Mexico: Oil & Gas Regulation 2018

1 Overview of Natural Gas Sector

1.1 A brief outline of your jurisdiction's natural gas sector, including a general description of: natural gas reserves; natural gas production including the extent to which production is associated or non-associated natural gas; import and export of natural gas, including liquefied natural gas (LNG) liquefaction and export facilities, and/or receiving and re-gasification facilities ("LNG facilities"); natural gas pipeline transportation and distribution/transmission network; natural gas storage; and commodity sales and trading.

According to the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos or "CNH"), the production of natural gas in Mexico, during the first semester of 2017, was approximately 26,094.96 million cubic feet per day ("MMCFD"), which represents a decrease of 4,658.30 MMCFD compared to the figures shown for the same period in 2016. Additionally, it is important to note that most of Mexico's natural gas reserves discovered in 2017 are located in Campo Akal (Cantarell area), Region Marina Noreste, Gulf of Mexico, with a 3P category, and account for approximately 2,181.61 billion cubic feet ("Bcf").

According to the Mexican Ministry of Energy (Secretaría de Energía or "SENER"), exports from U.S. pipelines to Mexico will reach 3.8 billion cubic feet per day (Bcf/d) in 2018, which represents more than twice the exports of natural gas from the U.S. to Mexico in 2013 (1.8 Bcf/d). This projected growth is driven mainly by higher demand from Mexico's electric power sector throughout the country. According to the CNH, in August 2017, Petroleos Mexicanos ("Pemex") burned and produced 128.2 MMCFD of natural gas in Mexico. This corresponds to a reduction of 352.4 MMCFD compared to the same month in 2016. To put this into perspective, this reduction represents 9% of the natural gas produced.

Furthermore, it is important to note that a new underwater pipeline running from southern Texas, USA, to Tuxpan, Veracruz, Mexico (along the coast of the Gulf of Mexico) will commence operations in 2018. Please be advised that such pipeline will have a capacity of 2,600 million cubic feet per day ("MMPCD") and an approximate length of 800 kilometres ("km"). This project will contribute to satisfying the natural gas requirements at the Federal Electricity Commission (Comisión Federal de Electricidad or "CFE") and will supply natural gas to newly constructed power plants and others that operate with fuel oil, which can be converted to use natural gas.

In July 2017, according to statistics published by the U.S. Energy Information Administration ("EIA"), SENER opened the onshore portion of the Burgos Basin, a shale-rich basin in northeastern Mexico, for natural gas exploration and development by private companies. This is the first time non-state entities were offered access to the Burgos Basin for development since the creation of the national oil company Pemex in 1938.

1.2 To what extent are your jurisdiction's energy requirements met using natural gas (including LNG)?

Currently, Mexico's energy requirements are met through diverse power sources such as natural gas (55%), hydraulic (14.8%), carbon (13%), fuel oil (10%), uranium (3.7%), geothermal (2.3%), wind (0.7%) and solar (less than 0.1% of total production). Although energy requirements are mainly met through the use of natural gas, statistics show a slight increase in the use of renewable energy sources such as hydraulic and wind power.

1.3 To what extent are your jurisdiction's natural gas requirements met through domestic natural gas production?

The substitution of natural gas produced from oil for electricity production has grown in 2017, with the main objective of reducing costs and the emission of pollutants, and satisfying the demand for electricity in the country.

According to the Ministry of Energy, from 2015 to 2030, the demand for natural gas will have increased by 20.3%, reaching a volume of 9,030.4 MMCFD. With regards to international trends, it is expected that the demand for electric power will have, from 2015 to 2040, increased by 24.4%, reaching a volume of 32,677.6 MMPCD.

1.4 To what extent is your jurisdiction's natural gas production exported (pipeline or LNG)?

According to the EIA, in August 2017, U.S. natural gas exports through pipelines to Mexico reached unseen levels, now estimated at almost 4.04 billion MMCFD.

U.S. gas exports are expected to grow further in 2018, due to growing natural gas exports to Mexico and increase in domestic demand.

