Mexico: Energy Reform – Chapter I: Overview Of The Energy Reform On The Matter Of Hydrocarbons

Last Updated: 29 June 2015
Article by Turanzas, Bravo & Ambrosi

The recently enacted energy reform marks a landmark in Mexico's governmental stance in this matter. Historical background and patriotic sentiments nourished a closeness perspective in this field (specially in the oil matters) that lasted for nearly more than 75 years.

The energy reform allows the participation of private parties (and Mexican public companies) in upstream activities; these economic agents may organize in corporate vehicles as permitted by the applicable mercantile laws, hence, the association legal mechanisms are broad and not specifically limited.

Even with the reform the ownership of oil and solid, liquid and gas hydrocarbons in the subsoil, remains exclusively of the Nation, the contracts' value for exploration and exploitation may be recorded for accounting and/or financial purposes.

The several types of contracts contemplated by the reform entail specific taxes and other consideration payments, creating obvious consequences in ascertain the profitability of these agreements.

CHAPTER I OVERVIEW OF THE ENERGY REFORM ON THE MATTER OF HIDROCARBONS

The Federal Executive submitted the bill with the constitutional amendment for the Energy Reform on August 12, 2013; the same was approved by the Upper Chamber (Cámara de Senadores) on December 11, 2013 and by the Lower Chamber (Cámara de Diputados) on December 12 of that same year. Said reform was approved by all legislative branches of the different Federal Entities and was finally published in the Federal Official Gazette (DOF, for its initials in Spanish, Diario Oficial of the Federación) on December 20, 2013.

In connection with this reform, paragraphs Fourth, Sixth and Eight of Article 25 of the Political Constitution for the United States of Mexico (CPEUM, for its initials in Spanish, Constitución Política de los Estados Unidos Mexicanos) were amended, as well as paragraph Sixth of Article 27, and paragraphs Fourth and Sixth of Article 28; additionally, a paragraph Seventh was added to Article 27 and a paragraph Eighth was added to Article 28.

On August 11, 2014, the following 9 secondary laws on energy matters were published in the DOF, supporting the Energy Reform:

  1. Hydrocarbon Revenue Law.
  2. Law on the Mexican Oil Fund for Stabilization and Development.
  3. Power Industry Law.
  4. Geothermal Energy Law.
  5. Law on Coordinated Regulatory Entities on Energy Matters.
  6. Law of the National Agency for Industrial Safety and Environmental Protection in the Hydrocarbon Sector.
  7. Hydrocarbon Law.
  8. Law on Petróleos Mexicanos.
  9. Law of the Federal Electricity Commission.

Resulting from the Energy Reform, the following existing 12 secondary laws were amended:

  1. Foreign Investment Law.
  2. Mining Law.
  3. Law on Public Private Associations.
  4. Law on National Waters.
  5. Federal Law on State-Owned Entities.
  6. Law on Acquisitions, Leases and Services for the Public Sector.
  7. Law on Works and Services Related Therewith.
  8. Organic Law on Federal Public Administration.
  9. Federal Law on Fees.
  10. Tax Coordination Law.
  11. Federal Law on Budget and Treasury Liabilities.
  12. General Law on Public Debt.

Finally, in connection with the Energy Reform, the following 9 regulations have been issued:

  1. Internal Regulations of the Ministry of Energy.
  2. Regulations of the Geothermal Energy Law.
  3. Regulations of the Hydrocarbon Law.
  4. Regulations of the Hydrocarbon Revenue Law.
  5. Regulations of the Law of the Federal Electricity Commission.
  6. Regulations of the Power Industry Law.
  7. Regulations of the Law on Petróleos Mexicanos.
  8. Regulations of the activities set forth in Title Third of the Hydrocarbon Law.
  9. Internal Regulations of the National Agency for Industrial Safety and Environmental Protection in the Hydrocarbon Sector.

Following is a brief description of those items of the Energy Reform that we consider core matters:

1. Strategic Areas

Paragraph Fourth of Article 28 of the CPEUM provides that Exploration and Extraction of Oil and other Hydrocarbons constitute strategic activities that shall be exercised exclusively by the State, which shall not constitute a monopoly.

Pursuant to Paragraph Fourth of Article 25 of the CPEUM, the Federal Government shall maintain ownership and control of organizations and State-Owned Companies (EPE, for its initials in Spanish, Empresas de Participación Estatal) that have the purpose of Exploring and Extracting oil and other Hydrocarbons.

Article 5 of the Hydrocarbon Law (LH, for its initials in Spanish, Ley de Hidrocarburos) provides that only the Nation shall carry on with the activities of Exploration and Extraction of Hydrocarbons, through Assignees and Contractors.

That same Article, however, provides that Reconnaissance and Surface Exploration activities may be carried on by PEMEX, any other EPE or state-owned company, as well as by any other person who obtains prior authorization or permit.

