David Enríquez
Senior Partner
Goodrich, Riquelme y Asociados
View from the Top

Create Independent Body to Monitor Oil and Gas

Wed, 01/18/2017 - 11:25

Q: How might corruption in Mexico and its institutions impact the implementation of the Energy Reform?

A: Anything related to governance and corruption in Mexico must be dissected on three levels: federal, state and municipal. On the federal level the roles of authorities like CNH, CRE and the Ministry of Energy are critical and effective. Corruption is not relevant federally because of the high level of transparency shown throughout the processes so far. None of our clients, which are mostly IOCs and first-class independents, have had any complaints related to corruption contrary to the Fair Credit Billing Act (FCBA).

State and municipal factors come into play more when implementing the contracts signed throughout the licensing rounds and specifically when obtaining production permits. Concerns center on land access and interaction with communities, especially when facing corruption and hostility from community leaders, which could include demanding a certain percentage of oil profits.

It is important that companies respect the rules set out by the International Labor Organization (ILO). Past projects, such as an aqueduct in Sonora, have been canceled because they did not comply with social and environmental regulations.

Q: What developments are required regarding the roles of the new regulatory bodies?

A: CNH, CRE and ASEA have varying roles. On one hand, they are regulators but CNH is also the counterpart of every new contract, since it signs and processes them. This dualstatus calls for an independent body to monitor the oil and gas industry, as COFECE does for competitiveness in Mexico. This nonprofit organization would observe what is happening in the oil and gas industry from a third-party viewpoint, evaluating the activity of the authorities and their relationship with operators. Focusing on the private players as much as the governmental bodies, it would evaluate the social, environmental, governmental and operational aspects of petroleum activity. Consulting bodies already exist but they deal with a specific aspect of the industry rather than all of it, so their perspective is limited to their own scope of specialization. 

Q: What role have Mexican law firms played in shaping new oil and gas regulations?

A: We are happy with the role Goodrich, Riquelme y Asociados has had in shaping the Energy Reform. We have been involved on a regulatory and legislative level and in the contractual projects. A clear example of our participation was during the Trion farm-out, throughout which we made presentations and had meetings with relevant industry and governmental players. By voicing the concerns of the industry, we influenced the Trion contract, which took into account industry worries and had a more improved risk balance. This process showed that the government did not cover its ears, they listened.

Q: What are the consequences of partnering with PEMEX for other operators?

A: There is a lot of interest in partnering with PEMEX, not just through farm-outs but in any capacity. As well as being completely free to form alliances, the NOC offers valuable knowledge of Mexico’s oil and gas industry and its infrastructure. Despite the interest, we believe that PEMEX has overestimated its protagonist role in Mexico on certain occasions. When forming partnerships, the key question is what each company brings to the table. It could be technology or money but in a joint venture a company must have something to offer to gain leverage. When a company does not offer anything tangible, as is the case with PEMEX, it creates a strange negotiating dynamic. 

Another issue involves miscommunication and misalignment of priorities between PEMEX’s top and middle management. Top executives at the NOC have an open mind and positive attitude toward creating associations through farm-outs and other models. But this sentiment does not sufficiently permeate middle management. 

Q: What were the implications of Round Zero, which saw PEMEX select fields without competition?

A: Round Zero was an expression of PEMEX’s problem but we believe that the origin lies in PEMEX’s leadership identity. A disconnect exists between the previous PEMEX, which was part of the government, and the new PEMEX, whose goal is to turn a financial profit like any other productive company. Higher management has a more international outlook but this is not always translated to middle management. This disconnect is causing delays with the monetization of assets and projects, which are stagnating due to internal blockages. The delays are not due to a lack of willingness or leadership in senior management but because their orders are not being implemented further down the line. 

A change in middle management’s mindset is urgent or PEMEX risks being unable to fully roll out its oil projects and being legally forced to return the fields from Round Zero to the government. In 2017 the first revision of PEMEX’s activity in the fields it won will be carried out and revocation processes will be initiated for the ones where no progress has been made. PEMEX is definitely making an effort to counteract this but it hasn’t spread to middle management yet. 

Q: What are the potential effects on the market from the lack of a transitional tax provision for PEMEX?

A: The lack of a transitional fiscal regime for PEMEX is a frequently criticized aspect of the reform, especially given the orderly fashion with which the wider industry deals with finances. To counteract this, the farm-outs should have been processed much earlier, preferably immediately after the conclusion of Round Zero. Farm-outs are indispensable due to PEMEX’s financial disorder. But the success of a farm-out is not guaranteed simply because it is awarded. Instead, the winning party must be evaluated and any matters of dispute resolved. The cash calls initiative could solve many of the payment issues between PEMEX and its future partners and Trion will be a test of this. The real results will be seen after the joint venture materializes and we can analyze it in real time. 

Q: What legal themes will define the Mexican oil and gas industry in 2017?

A: We believe project implementation will color the legal discussion surrounding the Energy Reform in 2017. The year 2016 was defined by licensing rounds and secondary regulations but all of that is now completed. In 2017 we will see the materialization of work plans and discussion will center on drilling permits and social and environmental aspects such as land access and negotiation with communities. 

A relevant legal consideration to take into account in the coming year is the subject of asymmetrical regulation. In Mexico, we have the problematic combination of a liberalized legal regime but an industry that is still dominated by one player. To avoid the inequality between players putting the brakes on progress, asymmetrical regulation is required.

We need to see modified regulations that take into account the NOC’s continued dominance in the market. Small steps are already being made when it comes to gas stations and pipelines to ensure a fair battleground and competition. If there is one player that should have a protagonist role in the Energy Reform at this point, it is COFECE. We are entering virgin territory when it comes to asymmetrical regulation and they need to maintain the conditionality of PEMEX’s role until the new players have time to achieve a level playing field.