Contracting Challenges in New Fiscal Arena

Wed, 01/22/2014 - 15:07

The applications of the different available contracting models as well as the conditions governing their extension to specific Mexican oil fields have sparked a lot of discussion. Miriam Grunstein, a leading researcher at CIDE, has some insight regarding the most appropriate application of these contracts in certain areas. She considers that licenses are the best contracting model for deepwater since she estimates that problems could arise between the government as the administrator and companies as operators under Production Sharing Agreements (PSAs). Even though the transitory articles do allow licenses, concessions are still banned by the Constitution. Grunstein believes concessions and licenses represent the same concept under a different name as they both involve negotiations for royalties and taxes. “With licenses, players get a title on the crude at the wellhead and then pay the government back through a royalty and taxes, which is exactly the same as a concession,” she states. Where licenses might best suit deepwater, she sees PSAs as preferable for onshore assets such as Chicontepec. Moreover, Grunstein says that service contractors should be hired for mature fields, believing that it is not in Mexico’s best interest for an IOC to operate these fields due to their low risk profile. Grunstein also sees booking reserves as a delicate topic. The process will not entitle private parties to the reserves, she says, but only allow them to get proof from regulators of their commercial titles’ value in the stock market. This will lead to companies being able to book expected profits, instead of reserves, referred to as ‘expected benefits’ in the transitory articles. She also predicts that the US Securities and Exchange Commission (SEC) will not be concerned about the booking of reserves, only seeking to ensure that their value is backed by the expected cash flows.

Grunstein sees another challenge looming: the Mexican government’s lack of experience in working with either model. The Energy Reform is overhauling the industry but she doubts whether the country’s public institutions will be able to handle these new conditions. As evidence she points to the substantial experience gap that exists between oil executives and public officials in handling contract negotiations and coordinating between multiple government entities. “Mexican authorities will be dealing with very experienced and highly specialized individuals while we have public officials who have never dealt with an IOC or with contracting models,” argues Grunstein. In terms of obtaining outside help to guide the government through this overhaul, she states that governments tend to underestimate the value of expert outside consulting. “But should these services be needed, they should come from entities completely devoted to assisting governments rather than companies,” she says.

Grunstein stresses that authorities should focus heavily on complete legal transparency to ensure that fair competition governs the entire process, while eschewing tailored bidding rounds. “I want to see the bidding contracts in their entirety uploaded on the internet and I want them to be understandable. It is very easy to blast a database with all kinds of information that people cannot digest. If I cannot understand it, it is not transparent. Transparency entails making things understandable for the general public,” Grunstein underlines. She emphasizes that it will already be a difficult task for public officials to choose the right partners for the country and ensure a successful bidding process for contracts. Ensuring that the fiscal and legal conditions are well detailed and laid out will go a long way to creating a truly competitive scenario for the Mexican oil and gas industry.