Finalization of Mexico’s energy reforms is accelerating and specific foreign investment opportunities are emerging, but detailed “Secondary Legislation” will likely be delayed to late April or a special congressional session in May.
Mexico’s enactment of its constitutional energy reforms in December 2013 included two critical milestone dates for the continued implementation of the reforms. The first such date was March 21, which was the deadline for Petróleos Mexicanos (Pemex) to submit its “Round Zero” request for the fields that it desires to maintain in its portfolio. The second such date was April 20, which was the deadline for the Mexican Congress to enact the Secondary Legislation that is to provide the commercial, legal and regulatory details of the landmark reforms.
Pemex complied with the Round Zero deadline and its submission highlights the immediate foreign investment opportunities that will be available as early as the first quarter of 2015. However, the ambitious April 20 deadline is likely to be missed as the Partido RevolucionarioInstitucional (PRI) and the Partido Acción Nacional (PAN) continue to negotiate a variety of issues related both to the energy reforms and other legislative matters.
Nonetheless, important details are emerging both about the direction that the Secondary Legislation will follow and the timeline ahead for the conduct of international oil and gas bid rounds and the creation of a new electricity market.
Set forth below are additional details on the current status of Mexico’s energy reform process. We will continue to monitor developments and provide updates on the Baker Botts Mexico Energy Reform LinkedIn group page, which can be found here.
Round Zero Joint Venture/Farm-In Opportunities and Pemex’s Selections
- Joint Venture/Farm-In Opportunities for Deep-water, Heavy Oil, the Burgos and Chicontepec Basins and Unconventionals:Pemex has identified, and officials from the Energy Ministry (SENER) have confirmed, that Pemex will seek joint venture/farm-in partners for its Round Zero selections involving:
- the Perdido Area (deep-water offshore);
- the Kayab Field (heavy oil shallow water);
- the Burgos and Chicontepec Basins (onshore conventional); and
- Unconventional Condensate and Oil Resource Plays.
- Approval Process for Pemex Joint Venture/Farm-In Partners is Unclear and Remains under Negotiation between the PRI and the PAN: for several months now, the PRI and the PAN have been negotiating the issue of whether Pemex or the National Hydrocarbons Commission (CNH) should determine the selection of Pemex’s joint venture/farm-in partners for its Round Zero selections and future bid rounds. The PRI’s position is that Pemex should make the initial determination and CNH’s role should be confirmatory in nature. The PAN’s position is that CNH should have the exclusive responsibility for making that determination.
- Summary of Pemex’s Round Zero Selections: Pemex has requested to retain: (a) 100% of its current 1P reserves, 83% of its current 2P reserves and 73% of its 3P reserves; and (b) roughly 31% of the country’s overall prospective hydrocarbon resources, which are specifically broken out as follows: (i) 93% of onshore resources (excluding unconventional resources), (ii) 59% of shallow-water resources, (iii) 29% of deep-water resources and (iv) 15% of unconventional resources.
- Timeframe for Approval of Pemex’s Round Zero Selections: September 17 is the deadline by which the Mexican government must approve Pemex’s Round Zero selections. However, SENER officials have indicated that approvals may be granted on a rolling basis leading up to that date. In addition, such officials have noted that Pemex will generally have a 3 year period, subject to a potential 2 year extension, to achieve commercial discovery (such a requirement will be identified in the Secondary Legislation that is to be developed and such time periods may also apply to other E&P sector participants).
Emerging Details about the Secondary Legislation and Future Oil and Gas Bid Rounds
- Complexity and Mexican Electoral Reform are Delaying the Secondary Legislation: the complexity of issues surrounding the reform of Mexico’s energy sector (there are 28 laws that either must be created or amended) and the PAN’s objective of passing further electoral reforms are likely to delay the finalization of the Secondary Legislation into late April or May. Indeed, the PAN’s negotiating tactic of preconditioning its support to the passage of further electoral reforms is the same strategy that it employed last year during the passage of the constitutional energy reform. Once the electoral reforms are enacted, the Secondary Legislation for Mexican energy reform should take center stage and be enacted by the Mexican Congress.
- Tax and Sliding Scale, Royalty Structure for the “Government Take”: off-the-record discussions and related media leaks are indicating that the government take for upstream contracts will consist of a tax and royalty structure. The government tax take will include the standard 30% corporate tax applicable to all Mexican corporate activity and may include a special tax on oil and gas production. The PRI and PAN have achieved a consensus that the royalty structure should be a sliding scale system that will vary on the type of field, the price of oil and gas and the production of the field. For example, unconventional fields would involve a royalty structure consisting of royalty discounts if profit margins were narrower and additional royalty charges would apply if production or prices were to exceed a certain threshold. The PRI also advocates establishing minimum required royalty levels, but the PAN opposes that requirement. Notwithstanding their differences on a limited range of tax-related issues, both PRI and PAN officials acknowledge the importance of creating a fiscal regime that will be attractive to the international oil and gas community. These officials cite the experiences of Colombia and Norway as the international benchmarks that are guiding their views.
- Sliding Scale National Content Requirements According to Fields Involved: similar to the consensus that is emerging on the government take, PRI and PAN officials are also designing a flexible, sliding scale system for national content requirements. The bottom end of the proposed scale contemplates zero national content requirements for deep-water fields because Mexican industry has no experience in such areas. The top end of the proposed scale contemplates 100% national content requirements for those onshore oil blocks where Pemex has drilled for decades. Similar to the government take issues, Mexican officials from both the PRI and the PAN emphasize that they understand the industry’s critiques about Brazil’s national content requirements and they stress a desire to establish a system with a less onerous burden on foreign investors.
- 1st and 3 rd Quarter 2015 Timeframes for Initial Oil and Gas Bid Rounds: SENER has stated that the first quarter of 2015 is the expected timeframe for the conduct of an oil and gas bid round involving Pemex’s Round Zero selections. SENER has also indicated that another bid round could be held in June or July of 2015 with respect to fields where Pemex will not have any positions after Round Zero. Thereafter, bid rounds could be held on annual basis through 2018 and, for unconventionals, such bid rounds could be on an even more frequent basis.
- Outlines of Electricity Sector Reform: The details to be included in the Secondary Legislation regarding the electricity sector reform remain limited. In general, however, Mexican officials have indicated that by June or July of 2015 their intentions are to have established:
- a wholesale power market in which (a) generators and marketers will make daily supply and demand offers, (b) the new independent system operator (CENACE) will establish the optimal dispatch and will calculate the equilibrium prices, (c) long term contracts will cover the majority of demand and a relatively small volume will be purchased on the spot market (which will be based on the short-term optimal dispatch) and (d) capacity markets will be implemented to ensure resource adequacy;
- a retail marketing framework that (a) consists of “standard users” who will receive their service from CFE-Retail and (b) “qualified users” who will be able to buy energy directly or through a retailer (and the threshold to be a “qualified user” will decrease over time); and
- state-owned transmission and distribution companies who will have rates regulated by the Energy Regulatory Commission (CRE), under incentive-based regulation, and whose rate payments will be processed by CENACE.