On December 20th 2013, the government of Mexico published in the Official Federal Gazette a Decree that amended several provisions of the Political Constitution of the United Mexican States in the area of energy (the “Reform”). As a consequence of this publication, the Reform became effective on December 21st 2013.
The long-awaited Reform represents a very important change for the energy sector in Mexico, since it will finally allow private parties to participate in a greater manner in several activities that were previously restricted or exclusively reserved to the Mexican State, through its para-state organisms: Petroleos Mexicanos (“PEMEX”) with regard to activities associated with hydrocarbons and the Federal Electricity Commission (“CFE”) in the area of electricity.
As opposed to the energy reform presented in 2008 during the Felipe Calderón administration (that only contemplated amendments to secondary laws and the creation of new federal laws) this Reform amends Constitution, which is the main pillar that regulates Mexico’s energy sector. The Reform amends paragraphs fourth, sixth and eighth of article 25; paragraph sixth of article 27 and paragraphs fourth and sixth of article 28; in addition, it adds a seventh paragraph to article 27 and an eighth paragraph to article 28 of the Mexican Constitution.
In the area of hydrocarbons, it is important to mention that the Reform does not eliminate the Nation’s domain over them (in liquid or gas form) located in the subsoil. Exploration and extraction of oil will take precedence over any activity that may imply the use of surface areas and the subsoil. This may have implications for those mining or water concessions in Mexico where there may be oil or gas, because their concession holders may have to allow the exploration and extraction activities in the areas over which they hold such concessions.
The most relevant feature of the Reform with regard to hydrocarbons, are the new contracting modalities that are now being contemplated and that will allow the State to hire exploration and exploitation services with private parties. Prior to the Reform, private parties acted as service providers for the oil industry, through service contracts with PEMEX, receiving always and without exception payments in cash, which hindered the interest on the part of many contractors of entering into these types of agreements, Now, the Reform introduces new modalities that are more attractive and consistent with the international oil industry, such as:
- Profit sharing agreements, allowing the private party to receive payment in cash, but as opposed to service agreements, the payment will consist in a percentage of the profit obtained by the sale of the resources (hydrocarbons) obtained;
- Production sharing agreements, that will allow the private party to receive as payment a percentage of the production, and
- License agreements, allowing the private party to receive the onerous transfer of hydrocarbons through the payment of a remuneration or contribution, once extracted from the subsoil.
Notwithstanding the above, the Reform also includes service agreements. In addition, it leaves open the possibility of implementing a combination of any of the above contract modalities (as well as service agreements).
We note a radical change to the contracting regime in force, since private parties may now dispose of the production resources once extracted from the subsoil, through production sharing or license agreements.
Also, it is important to note that the Reform will allow private parties the right to report, for accounting and financing purposes, those agreements entered into with the Mexican State for the exploration and exploitation of hydrocarbons and the expected benefits, but as long as it is clearly stipulated that all resources found in the subsoil will remain the property of the Mexican Nation. This was not possible prior to the Reform, given that private parties acted solely as service providers.
This change is of great relevance for private parties, because by having the right to register the expected benefits under the corresponding agreement will allow them to reflect this right in their financial and accounting statements, which in turn may give them economic advantages, such as increasing the value of their stock and/or the possibility of securing greater financing and credits to undertake their activities. However, the definition of this alternative will depend on the content, terms and conditions of the corresponding agreements.
Furthermore, it is important to mention that the Reform established a clear intent for allowing greater private participation in the oil industry. For example, basic petrochemical activities will no longer be reserved exclusively to the Mexican State and processing and refining activities may be undertaken by private parties after securing a permit from the Ministry of Energy.
Notwithstanding all of these changes in the hydrocarbons sector, PEMEX will continue to be a state-owned company and is expected to be an important player to accomplish Nation’s productive goals. PEMEX will become a productive company of the State, in order to increase the Nation’s revenue and maximizing its resources, as well as having a greater budgetary, technical and operating autonomy. Regarding its budgetary autonomy, PEMEX will now be subject to a financing balance and budget limit for personal services, to be proposed by the Ministry of Finance and Public Credit. This will allow PEMEX to secure more and better financing to compete or strategically associate with private parties through tenders for hydrocarbons. exploration and extraction to be called by the National Hydrocarbons Commission.
Given that the 2008 energy reform failed to have PEMEX attract specialized oil companies for exploration and exploitation activities, this new Reform contemplates an in-depth transformation, seeking to make PEMEX a world-class competitive company.
PEMEX will benefit by the so-called “Zero-Round” allowing it to be awarded with certain exploration areas and production fields, but as long as PEMEX demonstrates to have sufficient technical, financial and execution capacity to carry out the corresponding project.
In addition, the spirit of the Reform seeks to promote the participation and development of domestic companies within the sector, through the implementation of guidelines and minimal percentages of national content to be defined with greater clarity by the corresponding secondary laws, in the understanding that these should be consistent with the Constitution and with international treaties signed by Mexico.
The Reform also provides the creation of:
- A Mexican Oil Stabilization and Development Fund in charge of administering oil revenues.