2. Ownership by the Nation

Paragraph Sixth of Article 27 of the CPEUM provides that the Nation maintains direct ownership over any kind of Hydrocarbons, and that this ownership is inalienable and non-lapsable.

Paragraph Seventh of this Article provides that ownership of oil and solid, liquid and gas Hydrocarbons in the subsoil, is exclusively of the Nation and no concessions will be granted to private parties in connection with such Hydrocarbons. This situation must be stated in the Assignments and Contracts that are granted in connection therewith.

These principles are strengthened and extended by Article 1 of the LH, which provides that the Nation owns the direct, inalienable and non-lapsable property of all Hydrocarbons that are in the subsoil of national territory, including the continental shelf and the exclusive economic zone located outside the territorial sea and adjacent to it, in beds or fields, whatever their physical state may be.

3. Social Interests and Public Order

Transitory Article eight of the Decree of Constitutional Reform provides that the activities of Exploration and Extraction of Hydrocarbons (upstream) are considered of public order and social interests, based on which they shall be preferred over any other activity that implies benefiting from the subsoil surface and affected plots of land.

Article 25 of the LH provides that acts relative to the tender and awarding process for the Exploration and Extraction of Hydrocarbons (upstream) are also regarded of public order and social interests.

4. Participation of private entities and EPE in upstream operations

In order to obtain income for the State, Exploration and Extraction Activities of Hydrocarbons (upstream) shall be carried on through Assignments to be granted to EPE, and Contracts that will be awarded to EPE and/or private parties. In order to comply with Assignments, EPEs may retain private parties.

Pursuant to Transitory Article Third of the Decree for constitutional reform, PEMEX and CFE, currently de-centralized bodies, shall be converted into EPE.

4.1. Assignments

Transitory Article Sixth of the Decree for constitutional reform enables SENER (Ministry of Energy, for its initials in Spanish, Secretaría de Energía), assisted by the CNH (National Hydrocarbon Commission, for its initials in Spanish, Comisión Nacional de Hidrocarburos), to award Assignments to PEMEX, for which such EPE shall provide evidence that it has technical, financial and execution capabilities required to Explore and Extract Hydrocarbons in an efficient and competitive manner.

Article 6 of the LH provides that Assignment titles shall contain the following requirements:

  1. Assignment Area.
  2. Terms and conditions that must be observed in the Exploration and Extraction of Hydrocarbons.
  3. Conditions and mechanisms to reduce or return the Assignment Area.
  4. The term, as well as conditions, for extension.
  5. Procurement of guarantees and insurance.
  6. Minimum percentage of National content.
  7. The term for the Assignee to submit to the CNH, for approval, the Exploration plan or the Extraction development plan, as the case may be.

Pursuant to the provisions set forth in Article 9 of the LH, the Federal Executive, PEMEX and the other EPEs, may enter into service contracts with private entities, under schemes that allow them the most productivity and profitability, provided the resulting consideration is paid in cash.

Once the Assignment has been granted, PEMEX may propose to SENER the migration of the Assignment to any of the Contracts for Exploration and Extraction of Hydrocarbons. In such cases, the CNH shall carry on with the corresponding tender so that private parties may take part in such Contracts.

We believe it is correct that in case PEMEX decides to migrate an Assignment to a Contract, it is not such EPE who appoints the private parties who will take part in such Contract, but that such scenario is decided by means of a tender held by the CNH.

Upon prior approval from the SENER and notice to the CNH, Assignees may also waive their rights to the Assignment.

SENER may revoke an Assignment and recover the Assignment Area whenever any of the following serious grounds occurs:

  1. Whenever Assignee fails to begin or suspends the activities set forth in the Exploration plan or Extraction development plan in the Assignment Area for more than 180 consecutive calendar days, without justified cause or authorization from the CNH in the terms set forth in the Assignment title.
  2. In case the Assignee fails to meet the minimum work commitment, without justified cause, pursuant to the terms and conditions set forth in the Assignment granted.
  3. Whenever serious accidents occur caused by deceit or fault of the Assignee, which cause damage to the facilities, casualties and loss of production.
  4. Whenever Assignee in more than one occasion deceitfully or unjustifiably delivers false information or false or incomplete reports, or hides them from the SENER, the SHCP (Ministry of the Treasury and Public Credit, for its initials in Spanish, Secretaría de Hacienda y Crédito Público) or the Ministry of Economy, the CNH or the National Agency for Industrial Safety and Environmental Protection in the Hydrocarbon Sector, regarding the production, costs or any other relevant aspect of the Assignment.
  5. Any other grounds set forth in the Assignment title.

Article 10 of the LH provides an administrative proceeding that Assignees may follow as means of defense in case the Assignment is revoked.

