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Analysis

Navigating Mexico's Legislative and Regulatory Environment

Wed, 01/25/2012 - 14:06

As Pemex is the sole owner of Mexico’s oil and gas reserves, any oil and gas company that wishes to do business in Mexico must navigate the often-complex path of contracting with the NOC. The 2008 Energy Reform changed this environment significantly by addressing many of the regulatory and legal issues contractors found most challenging.

Before the 2008 reform, Pemex was forced into a position that many commentators saw as directly aecting their drive for productivity, namely that a statutory restriction forced the company to pay its contractor’s fixed fees, regardless of how ecient the contractor was at completing the assigned project, or the project’s eventual productivity. A second restriction was that, once Pemex had signed a service contract, it was eectively impossible to change the terms of the contract, even if the nature of the work changed during the course of the project. This environment was not conducive to encouraging foreign companies to invest in the Mexican market, particularly given the fact that Pemex was also granted the statutory right to terminate contracts for general interest reasons.

The 2008 Energy Reform created a single set of rules that were brought into existence through provisions from the Acquisition, Leasing and Public Services Law, the Public Works and Related Services Law, and a new code that lays out regulations for contracting between Pemex and other companies.

Some of the procurement procedure methods remained the same under the new rules. First, open tendering can still occur; invitations can be oered to three bidders, and single source procurement can still take place. However, there are some new components. For example, there will now be a register of contractors that will keep exhaustive records of previous exploration and production contracts, individual contractors and their certifications, as well as penalties that have been imposed in the past and contractors that are banned from the bidding process. Finally, the register will serve as a database detailing contractors’ past performance, including safety records, adherence to environmental standards, and eciency performance.

In certain tenders under the new regulations, prequalification proceedings will take place; there will also be new evaluation methods used for bids, including best price, net current value, binary and cost-benefit methods, among others. When goods or services are standardized, companies can oer consecutive discount oers. There will be a negotiation stage where tender guidelines can be negotiated as long as they are shown to have an impact on the economic content of a bid. For consortium bids, under certain conditions, consortium members can now be substituted prior to the execution of the agreement.

Contracts already signed by Pemex can now be amended as long as such amendments are needed due to either developments in technology, variations in the market price of equipment and materials, new information, or anything else related to a project’s eciency.

There are also a number of financial features related to the new contracting framework. First, bidders will have to be rated by agencies that are registered with Mexico’s National Banking and Securities Commission. Pemex will now be allowed to receive guarantees from the parent companies of bidding companies. One feature that will remain the same is that Pemex will continue to pay its contractors only in cash.

For the first time, Pemex will be allowed to oer incentivebased contracts. Compensation formulae can now include production incentives based on standard industry indicators such as production volume, costs, recovered and incorporated reserves. Extra compensation may also be arranged in a contract as long as it is based on eciency increases that lower costs or raise profits for Pemex.

The introduction of incentive-based contracts is arguably one of the biggest changes ever made to Pemex’s contracting methodology. Before this, the biggest change came in 2002 when Pemex launched multiple service contracts (MSCs), which focused on fostering investment in Mexico’s gas industry by allowing various services provided to Pemex to be consolidated into one contract. MSCs could include geophysical work, field and production engineering, drilling, infrastructure design, construction and maintenance, and gas transportation. As in any other contract, Pemex reserved the ownership of all hydrocarbons. MSCs were designed to last for between 10 and 20 years depending on the field.

However, a new contracting model was introduced in 2008. As in all Pemex contracts, the new integrated service contracts would not give the contractors any rights to book reserves, and all hydrocarbons produced will belong to Mexico. Pemex states that they designed the contract model based on terms and mechanisms known and accepted by international oil companies (IOCs), and indeed, there was a period of consultation with some of the world’s leading IOCs before the contracting system went to the Mexican government for ratification. In this spirit, the new contracts look like those found in many countries where the oil and gas industry is government controlled. For contractors, remuneration will be based on a fee per barrel produced and an integrated cost recovery scheme, expense limits are placed on contracts, which also specify a flexible work area, set terms, phases and investment, and a minimum work commitment. These contracts are known as integrated service contracts because they include the execution of all the services required for the appraisal, development and production of hydrocarbons in the area specified in the contract.

In order to bid for an integrated service contract, a company must go through five phases. The first of these is prequalification; to participate, companies must have previous operating experience, with minimum production of 10,000 bbl/day, and a minimum previous investment of US$35 million (although this is likely to change in future rounds). The company will also need HSE certification and a suciently high credit rating in order to be prequalified. This primary phase will be an evaluation stage and will last approximately three weeks. After this, eligible companies may apply for a bidding package, which costs US$25,000 plus VAT. Companies must also sign a confidentiality agreement at this stage. Subsequently, the clarifications phase takes place, during which visits to the contract area will be arranged, and meetings to discuss technical, legal and economic matters will be held. After this follows the consortium phase, when bidders may come together in order to bring the best oer to the table. Finally, a bid guarantee secured with a letter of credit for US$1 million will allow a company to be fully qualified to sign an integrated service contract. Tenders will be won by the company or consortium that can oer the lowest fee per barrel, with ties being solved by a second bid to increase the minimum work commitment for the evaluation phase.