2 Overview of Oil Sector

2.1 Please provide a brief outline of your jurisdiction's oil sector.

Pemex has reported that its average oil production in July 2017 was below 2 million barrels per day ("MBD"), the lowest level for a month in more than 20 years. The average production during July 2017 was 1.99 MBD compared to 2.01 MBD in June. According to official statistics, Pemex has estimated that Mexico will produce 1.951 MBD during 2018, lower than 2017.

2.2 To what extent are your jurisdiction's energy requirements met using oil?

In 2015, the demand for fossil fuels at the national level reached a volume of 17,115 MMPCD which represented an increase of 1.7% compared to 2014. Of the total of this demand, natural gas, with a share of 43.8% with a volume of 7,504.1 MMPCD, is followed by gasoline with a participation of 22.3%, diesel with 12.7%, coal with 7.3%, gas L.P. with 6.3%, fuel oil 4.9%, and finally coke of oil with 2.6% participation.

2.3 To what extent are your jurisdiction's oil requirements met through domestic oil production?

The largest demand was presented by the public electricity sector with a volume of 3,228.9 MMCFD of natural gas, followed by the oil sector with 2,200 MMPCD, the industrial sector with 1,375.8 MMPCD, and private demand with 568.6 MMCFD. The lowest participation was the residential sector with 94.6 MMPCD, services with 33.7 MMPCD and, finally, the transportation sector with a volume of 2.4 MMPCD. It is expected that in almost all sectors there will be an increase in demand, with the exception of the oil sector which will decrease by 34% compared to 2015. The electricity sector will continue to be the largest consumer with 58.7% participation; followed by the industrial sectors, with 23.2%; tanker, with 16.1%; residential and services, with 1.3% and 0.6% respectively; and, finally, the motor transport sector with 0.1%.

2.4 To what extent is your jurisdiction's oil production exported?

According to Pemex, Mexico exported, from January 2017 to August 2017, almost 1,099 thousand barrels per day. Mexico is one of the leading exporters of crude oil worldwide, through its national oil company Pemex (and its subsidiaries).

3 Development of Oil and Natural Gas

3.1 Outline broadly the legal/statutory and organisational framework for the exploration and production ("development") of oil and natural gas reserves including: principal legislation; in whom the State's mineral rights to oil and natural gas are vested; Government authority or authorities responsible for the regulation of oil and natural gas development; and current major initiatives or policies of the Government (if any) in relation to oil and natural gas development.

With the enactment of the Constitutional Reform in Energy Matters on December 20, 2013 (the "Energy Reform"), a major structural change took place which contributed to the development of the country through the sustainable and efficient use of all natural resources; but above all, it had a high impact on the oil exploration and extraction industry. All this began thanks to a reform at the constitutional level in which new provisions on energy were added.

One of the major advances of the Energy Reform has been in natural gas, particularly in the extraction and exploration of natural gas, with the introduction of Round Zero, Round One and Round Two. Round One is the first international public tender for the exploration and extraction of hydrocarbons in the history of Mexico. Derived from the above, various provisions were published in the Official Gazette of the Federation, specifying the requirements for treatment and refining permits for oil, natural gas processing, as well as matters involving the transportation, storage, distribution and commercialisation of natural gas, in order to generate a market that is more competitive and somehow more efficient.

3.2 How are the State's mineral rights to develop oil and natural gas reserves transferred to investors or companies ("participants") (e.g. licence, concession, service contract, contractual rights under Production Sharing Agreement?) and what is the legal status of those rights or interests under domestic law?

There are many types of exploration and extraction contracts that may be tendered by and executed with the CNH, but the contract to be awarded is previously decided by SENER. The contracts are: (i) services; (ii) profit sharing; (iii) production sharing; (iv) licence; and (v) any other contract resulting from the combination of the foregoing. By law, mineral rights of oil and natural gas shall remain state property. Under Mexican law, a licence contract gives partial ownership and possession to the contractor in exchange for the payment of taxes to the Mexican government. Finally, profit-sharing and service contracts do not give title or possession to the contractor of the hydrocarbons, only cash considerations.

