Cablegate: Approaching the Third Rail: Mexico's Big Parties

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PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #2335/01 2111852
ZNR UUUUU ZZH
P 291852Z JUL 08
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 2763
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY
RUEHC/DEPT OF INTERIOR WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 05 MEXICO 002335

SENSITIVE
SIPDIS

STATE FOR U/S JEFFERY AND A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD
USDOC FOR ITS/TD/ENERGY DIVISION
INTERIOR FOR MMS/STEVE TEXTORIS, KEVIN KARL, RENEE ORR
TREASURY FOR IA (LUYEN TRAN, RACHEL JARPE)
DOE FOR INTL AFFAIRS KDEUTSCH, ALOCKWOOD, AND GWARD
NSC FOR RICHARD MILES, DAN FISK
STATE PASS TO USTR (EISSENSTAT/MELLE/SHIGETOMI)
STATE PASS TO FEDERAL RESERVE (BORA DURDU)

E.O. 12958: N/A
TAGS: ENRG EPET ECON PGOV EFIN MX
SUBJECT: APPROACHING THE THIRD RAIL: MEXICO'S BIG PARTIES
BEGIN SERIOUS NEGOTIATIONS ON PEMEX REFORM

REF: (A) MEXICO 1072 (B) MEXICO 531 (C) MEXICO 209

Summary
-------

1. (SBU) With the conclusion of the Senate debates on the
Calderon Administration's proposal for reforming the
state-owned petroleum monopoly PEMEX, leaders of the three
major parties (the right-leaning ruling National Action
Party, or PAN; the more centrist opposition Institutional
Revolutionary Party, or PRI; and the leftist opposition
Democratic Revolutionary Party, or PRD) have committed to
working out a deal on this most politically sensitive of
issues, and the general shape of the likely consensus is
becoming clearer. The PRI has made public its reform
proposal, which government and PAN leaders have been quick to
praise as resembling in large measure the Administration's
own, though industry sees the PRI proposal as more
restrictive than the PAN's. Meanwhile, the PRD has more
intra-party differences to iron out before it will be able to
present its proposal, with a major fight likely between the
die-hard obstructionists and the party's more moderate wing.
Both the PRI and the PRD have legislators who will almost
certainly oppose any deal, but the chiefs of the three major
parties met last week to lay the groundwork for moving toward
a vote on a package aimed at their common goal of "rescuing
PEMEX without privatizing it" by early October in order to
have time to incorporate changes from the reform into the
annual budget and appropriations bills. They also decided to
follow routine congressional procedure. The willingness of
the three party leaders to negotiate via the legislative
process undermined the political impact of the controversial
public referendum on energy reform sponsored by the PRD that
was held in Mexico City and nine other states. Attracting
mostly PRD supporters, the referendum delivered predictably
anti-reform results, though many criticized voting
irregularities and the slanted questions. Industry sources
say that the final product of this intensely political
process is unlikely to result in the "rescue" of PEMEX, but
will hopefully provide some additional flexibility and pave
the way for further reform by finally breaking the taboo on
addressing the challenges the energy sector faces. End
summary.

Parties Agree to Negotiate, Honor Normal Legislative Process
--------------------------------------------- ---------------

2. (U) Rapidly sinking oil production from existing fields,
the inability to exploit new fields in the deep waters of the
Gulf of Mexico, and the need to import 40 percent of Mexico's
gasoline have sufficed to convince all three of Mexico's
major political parties that they need to work together to
rescue the tottering para-statal oil monopoly PEMEX. At the
same time, no party wants to be seen as giving away the
country's oil (which was nationalized in 1938, an event still
celebrated in school books and popular consciousness as one
of the great patriotic triumphs in Mexican history). Several
days after the conclusion of the 71-day debate period in the
Mexican Senate, the chiefs of the three main parties (German
Martinez of the PAN, Beatriz Paredes of the PRI, and
Guadalupe Acosta of the PRD) met to discuss how they would
handle what all agreed was urgently needed reform to "rescue
PEMEX without privatizing it." There are certainly divergent
views among (and even within) the parties over how best to
rescue PEMEX, and what does and does not constitute
privatization, but the three leaders agreed that these issues
will be hashed out via routine congressional procedures.
That means that all proposals will be considered, that there
will be no fast-track vote, and that the appropriate
committees will draft the bills. The expectation is that an
intense month-plus of congressional negotiations will lead to
a consensus package being passed in early October. This is
the latest that the issue can be dragged out, because the
Mexican Constitution requires that the federal revenue and
appropriations bills be approved at the end of October and

MEXICO 00002335 002 OF 005

mid-November, respectively, and both of these will be heavily
impacted by any reform to how PEMEX -- which currently
provides approximately 40 percent of all government revenue
-- operates.

