After the unprecedented constitutional amendment last December, Mexico’s energy reform has now reached a major milestone with the passing of the implementing legislation for such reform. Numerous laws were either passed for the first time or amended, and many of them have a major impact on the country’s energy markets. This review focuses on the oil and gas aspects of the amendment. A separate review will cover electricity later on.

On April 30, 2014, President Enrique Peña Nieto presented a comprehensive package of 21 proposed laws (also referred to as secondary legislation) to the Senate of Mexico, as mandated by the reformed Constitution of the United Mexican States (the Constitution) enacted last year and published in the Official Journal of the Federation on December 20, 2013.

On August 5, 2014, the Federal Legislature approved the new Hydrocarbons Law and the Law for Revenues on Hydrocarbons, as well as reforms to the Foreign Investment Law, the Mining Law, the Law on Public Private Associations, and the PEMEX Law. On August 11, 2014, President Peña Nieto enacted the relevant laws, which will come into force on August 12.

Following is a summary of certain relevant provisions of the laws mentioned above.

Hydrocarbons Law

The Hydrocarbons Law will become effective once it is published in the Official Journal of the Federation. It will regulate constitutional articles 25, 4th paragraph; 27, 7th paragraph; and 28, 4th paragraph, regarding matters of hydrocarbons.

When the Hydrocarbons Law is enacted by the Federal Executive, it will repeal the Law Regulating article 27 of the Constitution in the petroleum sector. Once it becomes effective, the Federal Executive must issue the Regulations to the Hydrocarbons Law within 180 calendar days.

Foreign Investment Law

Articles 5, 6 and 8 of the current Investment Law were amended in light of the new constitutional scheme, which provides that the petrochemical sector is no longer exclusively reserved to the state, and allows the free participation of foreign investors in the marketing of gasoline and the distribution of liquid petroleum gas and in support service activities for exploration and extraction of hydrocarbons.

Mining Law

As a result of the partial amendment of the Mining Law, mining rights (granted through concessions) will no longer be treated preferentially vis-à-vis petroleum and other hydrocarbons exploration and extraction activities. In addition, before a mining concession is granted the favorable opinion of the Energy Secretary (SENER) must be obtained. If hydrocarbons exploration and extraction activities are carried out in the area subject to a proposed mining concession and the coexistence of the hydrocarbons and mining activities are incompatible, the mining concession may be denied or the area may be reduced to carve out that part in which the hydrocarbons exploration and extraction activities are carried out, thereby prioritizing hydrocarbon activities.

Law on Public Private Associations

Article 10 of the Law on Public Private Associations was amended in order to allow the implementation of public-private associations in activities with specific legislation that foresees the free participation of the private sector. Thus, public-private associations may be adopted in activities such as petroleum refining and natural gas processing, as well as the transportation, storage and distribution of hydrocarbons, liquefied petroleum gas, hydrocarbon derivatives and petrochemicals, or the generation of electric energy within the domestic energy industry.

PEMEX Law

The PEMEX Law will become effective the day following its new board of directors (Consejo de Administración) is designated, which must take place within 90 days starting on the date the PEMEX Law is published in the Official Journal of the Federation. However, the special regime set out in the PEMEX regarding acquisitions of goods and services, among others, will become effective once the audit, transparency and rendering of accounts mechanisms set out in the PEMEX Law become operational.

The PEMEX Law will regulate constitutional Article 25, 4th paragraph, and the Twentieth Transitory Provision of the Decree by which the Constitution was reformed in matters of Energy.

There are 121 articles and 15 Transitory Provisions in the PEMEX Law, and, in accordance to its Second Transitory Provision, when enacted, it will repeal the Law of PEMEX published in the Official Journal of the Federation on November 28, 2008.

The Law transforms PEMEX and the Federal Electricity Commission (CFE) to State Productive Companies, with the purpose of creating profits and value. PEMEX is no longer a regulatory agency.

Hydrocarbon Revenues Law

The Hydrocarbon Revenues Law will regulate the revenues derived from the exploration and extraction activities referred to in constitutional Article 27, 7th paragraph, as well as those payments originating from entitlements and exploration and extraction contracts. We will describe these in the Government Take section below.

Exploration and Extraction of Hydrocarbons

Under the new Hydrocarbons Law, the Mexican Nation will carry out all Exploration and Extraction of Hydrocarbons. The following are possible structures for private participation in the pursuit of such activities.

Asignaciones

According to the Hydrocarbons Law, Asignación (or entitlement) is the administrative act of granting the assignee, PEMEX or any other State Productive Company, the exclusive right to develop Exploration and Extraction activities in a determined area of a specific depth, for a finite duration.

Asignaciones are granted, exceptionally, by the SENER. Their exceptional character mandates that SENER argue the reasons why an Asignación must be granted and seek its approval from the National Hydrocarbons Commission (CNH). The provisions of the Hydrocarbons Law on the procedure that the Federal Executive must follow do not apply to Round Zero, as the Round Zero process was regulated in the Constitutional Reform of 2013. The Asignaciones granted to PEMEX under Round Zero will be governed by the Hydrocarbons Law.

PEMEX or the State Productive Company may assign an Asignación of its own to another State Productive Company with SENER’s prior authorization. SENER has the power to revoke Asignaciones in certain cases.

Service contracts

A State Productive Company, including PEMEX, that legitimately holds an Asignación granted by SENER is able to develop all related activities indicated in the Asignación through contracts with private parties only through the execution of service contracts. Such contracts shall provide a scheme that allows greater productivity and profitability and payment of the contractor must be in cash. Service contracts must be distinguished from Exploration and Extraction Contracts (described below).

