Mexico: E&P Contract Migration in Mexico

Last Updated: 9 May 2017
Article by Carlos Flores, Rafael Quijano and Bruno Vera Stephens

Most Popular Article in Mexico, May 2017

Mexico's Energy Reform liberalized the entire supply chain of the energy sector opening the upstream oil industry to domestic and foreign investors. The Reform allows local and foreign operators, including Petróleos Mexicanos (Pemex) and other state-owned Productive Companies, to participate in E&P ("E&E", acronym for Exploration and Production in accordance with the current Mexican legal framework) by competing in public tenders carried out by the National Hydrocarbons Commission ("CNH", for its acronym in Spanish), an industry regulator responsible for representing the State and carrying on resource management functions. Local and foreign qualified companies can participate in these tenders, including Pemex. Bid winners sign an Exploration & Extraction Contract (CEE) with the CNH.

Prior to the time CNH began conducting tenders, Pemex was given the right to retain certain E&P legacy assets; a total of 4891 blocks, so-called Assignations ("Asignaciones", awarded to Pemex under Round Zero. In fact, these Assignations are agreements or "contracts" between Pemex and the Mexican State through the CNH. The parties are subject to a special (onerous) tax regime. Some assets retained by Pemex are not economically viable under the applicable fiscal regime. Therefore, the new Hydrocarbons Law allows Pemex the option to request both, Energy and Treasury authorities to move to or "Migrate" Assignations from the governing fiscal and contractual Assignations applicable terms to a more lenient scheme with fiscal and contractual terms available to the contractors that have won acreage in CNH's tenders. The key criteria to allow for migration of an Assignation to less burdensome fiscal and contractual regime are that the migrated assets must be operated more efficiently. Often requiring new capital investment, translates into greater benefits, measured in Net Present Value terms to the State that would not be otherwise possible under the original fiscal regime.

The current Hydrocarbons Law also provides Pemex with the option to share risks and rewards of a Migrated Assignation with a partner. It is noteworthy to mention that the partner must be selected in a competitive tender carried out by the CNH. That process is known in Mexico as "Farm-Out". Some Pemex assets operated under service contracts, awarded prior to the Reform are grandfathered and may migrate its contractual terms without the partner selection tender. Between 2003 and 2013, Pemex awarded 22 such service contracts known as COPF (Contratos de Obra Pública Financiada) and CIEP (Contrato Integral de Exploración y Producción).

The Migration process, be it a Farm-Out or a COPF/CIEP migrating into a CEE, officially starts with Pemex alone in a Farm-Out or jointly with the service contract operator, files an Migration Application to the Energy Ministry (SENER) that with the CNH support will sanction the proposed field development plan by Pemex. Mexico through the Ministry of Finance and Public Credit ("SHCP", for its acronym in Spanish) will define new fiscal terms of the migrated contract. In the case of a Farm-Out, the fiscal terms are set at a "just below market" level by SHCP and the potential partners bid will offer some economic terms, during the tender process.

Prior to the submission of an application for a grandfathered migration, Pemex and the COPF/CIEP contractors, prepare a field development plan, negotiate (in principle) the terms of a Joint Operating Agreement (JOA) including each party's working interest and, if it is the case, any investment Pemex may be carried for. The negotiation must be "in principle" because the fiscal and contractual terms are not known at that time. In the case of Farm-Out, Pemex proposes the JOA´s parameters to SENER and SHCP. These terms will be set in the tender rules and award criteria selected. Potential partners will bid additional royalties (set out by SHCP) and payable amount to Pemex.

For instance, in the Deep-water Tender (Round 1, 4th call or R1.4), the CNH offered a License Contract (Tax and Royalty). The R1.4 tender included the process to select a partner for Pemex's Trion Assignation. The Ministry of Finance and Public Credit set the economic bidding parameters limiting the minimum and maximum additional royalty at 3% and 4% respectively. The terms were designed to give priority weighting to the tie-breaker parameter by driving bidder to tie at the maximum additional royalty limit and offering additional work programs, or in the case of Trion, additional carry to Pemex.

As of September 28th, 2016, the Energy Ministry had received 14 migration requests with only one, the Trion block Farm-Out, being completed at the time of this writing. A second Farm- Out tender is ongoing, a 1,096 km2 block including the Ayin and Batsil fields that contain heavy crude. Bids are due June 19, 2017.

An M&A market for upstream assets have not yet developed in Mexico. The bid results of Round 1.3 (onshore marginal fields) do not represent a good indicator of market appetite, therefore, the SHCP did not have a reliable benchmark to assess the Government. Take investors are willing to accept onshore mature oil and gas fields. The drop of oil prices further complicated Pemex's valuation of its contribution to a JV (assessment of the value of Reserves in the corresponding Assignation) as well as the fiscal terms that are appropriate for the migrated contract.

At the time of this writing (April 10, 2017) none of the grandfathered Assignations have migrated to a CEE. It is expected that the Santuario Block, operated by Petrofac under a CIEP will be the first to migrate. Pemex and Petrofac formed a joint venture and executed a Joint Operating Agreement (JOA) to sign a new CEE, as a single entity, with CNH. We expect that with the experience of Trion´s award and the Santuario Assignation migration, when completed, Pemex officials as well as SENER and SHCP will have capitalized the steep learning curve they went through in their early efforts. Hopefully, the experience will streamline the process of future migrations.

Footnote

1. SENER awarded Pemex 489 Assignations in August 2014 of those 108 are considered exploratory Assignations)

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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