Gabriel Ruiz Rocha
Thompson & Knight
View from the Top

Breakdown of Risks Facing Private Market Entrants

Wed, 01/21/2015 - 14:56

Q: What are the main risks for companies that want to be the first in the market as the Energy Reform unfolds?

A: The biggest risk is posed by the short timespan in which the Energy Reform is being implemented. The first companies coming in will have to test drive the operating and legal frameworks, which involves a certain amount of risk. The new legal framework sets a good foundation but it is not perfect and the processes will evolve along the way. There are many aspects of the new laws that incite concerns as to how practical issues will be resolved. Another risk involves the significant role that the law prescribes for governmental supervision. Companies will have to deal with CNH, SENER, the Treasury, PEMEX, ASEA, as well as the Mexican Petroleum Fund. Moreover, these government entities do not seem to have enough staff to deal with the 169 blocks that may be tendered. There will be growing pains for the first private players to come in.

The new laws state that only companies incorporated in Mexico can be awarded new contracts. Yet, there are many different types of entities that can be incorporated depending on a series of factors, including country of origin. These factors drive the decisions regarding which type of entity to legally use in Mexico, which in turn defines the tax planning, exit strategy, and the possibility of attracting investment in the future. We are now mostly being contacted by companies looking to set up operations in Mexico for the first time. We are focusing on helping them understand the new rules that they have to play by, including the new Hydrocarbons Law, taxes, setting up offices, hiring personnel, and other such matters. These companies want to be ready and settled here by the time they are awarded projects. It is important to bear in mind that Thompson & Knight has had clients engaged in this process for the past ten years. Some clients started participating though ISCs while they waited for this  moment, while others stood by until now. On another note, some companies feel that they are already late by coming here for Round One, but that is not the case.

Q: What concerns do international companies have about partnering with a local Mexican company?

A: Some companies have the notion that a local partner may add value with respect to local requirements, be it permits, community relations, accessibility, or local contacts with service providers and government entities. On the other hand, foreign players are also concerned that local companies may not have the financial capabilities to keep up with the expenses that will be required for the development of large projects. We have to keep in mind that the agreements will not be similar to the previously held integrated service contracts (ISCs), but will rather be contracts in which all of the risk will be assumed by the contractor, licensee, or the production-sharing agreement holder. This poses a lot more risk than there was before.

Q: What is your perspective on what will happen with the migration from ISCs to new contracting regimes?

A: This migration process is a big challenge for PEMEX and for the government. The first 11 contracts were migrated in December 2014 but, technically, there was no migration. It was more like the termination of an existing contract and signing of a new one. Issues may arise since the migration needs to be carried out with the full agreement of both parties. Moreover, since the Hydrocarbon Revenue Law establishes changes to PEMEX’s tax regime for ISCs, maintaining the ISCs under the same terms may not be as favorable for PEMEX or for the contractor. This process will be difficult as it involves 22 individual contracts. It entails a complex negotiation process that considers many different financial terms. Before the migration happens, PEMEX will need to pay outstanding amounts for services that have already been performed but have not been paid for yet.

Q: What are Thompson & Knight’s main concerns regarding the new operating and regulatory frameworks?

A: Our main concern is that this once-in-a-lifetime opportunity to change Mexico’s oil and gas industry will go to waste due to a critical error being made during the staggering number of processes being reworked. In the end, the key will be to provide enough certainty and a fair playing field for all where no company gets special treatment. As long as those principles are met by the organizations involved, success can be reached. If that does not happen, issues with specific projects will emerge and companies will use the contract terms that allow for dispute resolution. Another consequence could be less participation in the bidding rounds. Everything must run smoothly so that large investments and large risk commitments in the following bidding rounds are not discouraged.