Mexico: Energy Reform In Mexico: Oil And Gas Brief Outlook

Mexico's landmark, historic energy reform is currently unfolding. This constitutes a major challenge for the country and a huge opportunity to regain a position in the global energy market. For decades, the energy sector in Mexico was an untouchable and an almost sacred realm. The sector was losing competitiveness and the legal framework was impeding the overhaul it very much needed. A truly significant game changer reform had to be implemented.

After a major political agreement was reached, core and fundamental aspects were discussed and agreed upon for a change. Under President Peña Nieto's mandate, the 75 years of a stiff legal framework came to an end. In December 2013, the long-awaited constitutional energy reform decree was issued. In accordance, key legislative and regulatory developments are taking place.

Mexico's Senate is reviewing and revising the first package of implementing legislation pursuant the above-mentioned decree. It is a comprehensive set of new laws (nine) and amendments to many others (12) that are being discussed and will be voted by the end of June. While some changes are expected in the implementing laws, the statement of intent clearly sets the pace of a new energy era in our country where the constitutional reform has already passed.

Many aspects are being introduced by this legislative package but it is noteworthy that Mexico is ready and open for investment. Since it is a comprehensive reform, only a quick overview of some aspects contained in the proposed legislation for the oil and gas component will be addressed here:

It is stated that liquid, solid or gaseous hydrocarbons are property of Mexican Nation as long as they are in the subsoil. However, private parties will be able to invest in upstream and midstream activities with different types of contractual arrangements allowed by the law. PEMEX and CFE (the national oil and electric power companies respectively) have been legally transformed into the so-called Productive State- Owned companies (abbreviated to EPE in Spanish). Competition and participation between them and private companies is provided.

The law establishes for E&P activities two different legal regimes: a) Assignment. Where an EPE is granted the right to explore and extract hydrocarbons for a determined time and place, and b) the E&P contracts; awarded through a tender or bidding process conducted by de National Hydrocarbon Commission (abbreviated to CNH in Spanish), which will execute and manage the said contracts (analysing them on a case-by-case basis). E&P contracts may be entered with: EPE, EPE with private sector (joint venture or joint operating venture) or private sector alone. This regime follows the contract models that international practice has proved to be the most adequate for the host country and for the contractors. The law also establishes that entire foreign investment is allowed through a domestic company, and that booking of reserves is possible. Finally, the Ministry of Finance (SHCP) sets fiscal conditions for contracts.

For the case of cross-border reservoirs, a mandatory 20% EPE participation is required regardless of the fact the EPE is or not the operating contractor. A round–zero is being conducted and by mid-September 2014, at the latest, PEMEX will receive direct assignments if deemed with the financial, technological and operating capabilities for an optimal development of a contract area. Under this regime, an EPE may enter into service contracts. The assignments may be migrated to E&P contracts with the previous consent of the Ministry of Energy (abbreviated to SENER in Spanish), in which case, SENER and SHCP will accordingly determine the applying type of contract and tax treatment. If an EPE -after the relinquishment of an assignment- wants to ally with a private party, a competitive bidding process will be conducted by CNH. SENER will seek PEMEX's opinion in the pre-qualification process in regard the technical, financial and operational capabilities.

SENER may determine PEMEX's participation in certain E&P contracts. Such would be the case if PEMEX has an assignment coexisting in a particular contract area, EPE or PEMEX participation -up to a 30% maximum- if a Mexican financial vehicle is used in that particular contract or if it is deemed that sharing of knowledge or technology would bring value and would enhance PEMEX capabilities.

E&P contracts require a minimum national content, which will gradually grow until reaching 25% within a scope of 10 years starting 2015. Notwithstanding the foregoing, the "national treatment rule" signed by Mexico on international treaties is applicable. Contractors are required to submit information from their surveys and E&P activities. The submitted information will be treated as confidential.

Midstream and downstream hydrocarbon activities are to be regulated by permits issued by the SENER or the Energy Regulatory Commission (abbreviated to CRE in Spanish), and the opening of the retail fuel sector will be done on stages until it is fully opened. Beginning in 2017, private companies will be able to sell gasoline and diesel without need of the PEMEX franchise and in 2019 to import gasoline and diesel complying with applicable provisions. Three months after the enactment of afore-mentioned law, a CRE or SENER permit must be obtained in order to continue transportation, storage, distribution and retail sale activities. The permit holder's shall allow open access subject to their capacity. Provisions to foster competitiveness and open access in midstream activities are established. It is also provided the gradual decrease of concentration in marketing and pipeline transportation of natural gas; the participants within a ten-year span after the issuance of the law shall not have more than 20% participation.

With respect to the regulatory bodies, a clear strengthening is introduced and new bodies are created:

  • The National Hydrocarbon Agency for Industrial Safety and Environmental Protection is created to regulate the activities for what it is named. Companies will be required to comply not only with industrial safety but also for an efficient use of energy and natural resources.
  • The Mexican Oil Fund for Stabilisation and Development is created to receive, administer and distribute income that derives from E&P activities being carried out by assignments and contracts. Two new implementing laws contain provisions regarding the different income and revenues that result from different types of contractual agreements such as profits, royalties, bonuses, fees, etc., and applicable tax provisions.
  • 12 months after the enactment of the above-mentioned law, the National Center for Natural Gas Control (CENEGAS) shall be established to own and operate PEMEX gas transmission pipeline and storage facilities. It will also be an independent operator of the National System for the Integrated Transportation and Storage of Natural Gas.

The Constitutional Reform and the implementing law establish a legal hydrocarbon easement since hydrocarbon activities are considered public interest activities. A first stage of negotiation between landowner and the EPE or E&P contractor is established for the use, occupation of land, goods or rights. If no negotiation for the consideration is reached, either judicially or through an administrative act, the easement or expropriation shall take place.

The law establishes mechanisms that secure transparency and anticorruption practices. Corrupt acts shall constitute termination events of assignments, E&P contracts and permits. The different regulatory bodies and agencies shall impose fines.

A huge impact can be achieved through this reform. Many are the challenges to be faced but Mexico has a great opportunity and a great historic moment to become a major player in the global energy market.

Originally published by Corporate Livewire - Expert Guide: Energy & Natural Resources 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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