4.2. Contracts for the Exploration and Extraction of Hydrocarbons

Only the Mexican State, through the CNH, may grant Contracts for Exploration and Extraction of Hydrocarbons, by previously following a tender subject to the general rules set forth in Article 23 of the LH; the indirect injunction proceeding (juicio de amparo indirecto) is the only defense recourse available against resolutions appointing the winner of a tender.

Said Contracts shall have the purpose of carrying on with the activities of Exploration and Extraction of Hydrocarbons (upstream), on behalf of the Nation, and the State itself shall define the most suitable contractual model for each specific case, always maximizing the Nation's income.

Article 27 of such law provides that Contracts for Exploration and Exploitation of Natural Gas may be awarded directly to mining concessionaires, without prior tender.

Transitory Article Fourth of the Decree for constitutional reform provides the following modes for contracting:

  1. Services.
  2. Shared Profits or Shared Production.
  3. License.

That same Transitory Article provides the following modes for the considerations:

  1. In cash, for Service Contracts.
  2. A percentage of the profits, for Contracts of Shared Profits.
  3. A percentage of production obtained, for the Contracts of Shared Production.
  4. Transfer of Hydrocarbons for a fee once these have been extracted from the sub-soil, in the case of License Contracts.
  5. Hybrid, that is, any combination of the above-mentioned modes.

Pursuant to the provisions set forth in Article 19 of the LH, Contracts for Exploration and Extraction of Hydrocarbons, shall contain the following minimum clauses:

  1. Definition of the Contractual Area.
  2. Exploration and Extraction development plans, including the term for their submission.
  3. Minimum work and investment program, as the case may be.
  4. Contractor's obligations and undertakings, including economic and tax terms.
  5. The term, as well as conditions, for its extension.
  6. Procurement of guarantees and insurance.
  7. The existence of an external audit system to supervise the effective recovery, as the case may be, of costs incurred and the other accounting involved in the contract's operation.
  8. Causes of termination for the contract, including early termination and administrative termination.
  9. Transparency obligations that enable access to information under the Contracts, including disclosure of considerations, contributions and payments set forth in the contract itself.
  10. The minimum percentage of National content.
  11. Conditions and mechanism to reduce or return the Contractual Area.
  12. Conflict solving, including alternative means to solve conflicts.
  13. Applicable penalties in case of default of contractual obligations and undertakings.
  14. The Contractor and the operator's liabilities pursuant to best international practices. In case of an accident, Contractor's or operator's liability shall not be limited if their willful misconduct or fault is proven.
  15. Observance of best international practices for operating the Contractual Area.

5. Regime applicable to information obtained

Article 32 of the LH provides that geological, geophysical, petro-physical and petrochemical information belongs to the Nation and, in general, any information obtained or that has been obtained from Superficial Reconnaissance and Exploration activities, as well as from Exploration and Extraction activities, carried out by PEMEX, any other EPE or any other person.

The CNH shall be in charge of the supply, custody, use, administration and update, as well as publication of the above-mentioned information, through the National Center of Hydrocarbon Information (Centro Nacional de Información de Hidrocarburos).

It is prohibited for those holding information to publish, deliver or obtain any information through means other than those set forth in the LH or without the CNH's prior consent.

Notwithstanding the above, pursuant to the provisions set forth in Article 33 of the LH, those holding information shall be entitled to the commercial exploitation of information obtained in connection with their activities, within the terms set forth for such purpose by the CNH.

6. Mexican Oil Fund for Stabilization and Development

Paragraph Sixth of Article 28 of the CPEUM provides that the State shall have a public trust denominated Mexican Oil Fund for Stabilization and Development (Fondo Mexicano del Petróleo para la Estabilización y el Desarrollo), with the Banco de México as trustee.

The main purpose of the above-mentioned public trust shall be to receive, manage and distribute income from Assignments and Contracts for Exploration and Extraction of Hydrocarbons (upstream), except taxes.

Transitory Article Fourteenth of the Decree for constitutional reform provides the following order or precedence for the management and distribution of income received by the Mexican Oil Fund for Stabilization and Development:

  1. Make payments set forth in the Assignments and Contracts. This matter will be explained later, in the section corresponding to income by the State.
  2. Make transfers to the Funds for Stabilization of Oil Income and Stabilization of Income for the Federal Entities (Fondos de Estabilización de los Ingresos Petroleros y de Estabilización de los Ingresos de las Entidades Federativas). Once the Fund for Stabilization of Oil Income, or its equivalent, has reached its maximum limit, resources allocated to the Fund shall be allocated to long term savings, as set forth in item e) below.
  3. Make transfers to the Fund for Hydrocarbon Extractions; the research funds on Hydrocarbons and energy sustainability, and on oil tax overview.
  4. Transfer required funds to the Federal Treasury so that oil income of the Federal Government allocated to cover the Federal Expense Budget each year, is maintained within 4.7% of the GNP, corresponding to the ratio equal to the one observed from oil income for the year 2013.
  5. Allocate funds to long-term savings, including investment in financial assets.

