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Insight

Potential Role of Bonuses in Licensing Contracts

Wed, 01/22/2014 - 11:02

Article Six of the new Hydrocarbon Revenue Law states that Mexican licensing contracts will include the payment of a signing bonus from the contractor to the Mexican government. Article Seven specifies that the amount of money involved in this signing bonus will be determined by SHCP on a case-by-case basis for each contract, and this public entity will also determine the conditions under which this payment will take place. Information about the signing bonus will be included in the bidding round terms for each contract, and it will be paid through the Mexican Oil Fund. The signing bonus is not calculated through a precisely determined percentage or equation set in stone, which will provide flexibility to Mexican authorities during the contracting process. However, the inherent lack of clarity in this aspect of the law may also create a certain amount of initial reluctance and skepticism among international oil and gas companies looking to invest in the Mexican deepwater sector, at least until the precise amounts are published alongside the first major tenders expected to be made public during the first half of 2015.

Licenses are now set to be the contracting model of choice for the development of the Mexican deepwater sector. This stands to reason given that PEMEX’s lack of experience and technological background in deepwater production and Petrobras’ relative lack of success with production sharing agreements for deepwater development make any other option less attractive by comparison. Additionally, the implementation of options besides licensing contracts is complicated due to the lack of information available regarding deepwater reservoirs, except for PEMEX’s few deepwater exploration successes. José Pablo Rinkenbach Lizárraga, Director of AINDA Consultores, explains this mechanism in the following terms. “The amount of attraction from investors will be proportional to the amount of knowledge and certainty that we possess of Mexican deepwater reservoirs. The objective is the maximization of oil revenues so how can we tip the odds in our favor? The most reasonable way forward is to act according to the information we already have available. When it comes to areas or reservoirs where no information is available, it is difficult to sign a production sharing or profit sharing agreement as there is no robust baseline to use as a reference, due to a complete lack of history or statistics.”

Although licenses will probably not only be used for deepwater development but also for the development of the shale segment, signing bonuses will have to look drastically different in either one of these cases since they play very different roles. Due to the contrasting timeframes involved, signing bonuses will be designed to fill revenue expectations of a different size given the fact that they will account for different amounts of time. As Rinkenbach Lizárraga explains, “What is the difference between shale and deepwater in terms of licenses? Production will begin quite quickly in shale, maybe after only a year a project gets going. In deepwater, the time necessary for exploration, development, tenders, and the beginning of production will probably be between five and six years. The government will need to capitalize or to show the benefits of the Reform, and will have to ask for a bonus. In both cases, you are using the same licensing scheme, but on the shale side you will see production happening quickly, and on the deepwater side you need a bonus because you cannot be expected to wait for five or six years for production to begin.”

Signing bonuses are not the exclusive realm of licensing or concession contracting models, as proven by Petrobras’ Libra pre-salt production sharing contract with CNOOC, CNPC, Total, and Shell and its US$1.4 billion signing bonus. However, they do play a unique role in making sure that licensing contracts are worth the trouble of transferring full ownership rights over all extracted hydrocarbons from the state to private companies. Licensing contracts are not the best way to develop national content, expertise or economic development when compared to production sharing agreements or joint ventures with PEMEX. Taking into consideration the amount of control and involvement that the state relinquishes, it makes sense to use all contractual aspects of the licensing model to maximize state revenues. As such, signing bonuses can be a great way of achieving that in a direct and immediate fashion so as to not wait for the payment of royalties or exploration fees, whose full amount can only begin to be calculated once the project begins to be executed. Rinkenbach exemplifies this maximization of state revenues. “Imagine a bidding round where I evaluate how much of a percentage I will get for the block as a royalty and as a bonus. Up to US$2 or 3 billion could be recouped as a bonus, besides the royalties.”

The use of signing bonuses is not a perfect tool, and it has its drawbacks, but it is still an indispensable part of Mexico’s early deepwater development, given the need for both short-term and long-term benefits. Rinkenbach is quick to illustrate this dilemma in economic terms. “I am not necessarily in favor of bonus-based schemes because they are regressive in fiscal terms. However, when it comes to building a workable compensation scheme for deepwater projects, this is the healthiest option available."