PEMEX must select service providers by open contest, through public procedures. There are, however, 22 cases where the PEMEX Law allows PEMEX to avoid public contests. In such exceptional circumstances, PEMEX may pursue restrictive invitations and/or direct award.

Migration of Asignaciones

PEMEX and other State Productive Companies will be able to migrate an Asignación that each legitimately holds into an Exploration and Extraction Contract, for the purposes of changing the fiscal regime and, in such cases, enter into Alliances or Associations with private investors, incorporated and existing validly in accordance with Mexican law. Interested parties will present their offers in bid procedures. This migration has to be approved by SENER, in consultation with CNH and the Treasury. For the selection of such alliance or association partners, CNH (not PEMEX) has to actually run the bid.

Exploration and Extraction Contracts

The Hydrocarbons Law made a significant change in terminology compared to the terms used in the Constitutional Reform of 2013 with regard to the types of contracts that are available to private investors.

The fourth transitory provision of the Decree reforming the Constitution established that the types of contracts available to investors are, among others, service contracts, production or profit-sharing contracts, and/or licenses. The Law for Revenues on Hydrocarbons does mirror this list of contracts and regulates in detail their fiscal terms.

In contrast, the Hydrocarbons Law refers to Service Contracts, Alliances and Associations among private investors and State Productive Companies, and Exploration and Extraction Contracts (which are the true E&P granting instruments along with the Asignaciones).

Exploration and Extraction Contracts are defined by the Hydrocarbons Law as legal acts by which the State of Mexico, acting through CNH, grants a contractor the right to conduct Exploration and Extraction activities in a Contractual Area for a specific period of time.

CNH must observe guidelines provided by SENER and the Treasury in order to execute such contracts. Parties to these contracts will bid their offers. The Hydrocarbons Law regulates the entire bidding process. Under the Law for Revenues on Hydrocarbons, in all cases the bid criteria will be economic, seeking always to maximize revenues for the state.

Assignees and contractors will have the right to report, for accounting and financial purposes, the Asignación or Contract for Exploration and Extraction, as well as the benefits expected from such agreements, as long as they express that the hydrocarbons in the subsoil are property of the Mexican State.

CNH may rescind Exploration and Extraction Contracts for any of the nine reasons provided for in the Hydrocarbons Law.

Mandatory state participation

The participation of the Mexican State is only mandatory in certain cases.

For transboundary reservoirs, such state participation will be set at a maximum of 20%. These situations will be regulated by the agreements operating them, and international treaties subscribed by Mexico.

Also, in accordance with the terms and guidelines for bidding Exploration and Extraction Contracts, the mandatory participation of the Mexican State (through PEMEX or other State Productive companies or a financial vehicle) may be required when (i) a Contractual Area subject to bidding coexists, at different depths, with an Area of Asignación, (ii) there are opportunities to promote the transfer of knowledge and technology, or (iii) certain projects are intended to be promoted by a special financial vehicle of the Mexican State. In cases one and three above, the mandatory state participation cannot be greater than 30%.

The amount of exploration and extraction activities performed in national territory through Asignaciones and Exploration and Extraction Contracts may reach an average of at least 35%, excluding the exploration and extraction activities performed in deep and ultra-deep waters.

Permits

There are several activities that require prior permits or the ex ante fulfillment of registration or other legal obligations (e.g., petroleum processing and refining, transportation, storage, distribution, compression, liquefaction, decompression, and re-gasification of hydrocarbons, refined products or petrochemicals; and the marketing of hydrocarbons, refined products and petrochemicals, natural gas processing, and export and import of hydrocarbons, liquid petroleum gas, oil and petrochemicals, among others). Such permits will be granted by the Energy Regulatory Commission.

Local content

All things being equal, including price, quality, and time of delivery, the Hydrocarbons Law establishes a preference towards the acquisition of local goods, and the contracting of “national” services.Holders of Asignaciones and contractors must individually meet a progressive minimum percentage of local content set out in the respective granting instrument.

Law and arbitration

Regarding potential disputes that may arise relative to Exploration and Extraction Contracts, arbitration clauses can be included in the contracts, under the terms of the Mexican Commercial Code and international treaties to which Mexico is party.Likewise, CNH and contractors will not be subject to foreign laws. Applicable law will be Mexican Federal Law and the process shall be conducted in Spanish.

Fiscal regime

There are incentives for the creation of interconnected pipelines to transport and store natural gas, petroleum, and petrochemicals.The regime of revenues that the Mexican State will receive from activities relating to Hydrocarbons is established in the Hydrocarbon Revenues Law.

Government take

The Law for Revenues on Hydrocarbons regulates the revenues that the Mexican State will receive from the exploration and extraction activities carried out through Asignaciones and Exploration and Extraction Contracts. The obligations under the Law for Revenues on Hydrocarbons are different from and in addition to the regular tax obligations set forth in other Mexican tax laws, such as the Income Tax Law.

The consideration that the holder of an Asignación or an Exploration and Extraction Contract must pay to the Mexican State will be calculated pursuant to the mechanisms set forth in each granting instrument, following the rules contained in the Law for Revenues on Hydrocarbons. Government take varies in the cases of licenses, profit sharing and production-sharing contracts as well as service contracts. In some cases a signing bonus is required, in addition to certain royalties, contractual quotas and other compensation, depending on the type of contract.