Only when the balance of investments on long-term savings is equal to or higher than 3% of the GNP of the immediately preceding year, the Fund's Technical Committee may allocate resources of the Fund's accrued balance to the following:

  1. Up to an amount equal to 10% of the increase observed in the preceding year in the balance of long term savings, to the Fund for universal pension system.
  2. Up to an amount equal to 10% of the increase observed in the preceding year in the balance of long term savings, to finance investment projects in science, technology and innovation, and in renewable energies.
  3. Up to an amount equal to 30% of the increase observed in the preceding year in the balance of long term savings, in funding an investment vehicle specialized in oil projects, with several fields based on SENER and, as the case may be, infrastructure investments for national development.
  4. Up to an amount equal to 10% of the increase observed in the preceding year in the balance of long term savings; in scholarships to train human capital in universities and postgraduate studies; in projects to improve connectivity; as well as the industry's regional development. Except for the scholarship program, no funds may be used for current expenses.

A specific rule is provided in case there is a significant reduction of public income in connection with a drop in the GNP, a severe reduction in oil price or a drop in the oil production platform, and once resources in the Fund for Stabilization of Oil Income or its equivalent, the Lower Chamber (Cámara de Diputados) may approve, by vote approved by two-thirds of members present, integration of resources from public savings to the Budget of Federal Expenses, even when the balance of long-term savings is reduced below 3% of the GNP for the preceding year.

Regarding its organic structure, the Mexican Fund for Stabilization of Oil and for Development has a Technical Committee formed by three members representing the State and four independent members.

Members representing the State shall be: the heads of the SENER, of the SHCP, as well as the Governor of the Banco de México. Independent members shall be appointed by the head of the Federal Executive, with the approval of two-thirds of members present of the Senate of the Republic. The head of the SHCP shall be appointed as Chairman of the Technical Committee.

The Technical Committee of the Mexican Fund for Stabilization of Oil and for Development shall have, amongst others, the following attributions:

  1. Determine the investment policy for long-term savings funds.
  2. Instruct the trustee to carry on with the transfers that may be applicable to the Federal Treasury.
  3. Recommend the Lower Chamber (Cámara de Diputados), no later than on February 28 of each year, the Assignment of the amounts corresponding to general items set forth in the above-mentioned sections a), b), c) and d).

7. Constitutional capacities of the Agencies and Bodies on energy matters

Transitory Article Tenth of the Decree for constitutional reform provides the following key capacities of the Agencies and Bodies on energy matters:

  1. SENER.- Is empowered to establish, direct and coordinate energy policy, the award of Assignments and selection of areas that may be subject to the Contracts for Exploration and Extraction of Hydrocarbons; the technical design of such Contracts and technical guidelines that must be observed in the tender processes; as well as granting permits to treat and refine oil and process natural gas.
  2. CNH.- Is empowered to provide technical consulting to SENER; compile geological and operative information; authorize reconnaissance and surface exploration services; carry on with the tenders, Assignment to winners and execution of Contracts for Exploration and Extraction of Hydrocarbons (upstream); management of Assignments and Contracts for technical purposes; supervising extraction plans that maximize productivity of the field in time and regulate the Exploration and Extraction of Hydrocarbons (upstream).
  3. CRE.- Is empowered to regulate and grant permits for the storage, transport and distribution of pipes for oil, gas, oil bearing and petrochemical products; regulate access of third parties to the transportation pipes and storage of Hydrocarbons and its by-products, and regulate first-hand sales of such products.
  4. SHCP.- Is empowered to establish the economic conditions of the tenders and of the Contracts for Exploration and Extraction of Hydrocarbons (upstream), regarding tax terms that allow the Nation to obtain, in time, income that contribute to its long-term development.

8. Others

  1. Coordinated Regulatory Bodies on Energy Matters.- Paragraph Eighth of Article 28 of the CPEUM provides that the Executive Power shall have the following two coordinated regulatory bodies on energy matters: CNH and CRE.
  2. State workers' labor rights.- Transitory Article Second of the Decree for constitutional reform provides that the labor rights of workers that render services in the Bodies, Agencies and Entities of the Federal Public Administration of the Hydrocarbons sector shall be observed at all times.
  3. Report for accounting and financial purposes.- Transitory Article Fifth of the Decree for constitutional reform provides that EPE and private parties that have executed Contracts for Exploration and Extraction of Hydrocarbons, may report the corresponding Assignment or Contracts for accounting and financial purposes, as well as their expected benefits. Such rule is also set forth in Article 45 of the LH.

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