In early May 2021, the Mexican Federal Congress approved two bills that materially amended Mexico's Hydrocarbons Law (Ley de Hidrocarburos-LH1), a product of the 2013 Energy Reform in Mexico that opened the upstream, midstream and downstream sectors in the oil and gas industry to private investment. The key provisions of the first bill (the "First Amendment"): (i) added new onerous requirements for granting of midstream and downstream permits, (ii) replaced the "deemed acceptance" standard with a "deemed rejection" standard for permit assignment requests not acted upon by the regulator within the statutory periods and (iii) granted regulators authority to (1) suspend existing permits and take over the operations of the permit holder and (2) revoke existing permits if permit holders fail to satisfy certain conditions under the LH. This First Amendment was officially published and became law on May 4, 2021.
The second bill (the "Second Amendment" and together with the First Amendment, the "LH Amendments") lifts "dominant player" restrictions imposed on Petróleos Mexicanos (Pemex), Mexico's national oil company, such that Pemex may now conduct business unfettered as a regular market participant. Although the Second Amendment has been approved by Congress, it has yet to become effective as its final publication is still pending (though expected to occur imminently).
The First Amendment was sent by Mexican President Andrés Manuel López Obrador (hereinafter, AMLO) to Congress on March 26, 2021, and the Second Amendment was submitted on April 20, 2021 by Congressman Manuel Rodríguez González-a member of AMLO's Morena party. The deliberation and approval processes of both LH Amendments in the Congress' Lower Chamber (Cámara de Diputados) were fast-tracked. The First Amendment was approved on April 14, 2021-reflecting minimal revisions from the initial draft sent by AMLO. The Second Amendment was approved in less than 48 hours after its submission by congressman Rodríguez with no revisions.
As noted below, as of the date of this article, several constitutional challenges have been filed by several industry players and several temporary injunctions (suspensiones provisionales) have been granted, suspending most of provisions of the LH Amendments.
Minimum Storage Capacity Requirements
Under the legal framework introduced as part of the historic 2013 Constitutional energy reform (the "Prior O&G Framework"), applicants could obtain their marketing permits before having to demonstrate compliance with the storage requirements established by the Mexican Ministry of Energy (Secretaría de Energía-SENER)2, which SENER has been publishing since 2007 for each upcoming calendar year.3 This was logical because developers and financing parties usually need to obtain marketing permits prior to securing and committing to, long-term storage infrastructure and the associated capital expenditures. However, under the Prior O&G Framework, failure to meet with the minimum storage requirements was not a cause for permit revocation, which was generally reserved for material defaults by the permit holder.
Per the First Amendment, the minimum storage requirement is now a condition to the issuance of the relevant midstream or downstream permit.4 This seemingly simple modification introduces a significant barrier to entry for new permit applicants. Applicants must now demonstrate ex-ante rights access to the necessary third-party storage infrastructure. Together with the concerns about the discretionary authority that the LH Amendments appear to grant to the Energy Regulatory Commission (Comisión Reguladora de Energía-CRE) and SENER, these changes create legal uncertainty for new investors. Ultimately, the First Amendment favors market participants that already have obtained the necessary infrastructure (i.e., Pemex); conversely, it imposes significant additional burdens on new market players in terms of development costs, time required to develop infrastructure and the risks associated with the permitting process itself. Particularly, this could result in a "Catch-22" for a new refined products trader: on the one hand, it will not be able to obtain a marketing permit without first obtaining the necessary storage infrastructure under long-term arrangements; on the other hand, it will be reluctant to enter into (and may have difficulty obtaining) such long-term commitments if its ability to obtain the marketing permit is uncertain. The same goes for debt financing parties.
Furthermore, the First Amendment provides that CRE has the discretion to revoke existing permits (including marketing permits) if the permit holder fails to meet the minimum storage requirement determined by SENER.5 Because of Mexico's limited storage infrastructure and the fact that most of the existing storage facilities are owned or managed by Pemex, permit holders will now face additional and potentially insurmountable challenges to obtaining rights to storage capacity.
Due Process for Revocation
The First Amendment provides that any permit holder that is in breach of either the minimum storage requirements or any other requirement under the LH will have its permits revoked. However, the First Amendment provides no process for determining such breaches whatsoever, nor does it provide any process to exercise any defenses for the affected permit holder.6 Based on the plain language of the First Amendment, this appears to be an automatic revocation that would take place when the First Amendment became effective, and it remains unclear whether the process for permit revocations under the Prior O&G Framework is still applicable. The vagueness of this provision raises serious due process concerns and, to the extent permits are revoked on this basis, it could give rise to constitutional challenges (amparos) and/or international treaty protection claims by affected parties.7 As of the date of this writing, several constitutional challenges to strike down the First Amendment have been filed by several industry players. Although the relevant judicial processes are still pending, temporary injunctions (suspensiones temporales) have been granted, suspending most of the provisions of the LH Amendments.
