Energy Reform 2013

On December 12, 2013, the Permanent Commission of the Mexican Congress approved amendments to Articles 25, 27, and 28 of the Mexican Constitution, which were subsequently approved by a majority of the state legislatures and signed into law by President Enrique Peña Nieto. On December 20, 2013, these amendments were published as the ‘Decree that Amends and Supplements various Provisions of the Mexican Constitution relating to Energy Matters’, better known as the Energy Reform Decree, in the Official Gazette of the Federation. The Energy Reform Decree, which took effect on December 21, 2013, includes transition articles that set forth the general framework for the secondary legislation. Below, the key features of the Energy Reform Decree that relate to the hydrocarbons sector in Mexico and its operations are described based on the interpretation presented by PEMEX in its 6-K filing:

• Ownership by Mexican Nation: Hydrocarbons in solid, liquid, or gas state located in the subsoil of Mexico remain the property of the Mexican state.

• Private Sector Participation: The Mexican government will carry out exploration and extraction of hydrocarbons by assigning blocks and projects to productive enterprises of the state – PEMEX and CFE – or through agreements between productive enterprises of the state and private sector companies. As part of the secondary legislation to be adopted, Congress must make necessary adjustments to the legal framework regulating the contractual regime for exploration and production activities, which may include the following contractual arrangements: licences, production-sharing agreements, profit-sharing agreements, and service contracts. The Mexican government will have the flexibility to combine elements of these contractual frameworks in order to maximize the income attributable to the Mexican state.

• Conversion: The Energy Reform Decree provides that PEMEX is to be converted from a decentralized public entity to a productive enterprise of the state within two years from the enactment of the Energy Reform Decree. During this two-year transition period, PEMEX will be entitled to be awarded the assignments and contracts mentioned above. The Energy Reform Decree provides that the corporate purpose of a productive enterprise of the state will be to create economic value and increase the income of the Mexican nation while adhering to principles of equity as well as social and environmental responsibility. To this end, PEMEX will be granted technical, managerial, and budgetary autonomy, subject to certain controls by the Mexican government. As a productive enterprise of the state, PEMEX’s CEO will be appointed by the Mexican President and its Board of Directors will consist of five representatives of the Mexican government, including the Minister of Energy (who will serve as Chairman of the Board), and five independent members.

• Initial Assignments and Subsequent Bidding Process: The transitory articles of the Energy Reform Decree outline a process, commonly referred to as Round Zero, for the determination of the initial allocation of rights to carry out exploration and production activities for PEMEX. Round Zero is being administered by SENER, with technical assistance from CNH. Pursuant to Round Zero, PEMEX has requested that SENER assign to it exploration areas and productive fields in which the company currently explores, operates, or which it has an interest in developing based on its operational capabilities. Any areas not requested by PEMEX or not assigned to it will be subject to a competitive bidding process open to participation by private companies.

• Booking of Reserves: PEMEX and private companies will be allowed to report assignments or contracts and the corresponding expected benefits for accounting and financial purposes, with the understanding that any hydrocarbons in solid, liquid, or gas state that are in the subsoil will remain the property of the Mexican state.

• Pipeline System: The National Center for Natural Gas Control, a decentralized public entity of the Mexican government, will be created to own and operate the national gas pipeline system and storage infrastructure. Pursuant to the applicable secondary legislation, PEMEX Gas and Basic Petrochemicals will transfer to the National Center for Natural Gas Control the assets and contracts necessary for it to manage this system and infrastructure.

• Regulatory Oversight and Authority: SENER, CNH, and CRE will be granted additional technical and administrative authority over certain PEMEX operations and the energy sector in general, as described below:

• SENER, with the technical assistance of CNH, will have the authority to grant assignments pursuant to Round Zero, select the areas that will be subject to public bidding, establish the technical guidelines for the bidding process as well as for the contracts themselves, and issue permits for oil refining and natural gas processing.

• CNH will be responsible for conducting the public bidding process and executing the corresponding contracts, as well as supervising oil and gas production activities.

• CRE will regulate and grant permits for the storage, transportation and distribution through pipelines of oil, gas, petroleum products, and petrochemicals; regulate third-party access to transportation pipelines, as well as to the storage of hydrocarbons and their derivatives; and regulate the first-hand sale of the aforementioned products.

• CNH and CRE will be vested with their own legal status and technical and administrative autonomy. SHCP, as well as other government entities, will be entrusted with establishing the economic terms for contracts assigned pursuant to the public bidding process.

• Safety and Environment: The National Agency of Industrial Safety and Environmental Protection for the Hydrocarbon Sector (ANSIPA) will be created to regulate and supervise activities and facilities related to the hydrocarbons industry with respect to industrial safety and environmental protection. This new entity will operate as an administrative body of SEMARNAT and will regulate industrial and operational safety, and supervise the decommissioning and abandonment of facilities. Furthermore, companies participating in the hydrocarbons sector will be subject to environmental regulations intended to reduce greenhouse gas emissions and help ensure that energy and natural resources are used efficiently.

• Mexican Oil Fund: The Mexican Oil Fund for Stabilization and Development will be created and entrusted with receiving, administering, and distributing the income that the government derives from exploration and extraction activities carried out under assignments or agreements, excluding any tax revenues generated as a result of such activities. This public trust will first use the income to make the payments required pursuant to the various assignments or agreements. It will then invest part of the income in financial assets. The Mexican Central Bank will act as trustee, and the allocation of the fund’s assets will be supervised by a technical committee composed of SENER, SHCP, the Governor of the Mexican Central Bank and four independent members.

• Anticorruption: A special anticorruption regime will be created to supervise, and, if necessary, investigate and prosecute, entities, individuals, and public officials participating in the Mexican energy sector.

  The impact of the Energy Reform Decree on PEMEX and the Mexican oil and gas industry will largely depend on how it is implemented through the secondary legislation.

  ROUND ZERO

  The 6th Transitory Article of the Energy Reform Decree outlines the Round Zero process. It required PEMEX to submit a proposal to SENER to be assigned the right to explore and develop areas in which it currently operates based on its technical, financial, and operational capabilities. Accordingly, on March 21, 2014, PEMEX submitted to SENER a request to retain rights that will allow the company to maintain its current production levels and provide sufficient exploration opportunities to increase production in the future. Together, the areas that PEMEX requested contain almost all of Mexico’s estimated proved reserves (1P) of crude oil and natural gas, as well as 83% of Mexico’s 2P reserves that total 24.8 billion barrels, and 71% of Mexico’s 43.8 barrels of 3P reserves as of January 1, 2013.

  SENER will take the following factors into consideration when determining whether to grant PEMEX an assignment:

• PEMEX’s investment capacity and evidence of a detailed plan for exploration are the main factors to take into account with respect to areas that PEMEX was actively exploring in which it had made commercial discoveries or investments as of December 21, 2013

• With respect to areas in which PEMEX had already undertaken production activities as of December 21, 2013: the NOC’s development plan for producing fields, including evidence of proper development of such fields and PEMEX’s ability to efficiently and competitively carry out extraction activities are the main criteria to consider

  Although SENER has until September 17, 2014 to respond to PEMEX requests, officials in charge of the decision have publicly announced that its response may be issued in multiple stages. Furthermore, the transitory articles of the Energy Reform Decree provide that PEMEX will be entitled to receive compensation in accordance with a valuation established by SENER when areas that PEMEX is currently operating are not assigned to the company.