Modifications Made in the Upstream Mexican Sector
Alejandro López-Velarde of López Velarde, Wilson, Hernández & Barhem, SC summarises the recent legislative changes to the Mexican upstream oil and gas industry.
The modifications to the oil and gas industry were published in the Federal Registry on 28 November 2008. In general terms, the presidential bill called for the facility to grant the so-called Incentive Contracts with the following aims:
• to increase the oil and gas reserves (the giant Mexican wellhead Cantarell, which used to be the sixth largest in the world, is declining rapidly);
• to explore and generate production from deep waters and abandoned wellheads, and attract the right technology and management resources; and
• to generally modernise Petroleos Mexicanos (Pemex).
THE UPSTREAM SECTOR
II.1 The Constitution: The Congressional reforms did not contemplate any change in the Mexican Constitution. Consequently, Mexico maintains direct dominion over the subsoil as well as the exclusive right of exploitation and development of petroleum and gas. Thus, private ownership of hydrocarbons is strictly prohibited, reserving ownership of petroleum and all solid, liquid and gaseous hydrocarbons to the state. This is a Constitutional right that is inalienable and imprescriptible without the possibility of conceding oil exploration and exploitation rights to private parties.
By the same token, the so-called strategic areas (such as oil and gas) were not modified by the current reforms. Consequently, all domestic petroleum and hydrocarbon resources and basic petrochemicals are deemed to be strategic activities which are exclusively reserved to the state. Private participation, either national or foreign, is clearly prohibited.
II.2 The general regulation through the congressional laws: In addition to the provisions specified above, the law applicable to the regulation of foreign capitals, the Foreign Investment Law (FIL) ratifies that petroleum and other hydrocarbons, as well as the basic petrochemical industries are reserved to the Mexican State. Nevertheless, neither Article 27 nor Article 28 provides a clear-cut definition and scope about the oil and gas industry. Pursuant to the modifications and reforms made in article 3 of the Petroleum Provisions of the Regulatory Law of Article 27 of the Mexican Constitution (Petroleum Law) the petroleum industry as governed by the state currently encompasses:
• the exploration, exploitation, refining, transportation, storage, distribution and first-hand sale of petroleum, and its by-products obtained through the refining process;
• the exploration, exploitation, production and first-hand sale of gas, not including associated gas, to the mineral coal wellheads, since the Mineral Law will regulate its exploitation; and
• the production, storage, transportation, distribution and first-hand sale of by-products that can be used as basic industrial materials, as well as those gases that are considered basic petrochemicals.
Based on the constitutional and FIL restrictions mentioned above, private parties have worked with Pemex in the upstream activities under the terms and conditions of the Public Acquisitions, Leases and Service Law, and the Public Works and Related Services Law (jointly referred as the Procurement Laws).
II.3 Contracts and incentive contracts Congress authorised two regimens applicable to contracts to be awarded by Pemex with the private sector.
The first of these is for substantive activities, mostly related to the activities established in Article 3 of the Pemex Law whereby the Procurement Laws might not be applicable. Instead, it will be applicable to the Pemex Law and its Regulation, and to the Administrative Guidelines for Granting Contracts Related with Substantive Activities (Pemex Guidelines) issued by Pemex’s board of administration. These legal ordinances include, as a general rule, the public bidding process in accordance with Article 134 of the Constitution. Article 134 dictates that acquisitions, leases, services and public works shall be awarded by public bidding after a public bid tender so that reliable proposals can be freely submitted in sealed envelopes, to be opened publicly, for the purposes of ensuring the state the best available conditions with respect to price, quality, financing, opportunity and any other pertinent circumstances. Therefore, the general rule must be the public bidding process and the exception the restricted invitation or the direct award.
It is important to mention that, as part of a policy towards obtaining better prices for Mexican public entities, the Pemex Law establishes the possibility to hold Reverse Auctions.
In substantive activities, a new Acquisitions, Leases, Works and Services Committee has been incorporated with the purpose to be in charge of:
• reviewing, evaluating and recommending the annual acquisitions, leases, services and public works programmes:
• evaluating the possibility to avoid the general public tender procedure advising the possibility of having a restricted invitation procedure or a direct award;
• the administrative interpretation of the applicable legal ordinances in the acquisitions, leases, services, public works, and sale of goods applicable to Pemex;
• evaluating the contract models to be executed with the private sector;
• authorising the incorporation of sub-committees;
• providing opinions requested by the Board of Administration regarding the execution of contracts and the possible applicable suspension, rescission or early termination of contracts, among others.