Permit Assignment Discretion
Under both the Prior O&G Framework and the LH Amendments, permit holders may assign their permits to third parties with the prior written consent of CRE or SENER, as applicable.8 Consents are granted by the relevant authority if the proposed assignee meets the required legal, financial and technical criteria set forth in the LH.9 Under the Prior O&G Framework, if CRE or SENER failed to approve or deny the proposed assignment within the applicable statutory timeframe, the consent to the assignment was deemed granted.10
The First Amendment replaces the "deemed approval" standard with a "deemed rejection" standard.11 As recently noted by the Federal Economic Competition Commission (Comisión Federal de Competencia Económica-COFECE)12, deemed rejections create perverse incentives for authorities as there is no consequence for administrative delay or silence, and, therefore, no regulatory requirement to provide sufficient legal grounds for rejecting permit holder requests. The First Amendment thus introduces structural inefficiencies to the market and the potential for discretionary and unjustified rejections of permit transfer requests.
Permit Suspension and Operation Step-In Rights for CRE/SENER
Under the Prior O&G Framework, either SENER or CRE, as applicable, could take over or "intervene" the operations of any permit holder when such intervention was deemed to be in the best interest of Mexico, so long as third-party beneficiary rights were honored.13 The First Amendment provides that permits may also be "suspended" upon: (i) imminent danger to "the national security, energy security or the national economy" or (ii) repeated breaches by the permit holder under the LH.14
First Amendment provides that if a permit is suspended, CRE and SENER are authorized to "take over the operations" of the permit holder to ensure continuity of operations for the benefit of consumers. CRE and SENER would be then authorized to use the permit holder's personnel and facilities and/or hire a new operator.15 The authority to take over the operations and control of an asset is not necessarily a new concept under Mexican Law-for example, certain assets, such as telecommunications assets, are subject to a similar form of seizure (requisa) when necessary for national security or the national economy, with the seizure lasting until such conditions persist. In contrast, the new oil and gas regulator's power to take over operations is not time limited. Notably, while the original proposed draft of the First Amendment distinguished between "temporary" and "definitive" permit suspensions, the First Amendment, as enacted, only refers to "suspensions" determined by CRE or SENER, without any reference to duration.16
If acted upon, the government's discretionary and open-ended authority to take-over the operations of an investor's assets could give rise to constitutional claims (amparo) and potentially international arbitration for uncompensated seizure or taking. This is concerning to private investors; moreso, when coupled with the nationalistic rhetoric by the AMLO administration with respect to the Mexican energy sector. It has the potential to set the stage for abuse.
The First Amendment provides that permit holders adversely affected by the First Amendment may request the payment of corresponding damages.17] It is unclear what kind of damages may be recovered since no reference is provided to any mechanism to determine the amount of damages. The lack of specificity under this provision creates significant complications. At a minimum, a claimant should be entitled to an evidentiary hearing in a court of law to ascertain what damages exist, in which case we would expect the government to attempt to reduce or negate the original claim.
Under the Prior O&G Framework, Pemex was deemed to be a "dominant player" in the Mexican oil and gas markets.18 As a result, several asymmetrical rules were imposed on Pemex with the purpose of ensuring a level playing field for new refined products players.19 Accordingly, CRE issued several specific rules for Pemex, including: (i) fixed price formulas for first hand sales (ventas de primera mano) of gasoline and diesel,20 (ii) limitations on Pemex's ability to deny the supply of petroleum products to non-affiliated third parties,21 and (iii) limitations on the duration of new contracts entered into by Pemex as a natural gas or refined products marketer.22.
The Second Amendment provides that Pemex is no longer a "dominant player" on the basis that the oil and gas markets are now allegedly "fully competitive because of wider participation from new players, which allows the efficient development of the markets."23 This "competitive market" determination was made considering the number of permits already granted to private entities.24 Specifically, the Second Amendment mentions that only 207 out of the 23,134 permits granted as of February 2021 are currently held by Pemex. The disparity between the number of Pemex and non-Pemex permits, according to the Second Amendment, evidences the "great participation of private entities in the relevant markets."25 Notably, official market reports published by SENER show that participation from private investment in the gasoline and diesel sectors is relatively low at almost 20 percent. Further, the infrastructure covered by Pemex's permits is typically much larger than that of new private projects and, in some cases, Pemex has aggregated several facilities under a single permit. Therefore, the numbers published by SENER are not necessarily indicative of the actual market penetration of private players. In any case, PEMEX direct sales prices are no longer capped or regulated for that matter and Pemex is now free to enter into refined products sales as any ordinary market trader.
Although COFECE has not yet issued an opinion in connection with this determination (likely due to the fast-tracked approval of the Second Amendment), it has repeatedly stressed the low participation of private players in the refined products and natural gas markets. One of the reasons for the low market participation of private parties is the limited availability of private storage and transportation capacity.26 It is yet unclear whether the "market efficiency" claim included in the Second Amendment will withstand COFECE's scrutiny. COFECE has recently issued opinions against Pemex's and CFE's monopolistic powers and any law or regulations that incentivize such practices. Further, COFECE could potentially impose sanctions on Pemex for anti-competitive practices under the Antitrust Law (Ley Federal de Competencia Economica-LFCE), as it has done so in the past.27
The LH Amendments bring to fruition AMLO's intention to tip the regulatory scales in favor of Pemex as a de facto dominant midstream and downstream player. Raising the requirements to obtain new marketing permits by including ex-ante storage requirements, as well as broadening the scenarios for government intervention in energy projects, create an unfavorable panorama for both existing and prospective private investors. Furthermore, discretionary (and potentially automatic) permit revocations further erode the existing energy legal framework, opening the door to legal claims in local courts and through foreign investment mechanisms under applicable international treaties.