PRI Lays its Cards on the Table
-------------------------------

3. (U) On July 23, the day after the Senate's extended
debates on the Calderon Administration's PEMEX reform
proposal had finally ended, Senator Manlio Fabio Beltrones,
leader of the Institutional Revolutionary Party's (PRI)
Senate bloc, presented his party's own proposal for reforming
the Mexican energy sector. The major elements of the PRI
proposal follow:

-- Private Participation: PEMEX would be permitted to solicit
private participation in various activities (e.g.,
exploration and drilling), but only via service contracts
payable in cash. There would be no direct link between
compensation to the contractor and the revenue stream
generated by any hydro-carbons found and exploited. However,
the proposal would allow for payment according to formulas
with variables that are determined at the time of payment,
rewards for successful results, and flexibility in
compensating contractors for factors related to technological
needs, level of difficulty, and quality of work. On the
other hand, if a project like a deep sea exploration fails to
find exploitable hydrocarbons, the contractor would be
responsible for all or some of the associated costs.

-- Mini-PEMEXes: Public subsidiaries of PEMEX would be
established at the state level, with public financing to
handle refining, transportation, distribution, and storage of
oil and petroleum products. Private capital would be
prohibited from operating these activities, but could be
contracted for specific services or projects as per above.

-- Transparency: PEMEX contracts would be subject to scrutiny
by the Congress and the Secretariat of Public Function, and a
committee for transparency and auditing would be created that
would submit a report to the PEMEX Board every March.

-- Greater Financial Autonomy: PEMEX would have greater
decision-making power over its own budget.

-- Board of Directors: Four independent, professional and
full-time members would be added to the PEMEX board by the
President and ratified by the Senate. For the PEMEX
subsidiaries, two independent members would be appointed to
each of their respective boards of directors.

-- New Regulator: A National Oil Regulator would be created
to issue technical regulation and protect and maximize
advantage of Mexican reserves. This would be an independent
entity.

-- Citizen Bonds: PEMEX would make "bonos ciudadanos"
available to all citizens. These debt instruments, worth
about $10 each, would pay rates of return similar to that of
PEMEX, and would be tradable among individuals, pension and
investment funds, though with rules prohibiting a single
entity from accumulating large volumes of these bonds.

Overlap and Differences Between PAN and PRI Proposals
--------------------------------------------- --------

4. (U) President Calderon, Energy Secretary Georgina Kessel,
Senate President Santiago Creel, PAN Senate Chief Gustavo
Madero, other PAN leaders, and numerous commentators have
publicly noted the many similarities between the PAN and PRI
proposals, asserting that it forms a promising basis for
reaching a mutually acceptable deal. In addition to
increased transparency, budget and management autonomy, and

MEXICO 00002335 003 OF 005

the creation of citizen bonds (ideas which no one opposes),
both seek to provide greater legal certainty to private
contractors and create flexible payment mechanisms while
taking pains to dissociate such payments from hydrocarbon
revenue streams. But there are also key differences. The
PAN proposal does not include the PRI provision that would
force private contractors to eat all or some of the costs
incurred for failed deep water exploration projects, nor does
it restrict in such detail the types of activities in which
the private sector can participate. And the Calderon
Administration would allow private capital to build, own, and
operate refineries, pipelines, and the like (though
maintaining government ownership of the petroleum being
processed) while the PRI calls for new PEMEX subsidiaries to
operate all these downstream activities. The PRI calls for
national content preferences for private contractors, while
the PAN would treat all private contractors equally. With
regard to the PEMEX Board of Directors (currently made up of
eleven people - six from the executive branch and five from
the petroleum workers union), the Administration proposes
four additional professional members to be appointed by the
President, with two of them full-time and two of them
part-time, while the PRI proposes that all four be full-time
directors (and thus legally liable) and ratified by the
Senate. Jesus Reyes-Heroles, the Calderon-appointed Director
General of PEMEX, perhaps assuming the "bad cop" role to lay
down markers of where the PAN plans to make a stand in the
coming negotiations, publicly criticized the PRI's position
on creating 100 percent-state owned PEMEX subsidiaries to
operate all downstream activities, saying that a higher
degree of private participation was necessary in those areas
precisely because PEMEX had proven itself incapable of
building and operating more refineries and pipelines. He
also said that requiring Senate approval of the four
additional professional board members would "politicize"
their selection. The PRI proposal has also received
criticism from a number of PRI legislators from the lower
chamber of the Congress, who criticized the provisions on
private sector participation as threatening to "privatize"
Mexico's petroleum, the political equivalent in Mexico of
touching the third rail.

