Derek Woodhouse
Partner
Woodhouse Lorente Ludlow
Giancarlo Schievenin
Giancarlo Schievenini
Associate
Woodhouse Lorente Ludlow
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View from the Top

Legal Framework for Deepwater Development

Wed, 01/22/2014 - 12:27

Q: How advanced is Mexico in the development of a regulatory scheme for deepwater exploration and production that will help prevent or minimize environmental impact and address safety issues?

DW: As a result of PEMEX engaging large offshore platforms such as Bicentenario and Sea Dragon and, more importantly, as a response to the Macondo oil spill, CNH issued security regulations for exploration and production in Mexican deepwater in 2010. The aim of these regulations was to establish technical, regulatory, and organizational safety levels for PEMEX to develop its deepwater activities and provide evaluation and monitoring mechanisms. In 2012, SENER also issued guidelines authorizing the drilling of wells, including deep and ultra-deepwater wells. However, both sets of regulations do not have the same standing as laws enacted by Congress. In fact, Mexico does not have an overarching environmental law for deepwater exploration and production as the country has taken advantage of its easy-to-drill oil, rather than focusing attention on creating a legal statute for oil that is difficult to extract. An example of this is PEMEX’s first major deepwater project, Lakach, where CNH has questioned the feasibility of the project and the contractors have externalized their concerns relating to the project’s liabilities, indemnities, and risk allocation. PEMEX, meanwhile, argues that its hands are tied by regulations and laws. We believe this disagreement is due to the lack of a tailored legal framework for such projects, which, due to their nature and complexity, are beyond the traditional contracting models of PEMEX. As a result of this Energy Reform, the Mexican Congress must make adjustments to its legal framework. They should establish foundations to ensure environmental protection is followed in the energy projects conducted by the productive enterprises of the state. These adjustments must include specific environmental laws in order to regulate and limit liabilities in oil and gas exploration and production projects, including deepwater activity.

Q: What are the main risks that private companies will have to manage once private participation begins in the Mexican deepwater sector?

GS: One of the major challenges for investors will be the requirement to adapt to these new sets of rules. This does not just involve one piece of legislation, but a combination of nine new laws and 13 amendments to the current legal framework, which will in turn impact many different acts, regulations, directives, and contracting models. It will be challenging for everyone to become acquainted with the new legal framework. A twofold approach is required: as investors will need to know how to do business in Mexico, regardless of their industry, as well as needing to know the rules of engagement for the oil and gas industry. The second major challenge will be to fully understand the different contracting models. One option will be to participate via PSAs, which have the capacity to attract oil majors. Companies are able to book the barrels they are entitled to lift under PSAs, which means they will be able to obtain funding from banks using their rights over the oil as a guarantee, which is crucial for deepwater development given the volume of capital required. A great deal of discussion and understanding will need to take place to facilitate these arrangements. The third challenge is that the Energy Reform will include provisions to protect and strengthen Mexico’s national industry and technology. Investors will have to use local service providers and transfer technology to PEMEX, which will create tension between the parties. Investors will have to understand and accept that these provisions or restrictions will be mandatory, they are the means by which Mexico will open up the coveted oil sector and should not be disputed.

Q: How is Woodhouse Lorente Ludlow reshaping its service portfolio to address the changing needs of the deepwater sector?

DW: One of the main reasons Mexico is opening up this important sector is to partner with international companies to obtain access to their technologies and expertise. However, only a few companies own such technology and will not simply give it away. To serve this market from a legal perspective, we also need to bring international experience and expertise to the table. This is what Woodhouse Lorente Ludlow is intending to do and is the main reason for our ongoing alliance with CMS Cameron McKenna. CMS Cameron McKenna is recognized as the preeminent legal advisor to the North Sea and the firm has drafted many of the industry standard documents adopted in the UK and exported around the world. I worked at CMS Cameron McKenna in London for five years. This allowed me to build a very close relationship with the firm, so it will be easy to work with them as a team. CMS Cameron McKenna is one of very few law firms that specializes in legal advice to oil majors when dealing with deepwater projects. While working for them seven years ago, I gained experience in the exploration and production of oil when I was seconded to an oil major for a year advising in Angola, a jurisdiction that has many legal parallels with Mexico.