These actions, coupled with the elimination of asymmetric rules previously imposed on Pemex, translate into material disadvantages for newcomers that may effectively prevent the entry of new players into the market. Furthermore, private entities already participating in the Mexican market may now face barriers to exit in the form of obstacles to transferring their permits to new entities coupled with administrative delays for the approval of permit modifications, including those arising from potential changes in the permit holder corporate structure (i.e., equity transfers resulting in change of control of the permit holder) which may also affect the valuation of their assets.
While the LH Amendments came as no surprise based on the AMLO administration's stated objective to unwind the 2013 Energy Reform and to empower state-owned companies in Mexico, they are still likely to generate serious uncertainty and protracted legal challenges. To date, the AMLO Administration has focused its policy reforms on the power generation and the refined products midstream and downstream sectors. Notably, these measures have not affected the upstream oil and gas sector beyond of the cancellation of the upstream tenders (Rondas) for the exploration and production of oil and gas blocks, which tenders had increased competition for Pemex in the upstream space. It remains to be seen whether other sectors will come under the purview of the AMLO Administration's actions to enhance the market power of state-owned companies. As was the case with the actions taken in connection with renewable energy (see our 3-chapter series discussing these actions: Chapter 1, Chapter 2 and Chapter 3), we anticipate that market players will pursue legal actions in Mexican courts and explore remedies through international arbitration. Indeed, at the date of this writing, several preliminary amparos have already been granted by Mexican courts suspending parts of the First Amendment.28 We will continue to closely follow the regulatory developments in the Mexican energy sector, as well as the likely consequences for market participants and potential claims.
Special thanks to visiting attorney Pedro Lladó for his valuable assistance with this note.
1 "Decreto por el que se reforman y adicionan diversas disposiciones de la Ley de Hidrocarburos," Official Gazette website, May 4, 2021.
2 Article 80 section II of the "Ley de Hidrocarburos."
3 Secretaría de Energía "Acuerdo por el que se emite la Política Pública de Almacenamiento Mínimo de Petrolíferos," Official Gazette website, Dec. 12, 2017.
4 Article 51 section III of the "Ley de Hidrocarburos" (as amended by the LH Amendment).
5 Fourth transitory article of the "Decreto por el que se reforman y adicionan diversas disposiciones de la Ley de Hidrocarburos."
6 Fourth and sixth transitory articles of the "Decreto por el que se reforman y adicionan diversas disposiciones de la Ley de Hidrocarburos."
7 Article 14 of the "Constitución Política de los Estados Unidos Mexicanos."
8 Article 53 of the "Ley de Hidrocarburos" (before the enactment of the LH Amendment).
11 Article 53 of the "Ley de Hidrocarburos" (after the enactment of the LH Amendment).
12 Comisión Federal de Competencia Económica "Opinion OPN-002-2021,", April 8, 2021.
13 Article 53 of the "Ley de Hidrocarburos" (before the enactment of the LH Amendment).
14 Article 57 of the "Ley de Hidrocarburos" (before the enactment of the LH Amendment).
15 Article 57 and 58 Bis of the "Ley de Hidrocarburos" (after the enactment of the LH Amendment).
17 Third transitory article of the "Decreto por el que se reforman y adicionan diversas disposiciones de la Ley de Hidrocarburos."
18 The LH fails to provide a definition of "dominancy". However, this concept seems to be somehow similar to the "preponderant" treatment provided for under the "Telecom Law" (Ley Federal de Telecomunicaciones y Radiodifusión or LFTR). See thirteenth transitory article of the "Ley de Hidrocarburos."
19 See Comisión Reguladora de Energía "RESOLUCIÓN por la que la Comisión Reguladora de Energía emite las disposiciones administrativas de carácter general aplicables a las ventas de primera mano y la comercialización de gasolina y diésel, con condiciones de regulación asimétrica a Petróleos Mexicanos, sus organismos subsidiarios, sus empresas filiales y divisiones y cualquier otra entidad controlada por dichas personas," Official Gazette website, March 22, 2016.
23 Exposición de motivos of the "Iniciativa que reforma el artículo décimo tercero transitorio de la Ley de Hidrocarburos" GACETA PARLAMENTARIA, April 20, 2021
26 See Comisión Federal de Competencia Económica "Transición hacia mercados competidos de gasolinas y diésel" Jan. 30, 2019.
27 See Ley Federal de Competencia Económica
28 Cristobal Riego "Mexican judge partially suspends hydrocarbons reform," BNAMERICAS, May 10, 2021; Arturo Solis "Haremos los cambios necesarios, amaga Nahle tras suspensiones a Ley de Hidrocarburos, FORBES MÉXICO, May 11, 2021.
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