PRD Proposal Faces Internal Opposition
--------------------------------------

5. (SBU) While the PAN's legislators seem unified around the
Calderon Administration proposal, the PRD faces even more
daunting internal divisions than the PRI. A top staffer
working for the Senate's PRD bloc told econoffs that his
party already had its own "reasonable" proposal ready, but
would hold off presenting it until early September in order
to afford more time to achieve party consensus. He said that
PRD moderates (including interim party chief Guadalupe Acosta
and Senator Graco Ramirez, the ranking PRD member of the
Senate's Energy Committee) were committed to a negotiated
deal with the PAN and PRI and would not engage in seizing
Congressional chambers or other such extraordinary tactics,
but that die-hard rejectionists loyal to failed 2006
presidential candidate Andres Manuel Lopez Obrador (AMLO)
were not yet resigned to pursuing dialogue (despite the fact
that as a presidential candidate, AMLO had made some noises
about reforming PEMEX). Our contact said that the idea was
to work very hard between now and August 30 (the scheduled
date for the 2008 PRD National Congress) to win over AMLO and
company, or at least convince them not to rupture the party
over energy reform. He characterized the PRD proposal as
similar to the PRI's and PAN's in updating contracting
regulations (including some flexible compensation schemes,
which PRD rejectionists, like their PRI counterparts,
characterize as akin to privatization), strengthening
management and budget autonomy, and forming a new regulatory
commission. In contrast to the PAN and PRI proposals, the
PRD proposal will not support any participation of the
private sector in downstream activities, wants to reduce the
representation of the oil workers union on the PEMEX board

MEXICO 00002335 004 OF 005

from five out of eleven to perhaps only two (the PRD
considers the PRI-affiliated oil workers union to be highly
corrupt and a big part of the problems that PEMEX faces), and
would re-centralize the PEMEX spin-off companies (PEMEX
Exploration and Production, PEMEX Refining, PEMEX Gas and
Basic Petrochemicals, and PEMEX Petrochemicals) into one
single corporate entity again. With regard to the downstream
activities, he said that Hacienda -- the Mexican equivalent
of the U.S. Treasury Department -- is sitting on $41 billion
of frozen PEMEX earnings that would be sufficient to build
four or five new refineries, obviating the need for any
private capital in constructing the new capacity necessary to
significantly reduce gasoline imports. (Note: It is our
understanding that this reserve fund is needed to comply with
the balanced budget requirement under Mexican law. End
note). He also noted that the PRI's national content
preferences were clearly intended to guarantee business to
people like telecoms monopolist Carlos Slim, who owns IDEAL,
a Mexican infrastructure company interested in providing oil
services. Regardless of whether the PRD can overcome its own
internal divisions or include some of its key provisions in
the final bill, our contact predicted that energy reform in
one shape or another would be passed early this fall.