3.3 If different authorisations are issued in respect of different stages of development (e.g., exploration appraisal or production arrangements), please specify those authorisations and briefly summarise the most important (standard) terms (such as term/duration, scope of rights, expenditure obligations).

In accordance with the CNH, all contractors that want to obtain exploration and extraction contracts, must carry out all operations plans as approved by the CNH. Also, the execution of any contract must include investment and several pieces of information depending on the block they want to operate in.

As mentioned in the answer to question 3.2 above, there are five different types of exploration and extraction contracts that have to be approved and executed with the CNH: (i) services; (ii) profit sharing; (iii) production sharing; (iv) licence; and (v) any other contract depending on the combination of the foregoing. Once the contract has been approved, the contractor has several obligations to carry out during the entire duration of the contract. Moreover, the amount of the work commitment would vary depending on the size and type of the fields that they will work with.

3.4 To what extent, if any, does the State have an ownership interest, or seek to participate, in the development of oil and natural gas reserves (whether as a matter of law or policy)?

According to the Mexican Constitution, oil and solid, liquid orgaseous hydrocarbons in Mexican subsoil are the inalienable and indefeasible property of the nation and no concessions will be granted. The purpose of this is to provide income for the state which will contribute to the long-term development of the nation, and provide income for the exploration and extraction of oil and other assignments of the productive enterprises of the state or through contracts with them or with individuals, in the terms of the Regulatory Law.

In 2014, the CNH stated in Round Zero that Pemex has to carry out its exploration and extraction plan in compliance with several contracts.

3.5 How does the State derive value from oil and natural gas development (e.g. royalty, share of production, taxes)?

In general, contractors under exploration and extraction contracts must pay: (i) a royalty that is a percentage of the gross revenues of the production; (ii) an exploration fee per square kilometre of the block during the exploration phase of the contract; (iii) a percentage of the profit oil or additional percentage of the production depending on the type of contract; and (iv) income tax applicable to the profits obtained from hydrocarbons production.

3.6 Are there any restrictions on the export of production?

As for service contracts and profit-sharing contracts, oil and gas production is transferred to a special State Trader ("Comercializador del Estado") as an intermediate, who will sell and then distribute the proceeds from the sale to: (i) the Mexican Fund for Stability and Development; and (ii) the contractor, once its commission fee has been charged.

On the other hand, for production-sharing contracts and licence contracts, the contractor is free to store or sell the production it owns to national or international markets, subject to the regulatory permits set forth by the Energy Regulatory Commission (Comisión Reguladora de Energía or "CRE").

3.7 Are there any currency exchange restrictions, or restrictions on the transfer of funds derived from production out of the jurisdiction?

Under the current legislation, there are no currency exchange restrictions or direct transfer fund restrictions. Notwithstanding the above, depending on the type of contract under which hydrocarbons are produced, contractors may not be able to market the production directly, but only through a special State Trader, which may indirectly limit currency exchange options available to monetise production.

3.8 What restrictions (if any) apply to the transfer or disposal of oil and natural gas development rights or interests?

Pursuant to the Hydrocarbons Law and the model contracts of the corresponding Round Bidding Guidelines, transfer of rights or interests shall not be permitted unless authorised by the CNH. The CNH will consider the same criteria for the prequalification process of the bid. Additionally, no change of control, either direct or indirect, shall exist without the previous consent of the CNH.

3.9 Are participants obliged to provide any security or guarantees in relation to oil and natural gas development?

As part of the formal bid proposal, bidders have to present a seriousness guarantee that shall be executed by the CNH in case a bidder wins a block in a bidding round but does not sign the corresponding contract. Once the winner of the bid executes the exploration and extraction contract with the CNH, such participant shall submit one Corporate Guarantee plus an additional Performance Guarantee to comply with the minimum work commitment. The Corporate Guarantee shall be submitted by the ultimate parent of the winning bidder that obliges jointly and severally with such bidder.

3.10 Can rights to develop oil and natural gas reserves granted to a participant be pledged for security, or booked for accounting purposes under domestic law?

