Foreign Investors to be able to undertake E&P activities, receive production and book oil and gas reserves

Yesterday, Mexico’s House of Deputies passed amendments to the Mexican Constitution and accompanying transitional legislation (the “Energy Reforms”) that will end the state-owned monopolies of Petróleos Mexicanos (PEMEX) and Comisión Federal de Electricidad (CFE) in Mexico’s energy sector. The Mexican Senate had approved the Energy Reforms earlier in the week and a majority of Mexico’s state legislatures are expected to ratify the Energy Reforms by early to mid-January.

The Energy Reforms are designed to allow:

  • Mexico’s Energy Ministry to grant and enter into E&P licenses and production-sharing contracts, as well as profit-sharing and service agreements and other such arrangements, with private sector entities, domestic and foreign;
  • private sector investors to book the oil and gas reserves associated with such agreements under the U.S. Securities and Exchange Commission’s “economic interest” methodology;
  • PEMEX to enter into joint venture arrangements with private sector entities;
  • for the conduct of a “Round Zero” in which PEMEX will be allowed to choose those initial fields in which it desires to maintain its existing interests and/or develop future ones;
  • direct private investment in the midstream and downstream oil and gas sectors;
  • for the creation of a new regulatory agency, the National Center of Natural Gas Control (CNCGN) which will oversee the operation of the national pipeline network currently operated by PEMEX;
  • for the creation of a wholesale power generation market with the National Energy Control Center (CENACE) acting as the system operator independently of the CFE;
  • for the creation of a new regulatory agency, the National Agency for Industrial Safety and Environmental Protection which will be independent of the Ministry of Environment and Natural Resources (SEMARNAT) and which will serve the purpose of regulating industrial, operational safety and environmental matters; and
  • for the establishment of a sovereign Mexican oil fund (the “Mexican Petroleum Fund for Stabilization and Development”).

The Energy Reforms only provide generalized conceptual legislation; however, they also specify that their implementing detailed legislation must be enacted within:

  • one hundred and twenty (120) days for both the oil and gas and electric power sectors, except with respect to environmental matters as noted below;
  • twelve (12) months for the development of additional environmental regulations governing the energy sector; and
  • twelve (12) months for the establishment of the National Center of Natural Gas Control (CNCGN) and the National Energy Control Center.

Upstream Oil and Gas

The Energy Reforms open the upstream oil and gas sector in two fundamental ways. First, they allow the Ministry of Energy to grant oil and gas rights to private companies in the form of licenses, production-sharing contracts, profit-sharing contracts, and service contracts (concessions, however, are still expressly prohibited by the Mexican constitution). The Energy Reforms contemplate an overlapping, multi-agency regulatory framework for the administration of such contracts involving the Energy Ministry (SENER), the National Hydrocarbon Commission (CNH) and the Ministry of Finance (SHCP). The Energy Ministry will be responsible for: (i) the selection of relevant contractual areas; and (ii) the technical design of the upstream contracts and the technical guidelines for the bidding processes. The National Hydrocarbon Commission (CNH) will be responsible for conducting the bidding processes and entering into and administering the related E&P contracts with private parties. The Ministry of Finance will be responsible for establishing the economic conditions for such contracts, such as the relevant royalty rates, tax levels and other aspects of the “government take”.

Second, the express intent of the legislation is to allow private parties that execute oil and gas contracts in Mexico to report the associated reserves for their accounting purposes. The legislation specifically recognizes that, while subsurface hydrocarbons will continue to be owned solely by the Mexican State, companies will be permitted to report their rights to revenues or production for accounting and financial purposes. Throughout the legislative process, Mexican policy-makers have acknowledged the importance of this issue for U.S. publicly-traded enterprises and the conventional wisdom is that the implementing legislation will provide a framework that will allow for the booking of reserves in accordance with the U.S. Securities and Exchange Commission’s “economic interest” methodology.

Another notable facet of the Energy Reforms in the upstream oil and gas sector is the fact that the Ministry of Energy will conduct a “Round Zero” in which PEMEX may request that it be assigned certain exploration and production areas. To be assigned any such areas, PEMEX must demonstrate to the National Hydrocarbons Commission that it has the expertise, technical ability and resources to efficiently operate. For areas where PEMEX has invested in exploratory work, PEMEX may propose to continue such activities for three years, with the option to extend for up to two more. These areas may be held beyond this time if PEMEX successfully produces hydrocarbons from them prior to the expiration of the assignment. To maintain an interest in areas where PEMEX is currently producing, PEMEX must deliver to the Ministry of Energy a development plan that provides for efficient and competitive production going forward.

Midstream and Downstream Oil and Gas

The Energy Reforms also seek to open the midstream oil and gas sector to private investment. Whereas currently a federal statute prohibits private participation in midstream and downstream projects, the Energy Reforms alter the regulatory framework to allow private companies to obtain permits to operate midstream and downstream assets.

In terms of the midstream sector, the Energy Regulatory Commission (CRE) will be the issuing body of permits for the storage, transportation and distribution of hydrocarbon products. The CRE will also be charged with promulgating regulations governing the first-hand sales of such products. Furthermore, within 12 months after the Energy Reforms’s enactment, the Executive Branch of the Mexican Government shall issue a decree to create the National Center of Natural Gas Control, an agency that will oversee the pipelines currently operated by PEMEX. PEMEX will be required to transfer to this new Center all resources, contracts and infrastructure necessary for it to carry out this function.

In the downstream sector, the Ministry of Energy will be the regulatory body that issues permits for processing gas and refining oil products.

Electric Power

Additionally, the Energy Reforms seek to create a competitive wholesale power market by opening the power generation sector to private investment. Electric transmission and distribution will remain a public activity and within the purview of CFE.

To effect this reform, the Executive Branch shall create the National Center of Energy Control within 12 months of the Energy Reforms’s enactment. It will be independent of CFE and will be charged with controlling the national wholesale electricity market as well as ensuring open access to the grid. CFE will be required to transfer all necessary resources to the National Center of Energy Control.

Environmental Regulation

The Energy Reforms provide for the creation of the National Agency for Industrial Safety and Environmental Protection (SEMARNAT) which will be charged with regulating and supervising industrial and operational safety as well as environmental protection efforts. In addition, within 12 months, the Mexican Congress is required to establish additional environmental protection guidelines regarding the energy sector.

Mexican Petroleum Fund for Stabilization and Development

The Energy Reforms create a public trust called the Mexican Petroleum Fund for Stabilization and Development. This trust will be administered by Mexico’s central bank, subject to transparency rules that will be developed in secondary legislation and will be charged with administering, investing and distributing oil revenues. The fund will be set up in 2014 and will become effective in 2015.