Mexico’s recently approved energy laws present a unique opportunity for private investors to once-again participate in Mexico’s oil and gas industry. The reform leads to some legal issues investors should consider when bidding on Mexico’s recently announced opportunities.
In November 2008, Mexico passed its first round of energy reforms (since privatization in 1938) authorizing PEMEX to enter into private contracts for exploration and production. Under those laws, PEMEX developed a model integrated services contract (the PEP Model Contract) and opened bidding for stakes in the Carrizo, Santuario and Magallanes fields.
The PEP Model Contracts were problematic. It was difficult for contractors to book reserves and take interests in the production, and PEMEX maintained unilateral terminations rights if the venture was inconvenient or unprofitable. Understandably, the first bidding round generated mixed results.
PEMEX initiated a second round in January 2012, for six blocks in Mexico’s northern production zone. Mexico attempted to address some of the identified problems in that round, permitting 100 percent of recoverable exploration costs (instead of 75 percent) and revising many other troublesome items. However, those efforts did not include an amendment to Mexico’s governing constitution, thus failing to give foreign energy investors the comfort needed to invest significant sums in Mexican production.
This time, Mexico passed a constitutional reformation in December 2013, and on Aug. 11, 2014, approved secondary laws establishing new parameters for private investment.
Under these Constitutional reforms, PEMEX committed to submitting its Round Zero requests for the fields it desires to maintain in its portfolio. Under that designation, PEMEX also identified properties for joint ventures/farm-in partners, including the Perdido area offshore, the Kayab field in shallow water, the Burgos and Chichontepec basins, several unconventional condensate and resource plays.
The next step is for the Mexican Energy Ministry (SENER) to open bids for PEMEX’s Round Zero selections in the first quarter of 2015, with another bid round in the summer 2015. PEMEX and the National Hydrocarbons Commission of Mexico (CNH) then determine any joint venture/farming partners. Mexico envisions having annual bid rounds through 2018.
For those Round Zero selections, PEMEX may enter into alliances or associate with private parties. Notably, that tender process shall be conducted in a way that is most beneficial to Mexico—not to PEMEX. The basic bid procedure will be to open any selected association opportunities (or in the future, non-Round Zero assets) to a competitive bidding process, organized and regulated by different state entities. While SENER is charged with selecting the areas for public bidding and establishing technical and financial requirements, the CNH is charged with conducting the bidding process, evaluating bids and awarding the contracts, and the Ministry of Finance is charged with establishing the economic and fiscal terms of those contracts.
In making the bids, a number of different new models are available, including license agreements, production sharing/profit sharing contracts and service contracts. The license contracts would include a signing bonus and exploratory phase fee, the payment of royalties at an agreeable rate, and the payment of a percentage of operating profits for the value of the hydrocarbons produced. After making those payments, the contractor may take in-kind at the wellhead, provided it pays any applicable taxes.
More traditional profit and production sharing contracts are available as well. Under these arrangements, the contractor would pay an exploratory phase fee, a certain set royalty and a payment consistent with the percentage of operating profits in the project. In this structure, the contractor has the right to recover costs and essentially share in the production of the resources.
Finally, under the service contract option, contractors will deliver all production to Mexico and the contractor will then be paid for its services out of funds generated from marketing and production.
Key Legal Issues
The new structure raises a number of legal issues. First, only private corporations duly organized and existing under Mexican law will be considered. Thus, foreign companies cannot directly participate in the public bids—they need to participate through Mexican subsidiaries.
Moreover, any production contracts for cross-border oilfields will require mandatory participation by PEMEX in at least 20 percent of the project’s investments. Those contracts must have a minimum participation of “national content,” set to gradually increase starting in 2015, with a maximum requirement of at least 25 percent in those projects by 2025.
Importantly, the energy reforms do not present any new anticorruption framework. They do, however, contain a special charter for certain conduct considered corrupt and sanctionable. In the same manner, participants should be familiar with the Foreign Corrupt Trade Practices Act, the Patriot Act, and the UK Bribery Act to ensure their bids and ultimate awards comply with these laws.
Finally, despite these changes, the ultimate ownership of Mexico’s subsoil hydrocarbons has not changed. The Mexican state unequivocally owns all unproduced hydrocarbons, and ownership is only transferred to a private entity after extraction and after all applicable payments have been made.
Mexico’s Energy Reform is a major step forward in improving the business environment for international oil companies. Successfully navigating this new landscape will require a firm understanding of the nuances of this legal framework and its associated bidding system.