Article 45 of the Hydrocarbons Law provides that contractors and assignees are allowed to report, for accounting and financial purposes, all the benefits of the exploration and extraction contracts or assignations, as long as such assignation or contract sets forth that mineral rights are owned by the state.

3.11 In addition to those rights/authorisations required to explore for and produce oil and natural gas, what other principal Government authorisations are required to develop oil and natural gas reserves (e.g. environmental, occupational health and safety) and from whom are these authorisations to be obtained?

The Hydrocarbons Law sets forth the need for a social impact authorisation issued by SENER for the development of a hydrocarbons project. It is noteworthy to mention that rights of way obtained for the development of hydrocarbon blocks are subject to a special acquisition process, which involves both executive and judicial authorities.

The National Agency for Industrial Safety and Environmental Protection for the Hydrocarbons Sector (Agencia Nacional de Seguridad Industrial y de Protección al Medio Ambiente del Sector Hidrocarburos or "ASEA") regulates and supervises environmental protection, and health and safety. The ASEA's health and safety provisions, which are applicable for activities related to hydrocarbons, are still pending publication. Also, Mexican law establishes that any person involved in the development of any oil and gas activity has to obtain an environmental impact authorisation, granted by Ministry of Environmental and Natural Resources (Secretaría de Medio Ambiente y Recursos Naturales or "SEMARNAT").

3.12 Is there any legislation or framework relating to the abandonment or decommissioning of physical structures used in oil and natural gas development? If so, what are the principal features/requirements of the legislation?

The ASEA Law sets out provisions for the abandonment or decommissioning of this kind of structure used in oil and natural gas.

Furthermore, the model contract used in Round One has a specific provision that requires the contractor to set an abandonment trust, which shall be controlled jointly by the contractor and the CNH, in case a commercial discovery exists.

3.13 Is there any legislation or framework relating to gas storage? If so, what are the principal features/ requirements of the legislation?

Pursuant to the Hydrocarbons Law, gas storage services, as a general rule, are subject to non-discriminatory third parties open access in exchange of a tariff payment approved by the CRE. A certain percentage of the storage capacity may be available for selfuse, subject to prior authorisation by the CRE.

Despite the above, it is essential to highlight that, as of August 28, 2014, the creation of the National Center of Natural Gas Control (hereinafter referred as "CENAGAS") was decreed with the purpose of generating a competitive natural gas transportation and storage market. This centre will also act as an independent operator of the Integrated National Natural Gas Transportation and Storage System, which is meant to maintain the continuity and safety of the supply of natural gas across Mexican territory.

4 Import / Export of Natural Gas (including LNG)

4.1 Outline any regulatory requirements, or specific terms, limitations or rules applying in respect of cross-border sales or deliveries of natural gas (including LNG).

According to Mexican regulations, contractors carrying out regulated activities and cross-border sales and deliveries, in relation to exportation activities, have to obtain a permit issued by SENER, an authorisation from the Tax Authorities is also needed, and for a marketing permit an authorisation is required from the CRE.

5 Import / Export of Oil

5.1 Outline any regulatory requirements, or specific terms, limitations or rules applying in respect of cross-border sales or deliveries of oil and oil products.

Following the Energy Reform and with the entry into force of the Hydrocarbons Law, the legal framework that has governed the development of the hydrocarbons and oil industry in the country was profoundly modified so that Mexico can achieve important energy goals and a new market structure.

Pursuant to article 48 of the Hydrocarbons Law, the export and import of hydrocarbons shall be subject to a permit granted by the Ministry of Energy. As for service contracts and profit-sharing contracts, oil and gas production is transferred to a special State Trader, an intermediary, which will distribute any proceeds from the sale to (i) the Mexican Fund for Stability and Development, and (ii) the contractor, once its commission fee has been charged.

On the other hand, for production-sharing contracts and licence contracts, the contractor is free to store or sell the production it owns to national or international markets, subject to the regulatory permits set forth by the CRE.

For sale of oil in Mexico, the contractors must obtain a permit issued by the CRE, and several Tax authorisations are required.

To view the full report please click here.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official opinion or position or institutional view of Rodríguez Dávalos Abogados.

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