The Importance of Getting the Contracts Right the First TimeTue, 01/20/2015 - 11:57
Q: How have the Energy Reform and the drop in oil prices affected the mindset of companies looking to invest in the Mexican energy sector?
A: The thought process of investors has definitely been impacted, but companies are very interested in participating in the Mexican upstream market. The drop in the oil price is a short-term challenge while companies are planning their long-term development strategies, but it serves as a hurdle that has to be taken simultaneously with analyzing the new Mexican regulatory environment in order to make investment decisions. The new regulatory framework is perhaps more complex and regulated than the international oil companies were hoping for initially, but through a process of dialogue the industry and the Mexican government entities involved in the design of the contracts are increasingly finding middle ground. The results of Round Zero ensure that PEMEX will remain the dominant player in the Mexican oil and gas industry. As the contractual frameworks for the various phases of Round One, and the schemes to be used for the farm-outs in the near future, are defined, we will see the ways in which private players can participate with PEMEX or independently. Further details are also needed on how the profit-sharing contracts will work, where the cutoff point will be, what tasks new operators must carry out to earn their participation, and what the role of PEMEX will be. The terms included in the contracts should speak for themselves, and can leave no room for interpretation and mistakes. Another area that must be addressed is the administrative rescission of contracts. This is not an easy concept for financiers and investors to guard against since the government and PEMEX can use this at will. Finally, a complex issue is how the arbitration will play out. The current lack of clarity combined with the high taxation of operators, and the drop in oil prices, have caused worries, but in the end did not negatively impact the decision of the 34 companies that decided to enter the bidding stage of the first shallow water exploration phase of Round One. As it stands, the balance between the oil price and the cost of production is what governs the attractiveness of the Mexican oil and gas industry. Naturally, we hope that uncertainty about taxation, the legal framework, and future oil price expectations will soon be left behind so that we will continue to see a growing interest in the Mexican energy industry among international players.
Q: How will Round One be affected if PEMEX does not participate with competitive bids in the first two shallow water phases?
A: The transparency of contractual terms and the tax regimes will trigger the entire market’s reaction to Mexico. If Mexico begins to deviate from the terms set out by other countries around the world, it is effectively shooting itself in the foot. To motivate companies to come to Mexico, taxes should be fair, processes should be transparent, and steps should be taken to help companies establish themselves in the country. While this is easier said than done, investment risk must be equal here to other jurisdictions around the world. If this is achieved, and Mexico’s risk-reward balance is more attractive than in other countries, then we can capitalize on the interest of companies that are already thinking of investing in this country.
Q: What elements of the contracts are a priority for companies that are interested in coming to Mexico?
A: No contracting model will be perfect or cover all points. International companies will view certain risks as acceptable and others as unacceptable. If compromise is not on the table, the contracts will not work, and it is essential that these contracts are done right from the beginning. The authorities must ensure that the terms of contracts are in such a form that they appeal to everyone. At the moment, it is difficult for us to provide proper advice to companies concerning Round One because of the lack of fundamentals. Companies are primarily asking for advice and criteria as to what might transpire. As a law firm, we are realistic about the situation but we do not prophesize doom and gloom. The truth is that Mexico is a good place to invest, and I hope that a level playing field is created by interested operators asking pertinent questions, which are then debated during the bidding process, before conclusions are reached and the contracts are adjusted for all parties involved. Naturally, the authorities cannot guess the wish lists that all interested parties might bring to the table. Therefore, they must learn to correct any problems by exchanging ideas during the negotiations. If this exchange does not happen and the contracts are to be signed with no prior interaction, then potential clients might seek better deals around the world.