Seventy-five years after Mexican President Lazaro Cardenas nationalized Mexico's energy sector and created the state-owned firm Petroleos Mexicanos, or Pemex, the country is once again on the verge of a major transformation that could reverse the fortunes of its waning energy sector. On Aug. 12, Mexican President Enrique Pena Nieto announced his party's long-awaited proposal to restructure the regulatory framework underpinning the country's energy sector. While much of the reform's success will depend on secondary legislation, this reform is the country's best chance in decades to attract foreign direct investment, particularly in challenging deep-water and unconventional plays. If the reform is successfully implemented, production in Mexico's energy sector will likely stabilize, which will be a boon for Mexican and North American energy security, and the country will not have to take the socially controversial step of forfeiting state ownership over its natural resources.

Ownership of mineral resources has been a perennially contentious issue in Mexico. Up until the 1880s, subsoil minerals belonged first to the Spanish crown and then to the nation. At the end of the 19th century, former Mexican President Porfirio Diaz liberalized the economy and transferred ownership of subsoil resources to private landowners. Foreign firms, primarily U.S. and British multinationals, swept in and gained control of nearly 90 percent of the country's oil production. The Mexican Revolution (1910-1920) changed this policy dramatically, and the 1917 constitution, which remains the country's foundational political document, returned ownership of subsoil minerals to the nation. 

But the daunting prospect of reconstruction in the aftermath of the war constrained implementation of further protectionist policies, at least in the interim, and foreign firms were allowed to continue to operate. However, in 1938, amid a crippling labor stoppage, Cardenas nationalized the energy sector and created Pemex. The move was revolutionary but fundamentally pragmatic. Foreign firms were allowed to invest, though they could not own the oil they were producing, and there was a great degree of political risk. However, their compensation could be linked to production, thereby providing incentives to invest and increase production.

This lasted until 1958, when the current regulatory regime was established. Amending the constitution, politicians added clauses granting Pemex a monopoly over both upstream and downstream activities and directly prohibiting contracts that linked compensation to production. From this point, foreign investment was extremely limited. The discovery of the massive Cantarell field in 1976 temporarily postponed the day of reckoning, but without investment and new technologies, production and reserve replacement has fallen. While recent attempts in 2002 and 2008 partly succeeded in granting some operational autonomy to Pemex and allowing for some service contracts, they did not generate investment on the scale needed to turn around flagging exploration and production trends.

Acutely aware of the realities of falling oil production and of the nationalist sentiment surrounding the sector, Pena Nieto and his team crafted a proposal that addressed both issues simultaneously. The Institutional Revolutionary Party's proposal calls for scrapping the Petroleum Law of 1958 and returning to Cardenas' original vision: a robust state-owned oil company alongside private investment, with all subsoil minerals remaining under the domain of the state.

What this means is that Pemex, the National Energy Commission and the country's subsoil minerals will remain completely state-owned, but foreign firms will be able to form more attractive profit-sharing contracts, particularly in areas where Pemex lacks the technology and expertise to expand production, such as in the deep waters of the Gulf of Mexico and the shale gas plays in the northeast of the country. Foreign energy companies will not technically own the oil or natural gas, which could discourage some investment, but they will be compensated in its equivalent dollar value. In addition, the reform calls for national content requirements to promote Mexican industry and for Pemex to be relieved of its high fiscal burden, which is on the order of 30 percent of all fiscal revenues.

Mexico's energy sector can be thought of as a pendulum; what began as massive shifts in the late 19th and early 20th century between privatization and nationalization continues today, albeit on a smaller, subtler scale. Mexico's tradition of governing through patronage networks, with some leaders pursuing nationalization to build popular support and others pursuing privatization as a means to build elite support, is the reason for these swings in policy. This current reform will swing the pendulum toward more private and foreign involvement but will ultimately stop short of radically changing the system. This will increase the likelihood of the bill's passage but could limit its effectiveness.

Without venturing into the realm of production-sharing agreements, and with the ability for foreign firms to "book" reserves still unclear, how firms will react is still very much in question. Once the parliament begins debating the issue on Sept. 1, and once secondary legislation is implemented after the constitutional reform's passage, it will become more clear whether this reform is just another bill passed in a broken system or whether it will bring about more oil production while retaining subsoil mineral rights.