News Article

Flexible Contract Models Are Key

Mon, 09/01/2014 - 15:28

One of the main questions surrounding the opening-up of the Mexican oil and gas market has been which contract models would optimize the attractiveness of Mexico for private companies. David Enríquez, Partner at Goodrich Riquelme Asociados, explains that a combination of licenses, production sharing agreements (PSAs), and joint ventures would allow the restructured Mexican market to most resemble other international markets. Enríquez stresses the importance of combining these contracts with flexible agreements. Otherwise, the Mexican model risks not being sanctioned by the global market. “The types of companies the country needs will not participate, or will do so with economic proposals unfavorable to Mexico, if unattractive contractual schemes are the norm. Reducing the flexibility of contracts within the Mexican model would have had a negative impact on the industry.” Enríquez has high expectations for the secondary legislation to detail the introduction of all contract used in international markets.

After the Energy Reform, companies will be contracting directly with the Mexican government. Enríquez is skeptical of the government’s experience in putting together bidding rounds or negotiating contracts. Furthermore, because companies will be contracting directly with the state, the contracts’ arbitration clauses should be expressly detailed to avoid conflicts of interests.

PEMEX will soon be limited to the areas that it will be awarded in Round Zero. During the first licensing round, PEMEX will be able to participate independently, as part of a consortium agreement, or opt out. “It is going to be virtually impossible for PEMEX to enter in a consortium with the likes of Shell in deepwater activities strictly based on operational, technical, and financial capabilities, since it does not control the licensing process, it does not possess deepwater experience, and it does not have as much capital as other players. Foreign investors will not necessarily want to team  up with PEMEX, while PEMEX may be unwilling to compete with operators with deep pockets,” says Enríquez. “The key to solving this conundrum is capitalization. PEMEX has a CAPEX of roughly US$30 billion per year and the objective of increasing production from 2.5 to 3 million b/d by 2018. However, should PEMEX decide to invest in unconventional fields and deepwater projects, the needed CAPEX figure would be substantially higher. Since PEMEX has no plans to participate in capital markets, and its involvement in debt markets is limited, Enríquez proposes the creation of a new national oil company purely devoted to deepwater. In his view, 51% of this company would be controlled by the state and the rest could be floated on the Mexican Stock Exchange market and abroad to raise capital. “In order for such a company to be attractive to investors it must have strong corporate governance. This cannot be said of PEMEX. Even if PEMEX E&P was turned into a separate company, it would need a large capital injection to survive. With these foundations, a newly created NOC dedicated to deepwater would be able to compete with the international oil companies.”

The Energy Reform proposes the option of risk and profit sharing contracts. A profit sharing agreement, explains Enríquez, is not a contract tailored for the oil and gas sector, but rather a generic bounding mechanism that can be applied to any business. In the case of oil and gas, the more profit sharing agreements resemble PSAs, the more international operators will be attracted to the Mexican market. “The very reason as to why oil and gas companies seek control over resources, as opposed to profits, is that this allows them to construe the economic value of their assets through the use of swaps, derivatives, or futures, for example,” explains Enríquez. PSAs grant these players such freedom but Enríquez identifies a potential issue regarding secondary legislation. “Policymakers have to fully understand how the oil and gas industry works with respect to profits and assets. I disagree with the claim that profit sharing agreements would provide certain legal advantages over PSAs because the term ‘profit sharing agreement’ is too broad. If operators are not given access to crude oil, their business will be negatively impacted.”