Iván Alemán Aleksei
Chief of the Legal Unit
Mexico’s Energy Ministry
View from the Top

Possible Contracting Methods for Deepwater

Tue, 01/22/2013 - 17:39

Q: The fourth round of ISC contracts is expected to involve deepwater areas. What are the benefits of continuing to use this contracting model for deepwater?

A: The main advantage is the fact that companies are guaranteed to recover their investment in an efficient way. In Mexico’s case, the cost-recovery ratio is 75%. On the other side, these contracts include a variable fee per barrel produced that is directly influenced by the performance and efficiency of the service provider, which creates an incentive to optimize the investment allocation and encourages the implementation of effective new technologies. A benefit that Pemex gets from ISC contracts is knowledge spillover. The clause that enables Pemex to own a 10% participation in the project means that the NOC is guaranteed to have privileged access to learning from service providers.

Q: How could the ISC contracting model be improved?

A: Rethinking the dispute resolution methods and legal frameworks under which the contracts are administered are two things that come to mind. But the contract extension clauses need to be changed. Under the current model, contracts include several repetitions of Constitutional formulas and legal redundancies that, instead of helping companies to interpret the contracts correctly, fill them with unnecessary information that leads to confusion and uneasiness. There is too much information that is already included in different laws and should not be included in the contract.

Rethinking where the line is drawn between the government’s influence on exploration and production strategies and Pemex’s business decisions presents another area of opportunity. Service providers have the incentive to extract as much as possible from the reservoir during the contracted period, since the variable component of their payment depends on it. On the other side, the integrity of the reservoir has to be maintained without depressurizing or damaging it. The complexity of this decision is where national sovereignty truly lies: it is the government’s responsibility to decide at what rate production should be monetized, and if technical issues emerge with the strategies followed by the service providers operating there, the government should have the ability to intervene and halt production, even if it is detrimental to the interests of the operator.

Q: Could Mexico introduce a concession model under the current legal framework?

A: A concession model, by definition, implies resource appropriation. It would grant a private company the whole production responsibility, while Pemex would act as a governing body, in charge of monitoring and controlling the operator, but without the conflicting interest of being part of the business, and charging a fixed concession fee. The private company has the incentive to optimize production over the long term, taking good care of the reservoir, as opposed to the time constrained vision that companies have under the ISC model. However, the current contracting model, and the Mexican Constitution, prohibits private operators from owning the resources being extracted.

Q: Is it possible to introduce a production-sharing agreement model without making amendments to the Constitution?

A: Under the current regulatory framework, it would be possible for private companies to be remunerated in cash and then use that money to buy hydrocarbons from Pemex. While there is no legal or constitutional doubt that Mexico could sell hydrocarbons in Mexico, and that a private company could buy them, I am one of the few people that consider this option to be viable. If this were a strategy to follow, though, the most recommendable thing would be to modify the law to ensure legal certainty. The law should clearly state if a payment scheme of this type could be feasible or not.

Q: What could be learned from other country’s experiences to create the right model for Mexico to face the deepwater challenges?

A: Mexico has to build its own model, so it is really important to consider international experiences and combine these with our own peculiarities, working culture, regulatory framework, and historical background, in order to tailor our own contracting model.