- A National Natural Gas Control Center, in charge of operating national natural gas transportation and storage ducts.
- A National Industrial Safety and Environmental Protection Agency for the Hydrocarbons Sector, entrusted with regulating and supervising the sector’s installations and activities in the area of industrial and operating safety as well as in the area of environmental protection.
- Increased attributions in order to strengthen the National Hydrocarbons Commission, for hydrocarbon exploration and extraction, and the Energy Regulatory Commission, for natural gas, oil by-products and petrochemicals. Both will now be coordinated by regulatory government agencies, having independent legal capacity, technical and management autonomy, as well as the possibility to manage and expend those incomes derived from the exercise of its regulatory functions.
- A Hydrocarbons Information National Center, operated by the Hydrocarbons National Commission, which will hold information regarding the exploration and extraction of hydrocarbons in Mexico.
With regard to the power sector, the Reform sets as a principle that the planning and control of the National Electrical System (“SEN”) as well as the public service of transmission and distribution of power, shall remain activities entrusted exclusively to the Mexican Nation. However, the Nation will have the possibility of contracting with private parties for carrying out these activities. In this manner, private parties will be allowed to be hired by the State to finance, install, maintain, operate and expand the infrastructure necessary to provide the public service of power transmission and distribution.
Even though it is true that currently private parties in Mexico already have the legal possibility of generating power under certain modalities and/or conditions specifically established by applicable law, these power generation alternatives are limited to self-supply, sale of power to the CFE and power exportation. With the implementation of the Reform, the power generation is no longer a Mexican State’s strategic exclusive activity, therefore there will be a horizontal disintegration of power generation, transmission, distribution and marketing services, allowing private parties the right to market the power they generate.
A wholesale power market will be created in Mexico in which public and private companies will place their production. This market will have output rules for the purpose of satisfying the demand of electricity users at the lowest possible cost. In this new market, the planning and expansion of networks will be for the benefit of all users and interconnections will be made with transparency and under non-discriminatory rules.
As in the case of hydrocarbons, the Reform seeks to promote the participation of Mexican companies in activities of the power industry, through domestic-content rules to be defined in secondary laws.
Because there will be free competition in the area of power generation and marketing, the Reform anticipates the creation of a decentralized organism by the name of National Energy Control Center. Although the name of this entity and the activities it will undertake are similar to those carried out by CENACE, currently in charge of SEN’s operations, this new National Energy Control Center will now be a decentralized government agency and will have autonomy and independence with regard to CFE, since it originally was structured as an Operative Deputy Management office in CFE, and its functions will also include controlling the wholesale power market, operate the SEN and ensure an open and non-discriminatory access to the transmission and distribution network. It is expected that because of its neutrality and independence, the new National Energy Control Center will observe a fair balance with regard to the operation of the national electrical system, without giving preference to CFE or any other private party.
It is also important to note that the Reform strengthens the Energy Regulatory Commission in electricity matters, as this government agency will have authority for granting power generation permits, as well as to provide the wheeling tariffs for transmission and distribution.
Likewise, as in the case of PEMEX, the CFE will become a productive company of the State, mainly to shift it to a company that interacts in the power sector in competition with private parties. In our opinion, with the opening of the power sector and the new regulation and oversight, the CFE shall become a renewed company, prepared to compete.
The Reform also seeks to promote energy sustainability. Some of its provisions lead to the inclusion of a transition strategy, for the purpose of promoting the use of cleaner technology and fuels within the National Program for the Sustainable Use of Energy. In addition, even though no specific details are provided and space is allowed for secondary laws to address these issues, there is a reference to the promotion and creation of programs and obligations in the area of energy efficiency in final uses, mitigation of greenhouse gases, preservation of natural resources and low waste generation; for the participating parties in the power sector, certain obligations regarding clean energies and the reduction of pollutant emissions will be provided. Finally, in order to promote the power generation through renewable sources, the Reform provides an obligation to create a law for the exploration and exploitation of geothermal resources located in the Mexican subsoil, which will add greater regulatory certainty to the current legal framework in effect with respect to the access to this resources and its associated risks particularly during its exploration phase.
To implement the Reform, it will be necessary to amend most of the current legal framework in the area of hydrocarbons and electricity. Transitory articles of the Reform decree have set a timeline of 120 calendar days upon the Reform becoming effective, in order for Congress and the Federal Executive to approve the changes to applicable laws that will be necessary. In addition, the Mexican Oil Fund will begin its operations in 2015, and within 12 months following the entry into force of the new legal framework, new decrees must be enacted, creating the National Natural Gas Control Center as well as theNational Energy Control Center. Therefore, considering that the limit date to implement the new legal framework is April 19, 2014, these decrees should be issued no later than April 19, 2015.
Lastly, a term of 365 days as of the entry into force of the Reform, that is, December 20, 2014, is established to set the guidelines for the protection of the environment of the sector, better criteria for energy efficiency and for obligations in the area of clean energy for participants in the power sector, as well as for the implementation of the strategy for clean technology and fuels and the creation of the new National Industrial Safety and Environmental Protection Agency for the Hydrocarbons Sector.