Public Referendum Fizzles
-------------------------

6. (U) The PRD attempted to gain leverage over the energy
debate by investing considerable money and political capital
in carrying out a public referendum in Mexico City and nine
other states on July 27. The referendum featured two
questions: 1) Should the petroleum industry be a private
rather than a public enterprise? 2) Should the government's
energy reform proposal be approved? In Mexico City,
approximately one million voters participated in this
exercise, with over 80 percent answering "no" to both
questions. This result surprised no one, as few PAN or PRI
supporters were interested in participating in this clearly
partisan and non-binding referendum. Numerous politicians
(including some from the moderate wing of the PRD) and
commentators criticized the leading nature of the questions,
and many cast doubt on the election itself, noting that the
last election the PRD ran -- that for PRD president earlier
this year -- had to be annulled due to myriad irregularities
that left no clear winner. (Note: Guadalupe Acosta was not a
candidate for the post and is serving only as interim party
chief. End note). Given the aforementioned criticisms of
the referendum's substance and process, the public commitment
of the moderate PRD leadership to negotiating a reform
package with the PAN and PRI, as well as the fact that
turnout was low relative to national elections, the political
significance of the referendum was limited. That probably
won't stop moderate PRD politicians from referencing the
referendum in negotiations with their PAN and PRI
counterparts, just as it probably won't stop PRD radicals
from using the referendum as justification for whatever
course of action they end up deciding to pursue. But it
clearly failed to provide AMLO and his supporters a public
mandate for rejecting reform.

Industry View: Substantively Light, Politically Heavy
--------------------------------------------- --------

7. (SBU) A major U.S. oil company representative told
econoffs that the PAN proposal provisions on private sector
participation in the oil sector, while not ideal, were
written in very general terms that would allow sufficient
flexibility to attract the interest of large, international
oil companies (IOC) like Shell, ExxonMobil, and BP, in
exploring possible upstream activities. She said that the
IOCs were the only ones who could provide the kind of
capital, technology, and integrated project management that
Mexico needs to reverse its declining oil production. The
PRI proposal, on the other hand, includes detailed

MEXICO 00002335 005 OF 005

prohibitions on strategic alliances and the booking of
Mexican oil on private company books, as well as the
aforementioned national content preferences, all of which
seem specifically designed to encourage the participation of
service companies like Halliburton, Schlumberger, and Carlos
Slim's IDEAL, while keeping the integrated IOCs out of the
picture. The problem with this approach, our contact
asserted, was that the service companies do not bring any new
investment with them and simply comply with their contract
obligations and take their money. She noted that the PRI
proposal to force private contractors to eat the costs of
something like a deep sea drilling that found no oil or gas
was completely fanciful, as no service company would ever
accept such terms. Only the IOCs are willing to accept risk,
as long they get to enjoy the rewards when the risk pans out.
For that reason, her company is hoping that the PAN can
overcome PRI (and PRD) opposition to more flexible rules on
private sector participation that leave the door open to some
artfully disguised version of risk contracts. She proffered
no prediction on how this round of reform would end up
treating private participation, but said that the
improvements to PEMEX oversight and managerial and financial
autonomy would be positive, and any reform at all would break
the decades-long taboo on talking about and dealing with the
energy sector's problems. She did predict that if an overly
narrow energy package is all that can be passed this year,
there would be another round of reform in the next couple of
years when it became clear that Mexico's production and
gasoline import woes had not been solved.

Comment
-------

8. (SBU) President Calderon seems prepared to yet again
succeed in moving forward, however cautiously, on reforming a
major structural barrier to Mexican economic growth. Given
the nationalist neuralgia surrounding oil in this country,
this will be a major political achievement. With the passage
of some kind of energy reform this year a near certainty, the
question now is how far the reform will go in giving PEMEX
the flexibility it needs to turn itself around. The next two
months will witness a delicate political dance among the
three parties as the PAN and PRI jockey to take credit for
being the more responsible and reasonable actor, while the
PRD merely tries to be relevant while avoiding a major
internal meltdown. Given the PRI's robust occupation of the
middle ground and the still powerful ring of the "no
privatization" mantra, it seems tactically best positioned to
win many of the arguments that will take up most of the
congressional negotiators' time. This might prove of
immediate benefit to the PRI during next year's mid-term
congressional election. On the other hand, if a final reform
package ends up being too watered down to solve the serious
problems that PEMEX faces, that could prove to be a political
liability. We anticipate the coming months of backroom
debate and public posturing will produce political theater of
the highest order. From now until President Calderon signs
something into law, the Embassy strongly recommends that all
USG officials remain quiet and enjoy the show. End comment.
Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity and the North American
Partnership Blog at http://www.intelink.gov/communities/state/nap /
WILLIAMS

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