WSG Article: Historic Mexico Energy Reform Opens Opportunities for Domestic and Foreign Companies in the Oil and Gas and Power Industries

Historic Mexico Energy Reform Opens Opportunities for Domestic and Foreign Companies in the Oil and Gas and Power Industries

December, 2013 - Ariel Ramos, William (Hunt) Buckley, Eduardo Corzo Ramos

This past December 12, the Mexican congress finally approved a constitutional energy reform (the “Energy Reform”). As of today, the required majority of state congresses have also ratified it. What now remains is a declaration from the Permanent Commission of the Mexican congress, which is expected shortly. The combination of the amendments to Articles 25, 27 and 28 of the Mexican Constitution and the transitory articles of the Energy Reform will open the oil and gas and power sectors to private participation for the first time in more than 75 years. To this end, the Mexican congress must pass effective implementing legislation, the administration must adopt effective regulations, and that legislation and those regulations must be effectively implemented. The transitory articles entrust the Mexican congress with passing the bulk of the implementing legislation within approximately 120 days from the date of the official publication of the Energy Reform. Achieving business readiness will take longer.

The Energy Reform is the first, necessary step in what could be exciting times for the Mexican energy industry and the domestic and foreign private energy sectors. Although many challenges remain ahead (among others, the adequacy of the implementing legislation and further regulations, including such items as conforming amendments to the foreign investment law to eliminate barriers to entry; and implementation into practice of the new legislation and regulations), we appear to be entering a new era in which partisan politics bow to national interest.

Hot Topics

I. Oil and Gas

A. Exploration and Production

Ownership of Hydrocarbons. Ownership of hydrocarbons in situ remain the exclusive property of the State. No concessions may be granted; but contracts to explore for, develop, and produce hydrocarbons will be allowed under the implementing legislation and related regulations.
Contracts for Exploration and Production. Exploration and production of hydrocarbons will be conducted through contracts between the State and the private sector or the State and “productive state companies” (the latter would include PEMEX). In turn, “productive state companies” can contract with the private sector.
Contract Models. The transitory articles allude to four authorized contract models: (i) service contracts; (ii) profit sharing agreements; (iii) production sharing contracts; and (iv) licenses. The details of the scope and content of these contract models is left to the implementing legislation and subsequent regulations. There is an open question on what will happen to the existing multiple service and public works contracts, and the relatively new incentivized contracts.
Compensation Models. The transitory articles contemplate the following contractor compensation models: (i) cash for service contracts; (ii) a percentage of profits for profit sharing agreements; (iii) a percentage of production for production sharing contracts; (iv) transfer of title of produced hydrocarbons for licenses; and, importantly, (v) any combination of the foregoing. Interestingly, the notion of title transfer is not included in the description of production sharing contracts, as it is respecting licenses. Related issues, such as the amount of royalty (in the case of profit sharing, production sharing, or license agreements) or production share (for production sharing contracts), or whether under any of these models there will be a cost recovery feature, are left to the implementing legislation and related regulations.
Booking of Reserves. The transitory articles of the Energy Reform provide that the private sector (and “productive state companies”) will be able to report, for accounting and financial purposes, the existence of the awarded contract and its related benefits. It is hoped (and the transitory articles touch on the subject albeit parsimoniously) that the implementing legislation, the regulations, and the final forms of contracts (profit sharing, production sharing, and licenses) will satisfy the requirements for the private sector to book reserves.
Creation and Role of the Mexican Oil Fund for the Stabilization and Development (Fondo Mexicano del Petroleo para la Estabilización y el Desarrollo). A public trust (fideicomiso) is to be created at the Mexican Central Bank (Banco de México), with that bank as the trustee. The trust is to receive and distribute all income (other than taxes) payable to the State from the three principal contract models (profit sharing, production sharing, and licenses). The trust is to be created during 2014 and to be fully operational in 2015. It is unclear how the trust will work in the context of the profit sharing, production sharing, and license agreements (e.g., royalty versus contractor share), such details being left to the implementing legislation and related regulations.

B. Competent Authorities and Agencies; PEMEX Round Zero

The Role of the Secretaría de Energía. The Ministry of Energy’s role includes managing and leading the State’s energy policy, making direct awards to “productive state companies,” selecting contract areas, designing the contracts, and establishing technical guidelines for the bidding and award procedures. The Ministry of Energy is also tasked with the function of granting permits for treatment, processing, and refining of oil and gas.
The Role of the Comisión Nacional de Hidrocarburos. The National Hydrocarbons Commission’s tasks include assisting the Ministry of Energy in technical and informational matters (such as geological, geophysical, production, and other operational information), conducting public bids and awarding oil and gas contracts, supervising production plans, and regulating operations.
The Role of the Comisión Reguladora de Energía. The Energy Regulatory Commission will be empowered to regulate and grant permits for storage, transportation, and distribution of oil, gas, refined products, and petrochemicals through pipelines, as well as first sales of the foregoing products. Both this commission and the National Hydrocarbons Commission will be established as agencies independent of the federal government, pursuant to the implementing legislation and related regulations.
Creation of the National Center of Control of Natural Gas (Centro Nacional de Control de Gas Natural). The transitory articles to the Energy Reform require congress to pass implementing legislation to create a new center to operate the national pipeline system for the transportation and storage of natural gas, and to manage existing contracts.
Transformation of PEMEX to a Productive State Company. PEMEX is to be transformed into a “productive state company” within two years. PEMEX will then have an autonomous budget and will operate autonomously. PEMEX’s tax burden will be reduced and the lost tax revenue to the State is expected to be made up through royalties, production and profit sharing, and corporate taxes. The transformation will also exclude the PEMEX union from participation in PEMEX’s board.
Round Zero. The Ministry of Energy (Secretaría de Energía), with technical assistance from the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos), will assign to PEMEX those producing fields that PEMEX requests be assigned to it and that the Ministry considers PEMEX is capable of operating.

II. Power

State Reservation; Private Sector Participation. The State reserves exclusive control over transmission and distribution of power, for which it may not grant any concessions. However, among other activities, the private sector will be allowed to generate power and sell it to end users, and, on behalf of the State, to build, operate, finance, and extend the infrastructure that is necessary for the State to provide the public service of transmission and distribution. The implementing legislation is to design contracts regarding these aspects of the power industry.
Power Permits and Rates. The Comisión Reguladora de Energía will have the authority to regulate and grant permits for power generation by the private sector and “productive state companies,” as well as to regulate and establish the fees for transmission and distribution.
Transition to Clean Energy. Within 365 days from the Energy Reform becoming effective, the Ministry of Energy must include in the “National Program for Sustainable Use of Energy,” a strategy to promote the use of cleaner fuels and technologies.
Geothermal Energy. The transitory articles to the Energy Reform require the Mexican congress to issue, within 120 days of the Energy Reform becoming effective, a law to regulate the survey, exploration, and exploitation of geothermal resources.
Creation of the National Center of Energy Control (“Centro Nacional de Control de Energía” – “CENACE”). The transitory articles to the Energy Reform require the passage of implementing legislation to create a center, as a decentralized federal entity with its own legal personality and patrimony, to operate the “national power grid” and the power market, and to provide non-discriminatory access to the national transmission system and the general channels of distribution. This reorganization will necessarily require the spin-off of certain CFE assets and the implementing legislation should address the effect of these changes on existing CFE commitments and contracts (e.g., those under the independent power producer arrangements).
Transformation of the Federal Electricity Commission (Comisión Federal de Electricidad) to a Productive State Company. The Federal Electricity Commission is to be transformed into a “productive state company,” with an autonomous budget and autonomous performance.