The second regimen applicable to contracts to be awarded by Pemex with the private sector is for non-substantive activities: activities such as the purchase of materials and equipments for Pemex’s offices, construction of administrative buildings and so on, which are not considered substantive activities are subject to the terms and conditions of the Procurement Laws. The Federal Controller Bureau will continue to be in charge of the administrative application of the Procurement Laws.
II.3.1 Terms and conditions applicable to contracts
The new general terms and conditions applicable to administrative contracts to be executed with Pemex are the following:
• Pemex and its subsidiary entities will be able to execute any kind of acts, agreements and contracts and issue negotiable instruments keeping at all times the ownership and control of the hydrocarbons in the hands of the Mexican state.
• Public work and service contracts are valid and shall be executed within the four tenets of Article 6 of the Petroleum Law; that is to say:
- payment shall be in cash;
- ownership of hydrocarbons cannot be granted to contractors; and
- production-sharing agreements, participation agreements or any agreement which share a percentage in the production or the value of the sale of hydrocarbons or its by-products are not allowed.
• No rights will be granted on the oil and gas reserves. Consequently, contractors cannot record the oil and gas reserves in their financial statements as their own assets.
• The control and direction of the oil and gas industry will be vested in the Mexican Nation.
• The price to be paid to contractors shall be established in the contract in accordance with the rules established in the Civil Code. Each contract must establish a set price.
• Compensation shall always be in cash. Therefore, compensation as a percentage of the production, or the sale of the production, is clearly prohibited. These payments shall be similar to those paid in the oil and gas industry in Mexico and internationally.
• Pemex will be able to pay incentives in accordance with the production and tasks to be carried out by contractors. Nevertheless, it is important to mention that these payments cannot become the contract of a production-sharing agreements, participation agreements or strategic alliances in upstream activities.
• Preferential rights for the acquisition of the oil and gas are not allowed.
• Sharing production agreements, joint venture agreements in the strategic activities established in Articles 27 and 28 of the Constitution and Article 3 of the Petroleum Law are not allowed.
• One of the most important changes in the contract regime is the facility to modify the contracts in issues related to the incorporation of new technical applications, variations of prices in inputs, raw materials or equipment to be used in the work, or for the acquisition of new data obtained during the execution of the works which will benefit the project. Additional compensation will be granted when:
- Pemex obtains benefits for the execution of the works in advance by the contractor;
- Pemex obtains or is the beneficiary of the application of new technologies; or
- additional circumstances brought by the contractor increase Pemex’s income and better results are produced, as long as a percentage of the value of the sales or of the production of hydrocarbons are not engaged by the parties. This possible compensation shall be expressly established at the time of execution of the corresponding contract.
• Compensation shall be subject to be:
- in cash;
- reasonable in terms of the standards and usages of the industry;
- authorised in Pemex’s budget;
- a fix price or predetermined formula in accordance with the civil law.
Furthermore, multi-annual contracts might establish revisions for the incorporation of advance technologies or variation in prices of the materials and equipment to be used in the project.
• Liquidated damages may be applicable for breach of contract or environmental damages.
• National content will be requested in the execution of contracts.
Any provision established in contracts which does not comply with the above-mentioned mandate will be considered void ad initio.
II.3.2 International energy agreements
Despite the fact that the modifications and reforms to the Petroleum Law constitute an important step towards liberalising this sector, Mexican Congress did not permit international energy agreements, such as: product-sharing agreements; participation agreements; earn-in contracts; and concessions. Thus, corporations are prohibited from entering into agreements with Pemex in which they may have ownership rights in the production of hydrocarbons. Consequently, private investors, including foreign concerns, may participate in the upstream sector through the execution of incentive contracts and the terms and conditions of the Pemex Law and the Pemex Guidelines.
II.4 Drilling of petroleum and gas
The FIL establishes that foreign investors can participate in the drilling of petroleum and gas wells in a proportion greater than 49 per cent. However, in order to do so, the foreign investor must obtain the favourable resolution from the Foreign Investment Commission.
II.5 The National Hydrocarbon Commission: This new Commission was incorporated with the 2009 reforms, acting mainly as an upstream authority regulating and supervising Pemex in:
• exploration and production projects from the technical perspective;
• determining the production levels and restitution of reserves programme;
• recording contracts executed by Pemex; among others.
The new rules applicable to upstream activities represent a step forward towards liberalising the industry to the private sector, allowing a capability to negotiate better terms and conditions between Pemex and the private sector, either nationally or internationally. The new incentive contracts do not violate Articles 27 and 28 of the Constitution since ownership of the hydrocarbons remains in the hands of the Mexican state. The Pemex Guidelines, issued by the Pemex board of administration, provide important negotiating rules for obtaining price conditions similar to those granted internationally by the common international energy agreements.