Secondary Laws Proposal

On April 30, 2014, President Enrique Peña Nieto submitted the proposal for the secondary laws of the Energy Reform to Congress. This date coincided with the last day of the first ordinary legislative session of the year. As a result, members of both chambers claimed to not have any opinion or analysis ready in support or in opposition to these laws, due to the fact that they were delivered too late for them to read or process said laws in due form. Therefore, an extraordinary legislative session is expected to take place in June 2014 in order to discuss and pass these laws as soon as possible. On the same day, the laws were presented in a press conference hosted by Minister of Finance and Public Credit Luis Videgaray and Minister of Energy Pedro Joaquín Coldwell. The package consists of 21 laws organized in nine blocks, including eight new laws and 13 laws that will undergo modifications. Coldwell and Videgaray listed five underlying principles of the package:

Ownership of all hydrocarbons located in Mexican subsoil is in the hands of the Mexican state; this principle, previously established in the original Energy Reform passed in December 2013, remains unchanged and is underlined by the secondary laws.

• All activities in the upstream, midstream and downstream sectors will be open to the participation of and competition between public and private companies. The sale of fuel to the public will be the only activity that will remain temporarily closed to this free participation. According to remarks made during the press conference, this opening will take place “gradually, depending on the progress of the infrastructure and conditions for competition.”

• SENER, CRE, and CNH will be significantly strengthened

• Transparency and accountability will be emphasized during the hydrocarbon contracting process and all other processes pertaining to the administration of Mexico’s hydrocarbon wealth

• Clean energies will be promoted and the mitigation of negative environmental effects will be prioritized

• Contracting: All exploration and production contracts (which, as previously mentioned in the Energy Reform passed in December, may be structured under production sharing, profit sharing and licensing schemes) will be awarded through public bids to those companies making the best offers in terms of state revenue and economic benefit for the country Regarding the previously mentioned fourth principle, the secondary laws put forward five rules to ensure transparency during the contracting processes:

• All bidding rounds will be public and transmitted in real time online

• All contracts will include transparency clauses so that they can be consulted by the public

• Companies must make public all costs and expenses involved in their operations, along with all payments they receive from the Mexican state

• All revenue that the Mexican state receives from hydrocarbon exploitation activities will be made public, along with its use and destination

• Responsibilities will be shared among four public entities (SENER, SHCP, CNH, and the Mexican Oil Fund) to ensure the transparency and accountability of the contracting process, so as to avoid the centralization of the flow of information

Furthermore, the distribution of these responsibilities among said entities during the contracting process will be as follows:

• SENER: Defining the contracts’ technical framework

• SHCP: Defining the contracts’ economic and tax regime

• CNH: Conducting the bidding rounds and administrating contracts

Mexican Oil Fund: Making corresponding payments as defined by the contracts as a trustee of Mexico’s Central Bank Additionally, the secondary laws also define the circumstances under which contracts may be rescinded; they include:

• Failure to follow exploration and development plans as submitted to CNH

• Submitting false information to public authorities and regulators

• Failure to make the corresponding payments to the Mexican state

• Damaging communities and the environment

• Failure to submit to the decisions and resolutions of federal judicial authorities

  Licensing contracts will include the following benefits for the state:

• A signing bonus to be determined by SHCP on a case-by-case basis

• A contracting fee for the exploration phase in the order of MX$2,650 (US$200) per square kilometer during the first sixty months of the contract, and MX$4,250 (US$320) per square kilometers after the first sixty months of the contract

• Royalties determined by calculation based on the market price of hydrocarbons

• An additional calculated percentage of either operating profits or the value of all extracted hydrocarbons as described in the contract in question

• In exchange for full compliance with these payments, contractors will receive full rights over all hydrocarbons successfully extracted from the subsoil.

PEMEX LEADERSHIP

• PEMEX’s new Board of Directors will consist of 12 members: 1 member from SENER, 1 member from SHCP, 5 members designated by the executive branch and 5 independent members. Additionally, a Board of Coordination of the Energy Sector shall be created; this board will be integrated by SENER and will also consist of representatives from CRE, CNH, CENAGAS and CENACE. Its stated purpose will be to coordinate the work programs of the regulating entities within the national energy policy.

TRANSBOUNDARY FIELDS

PEMEX shall have a participation of at least 20% in all transboundary oilfield projects. It will be able to act as an operator, if possible, or at least be required to be involved as a partner in order to have access to all information related to and arising from these projects.

NATIONAL CONTENT

All projects shall meet a 25% national content requirement by 2025. To aid this transition, the secondary laws also describe the creation of a public trust to assist and promote the growth of national providers, suppliers and contractors.

TAX REGIME

All contracts will be subject to a new tax regime defined by three postulates:

• A minimum contracting fee will be established to guarantee that the Mexican state can receive a minimum influx of revenue. This fee will not depend on the development phase or the commercial feasibility of the projects in question

• Incentives will be generated for operators so as to minimize costs, ensure that production is sustainable, and that state revenue is maximized

• The tax regime for new contracts is progressive, it insures that the Mexican state will keep a higher proportion of resources in the cases where the market price of hydrocarbons rises or larger or more commercially viable reservoirs are discovered

Additionally, PEMEX’s new tax regime will provide it with significant benefits which will include:

• The elimination of the cost cap that previously limited its exploration and production expenses PEMEX’s tax burden will be significantly reduced from 79% to an average number lower than 65%, as a result of which PEMEX will be able to receive three or four times the profit it is currently receiving Neither PEMEX nor CFE will need to have their budgets approved by SHCP, they will not have to submit any budgetary changes to any kind of approval process either. However, they will be subject to two requirements in order to keep this independence: a debt cap and an expense cap, both applicable exclusively to personal service expenditures. These caps will be set not by the SHCP but by the federal legislative bodies ANSIPA: The responsibilities of the new National Agency of Industrial Safety and Environmental Protection will include:

• Establishing the regulatory framework for environmental protection and industrial safety for the entire national hydrocarbon industry according to international best practices

• Visiting oil and gas worksites to inspect and verify that the requirements of said regulation are being met, along with the previously established requirements and regulations contemplated by Mexican law

• Determining the appropriate sanctions and security measures to address any lack of compliance with the new regulatory framework on environmental protection and industrial safety

• Collaborating with other public entities such as SEMARNAT to ensure that the industry meets the highest standards of environmental protection and industrial safety

• Investigating root causes of workplace accidents and potential environmental catastrophes resulting from oil and gas exploitation activities