Q: What impact do you think the Energy Reform will have on exploration and production in deepwater and ultradeepwater sites located on cross-border reservoirs?

GS: The new Hydrocarbons Law provides us with a legal framework that is similar to the Agreement for Transboundary Hydrocarbon Reservoirs signed in 2012 by the US and Mexican governments. In this regard, PEMEX or other productive companies of the state must participate with at least a 20% interest in any contract area that might contain cross-border reservoirs. However, the law establishes that these companies are not required to be the operator in such projects, opening a wide window of opportunities for private companies to partner with PEMEX for projects. The potential for investment is huge, as this represents an area of about 600,000 acres in the Gulf of Mexico, with potential resources estimated to be about 172 million barrels of oil and 304tcf of natural gas.

Q: How will the alliances between PEMEX and private companies work after the Energy Reform?

DW: Private companies are now able to enter into different contracting schemes with CNH, whether in their individual capacity or in joint venture with PEMEX, for the exploration and extraction of hydrocarbons. Features of these joint ventures include: traditional services contracts with payment in cash, profit sharing agreements, PSAs, and licenses. It seems that the government’s intention is to open doors for PEMEX in areas where joint venture partners can bring technical competence and experience, particularly in deepwater, unconventional plays, mature assets needing enhanced recovery, and extra-heavy oil in shallow waters. PEMEX will be particularly interested in companies with experience in the Gulf of Mexico, due to certain geological similarities. In the case of unconventional resources, PEMEX is pursuing shale oil in the TampicoMisantla basin, which could hold considerable potential and has strong similarities with the US’ Eagle Ford Shale.

Q: How deep do you think foreign participation will go in oil and gas projects after the Energy Reform?

DW: When the Constitutional Reform was passed, we were concerned that the laws would establish such high local content requirements for upcoming projects that national capacity would not be able to meet demand, making oil and gas exploration and production stalled. We saw a similar situation happen in Brazil where the government set local content requirements at 40% of the value of contracts, thereby weakening interest from investors. We welcome the news that the new Hydrocarbons Law establishes a 25% target for local content to be achieved by 2025, giving Mexican contractors ten years to build up national capacity. This reasonable target is an encouraging sign for foreign companies as it shows the government’s willingness to bring foreign expertise and capital to the country. There will be many joint venture opportunities. This also represents a big opportunity for Mexican companies, who will be the first generation of privately held energy companies to invest in the country. Mexican companies have the advantage of being familiar with doing business with their own government. IOCs will need specialists’ advice to determine the capabilities of these new private Mexican entities and to understand how the Mexican industry works in order to evaluate a potential joint venture.

Q: How do you promote and optimize the correct development of Woodhouse Lorente Ludlow?

GS: We believe that law firms in Mexico need to partner with international law firms for the same reason that PEMEX needs to partner with international oil companies, so as to truly provide the best possible service. How can we truly understand an industry which is completely new to us? How can we access the knowledge that other projects around the world have generated? The answer is through a Mexican law firm capable of understanding the upcoming changes through the experience of its partners who have already travelled that road. We believe the wider market will reshape itself according to this trend, and only those who can offer this combined capability of experience and expertise will succeed. Local law firms trying to move forward on their own will end up servicing only very small areas of the value chain.

Q: What are the short and long term ambitions of Woodhouse Lorente Ludlow in the Mexican oil and gas industry?

DW: Our goal is to become the number one boutique law firm in this industry in Mexico. We do not want to be perceived as a large global law firm that covers everything. We want to focus on energy and infrastructure by partnering with CMS Cameron McKenna and covering the oil and gas sector better, particularly in deepwater exploration and production expertise. Our true objective is to make things work in our country. Mexico has a lot of resources and it is a pity that it is not taking advantage of them.