expensive fuels like diesel to continue generation in some of its plants, which in turn has led to skyrocketing electricity prices.

Industrial chambers are up in arms as their competitiveness plummets due to rising energy costs.

"We have electricity, natural gas, gasoline and diesel that is more expensive than in the United States. How are we expected to compete?" asked Hector Rangel, president of the Business Coordinating Council (CCE).

COMMERCIALIZATION CHORUS

Rangel is just one of many businesspeople calling for changes in how the state energy companies including Pemex and CFE are run. Both Finance Secretary Francisco Gil Diaz and Bank of Mexico Gov. Guillermo Ortiz have expressed their concerns about current energy policy and its damage to Mexican competitiveness.

But when it comes to Mexican energy matters, politics is everything.

Staunch nationalistic legislators sensitive to the concept of multinational companies extracting natural gas from Mexican soil say they will take the MSC matter before the Supreme Court to decide its legality.

Legal or not, such a move will lead to a postponement of the contracts while the Supreme Court makes a decision, a postponement which Munoz Leos said will cost Pemex clearly.

The question of the MSC's constitutional viability and general political sensitivity in energy matters has led analysts such as Shields to the conclusion that the MSCs will never see the light of day.

"I think the MSCs won't go ahead but are probably not necessary from a purist standpoint, since I think Pemex could produce the gas with existing contracts," said Shields.

And while Munoz Leos is also pushing for the MSCs to be passed, he has also recently played down their immediate importance to the country.

"If the MSCs are blocked then they are just cherries which will not be added to the pie," he told journalists after his two-hour grilling before Congress. "But, we are baking a pie for a very large party."

The cherry on this particular pie would have helped Pemex grow to "levels previously not seen," but Pemex will survive without them if it has to, said a defiant Munoz Leos.

However, this is a different message than Munoz Leos was giving a year ago when the plan of MSCs first arose. Asked whether there was a Plan B if the MSCs were stalled in the Supreme Court, the Pemex head refused to even contemplate the question, replying that the contracts were within constitutional limits and that "I don't even have to consult Congress on this matter."

PIECE OF A LARGER DEBATE

Now faced with legislators determined to halt what they see as a slippery slope to privatization, Munoz Leos is being forced to make a U-turn on the contracts' importance but is using the opportunity to remind the country Pemex is in trouble, which could mean trouble for the country itself.

As political blood boils over the MSC contracts and this most recent affront to national sovereignty, analysts say the discussion is just a smokescreen for the much larger debate of whether multinationals should be permitted to work in Mexico and under what circumstances.

"The debate is not specifically about the MSCs. The debate is, can multinational oil companies have a major role under the current law? That's what this is all about. If they can work with large multi-billion dollar contracts in Burgos with natural gas, then they can do it offshore with oil. They can start looking at contracts to explore the next areas that Pemex cannot reach, such as deep sea oil fields," said Shields.

CASH COW MILKED DRY

Pemex is in dire straits financially as the government bleeds nearly a third of its entire federal revenue from the company every year in the absence of any substantial tax income.

In order to fund the federal budget, Pemex is pouring massive amounts of its revenue directly into government coffers, forcing it to borrow so it can pay its high tax burden.

Last year, Pemex finished 30 billion pesos in debt, despite revenues in 2002 of 487 billion pesos. Its tax payments were a large drain--283 billion pesos of revenue went directly to the Finance Secretariat.

"Cash flow after payment of taxes is insufficient to cover investment necessities obliging Pemex to increase its debt levels to finance its growth," Munoz Leos told Congress. He showed slide after slide showing how the company could not possibly pay for the necessary investment to begin new and essential projects.

The introduction of private companies under contracts is just a band-aid on a gaping wound, says Shields, who believes the company has three major problems.

First, he says, the fiscal burden is too great. Second, the major oil wells are drying up with the Canterell Field, one of Pemex's main oil sources, estimated to be empty by 2005 at the latest. Finally, the company must face excessive labor burdens, mostly at the bureaucratic level where the number of posts are actually growing. Shields said 40,000 of Pemex's 140,000 employees are bureacrats.

With the rising controversy over MSCs and the consequent noise of massive multinationals sniffing around Mexico's still untapped natural resources with open criticism on how Pemex is being run and exploited by a cash-strapped government, the new Congress will need to place energy policy at the top of its agenda.

The question remains as to whether the nation's newly ejected legislators can solve the country's growing energy and economic problems or whether the matter will be smothered by populist vote seekers in the run up to the 2006 presidential elections.

Paul Day is a correspondent for Market News International and also writes for the energy wire Platts. He is based in Mexico City.