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News Article

What Contracting Model Is Best For Upstream Success?

Mon, 04/27/2020 - 17:30

After the enactment of the Energy Reform in Mexico, hydrocarbon exploration and production projects were able to participate with state enterprises (PEMEX), or through private contracts and association between parties. The reform also resulted in the establishment of the Hydrocarbon Revenue Law (HRL). Its objective is to establish “the tax regime that determines the revenue to be received by the Mexican government as a result of hydrocarbon exploration and production activities executed through assignments and contracts referred to in article 27, paragraph seven of the Political Constitution of The United Mexican States and in the Hydrocarbons Law, along with compensations established on those contracts.” These laws were approved by the Chamber of Deputies in August 2014. 

The mechanisms in which exploration and production activities are conducted define the process through which the State collects revenue. According to the second article of the HRL, activities take place through:

An assignment: The state receives all rights and taxes established by the HRL, including income taxes. An assignment can only be granted to a productive enterprise of the state, and in this case, the only one that exists in the sector is PEMEX.

A contract: The state receives compensation and taxes established by the HRL. It is worth highlighting that there are a number of types of contracts: licensing contracts, profit-sharing contracts, production-sharing contracts and service contracts. Compensation for the state and for the contractor vary according to the type of contract. 

The payment of rights and taxes for the assignment model presents some similarities with the payment of benefits and taxes in the contract-based model. In both models, the payment of rights to hydrocarbon exploration has to take place (meaning a contractual tax on a project’s exploration phase), along with payment of rights to hydrocarbon production (usually in the form of royalties), payment for rights to shared profits (meaning a percentage of operational utilities), payment on a general tax on all hydrocarbon exploration and production activities and payment of income tax. Contracting models allow the party to avoid an additional dividend to the state, which applies to the assignment model. Through assignments there is no payment for a signing bonus, which applies to licensing contracts.  

Although payment of rights and taxes in the assignment model presents similarities with the models based on compensation and taxes designed for contracts, there is considerable variation from one contracting model to another. This is why establishing which fiscal model is more convenient for the exploration and production of a field depends on a comparative economic evaluation that contains the parameters established by HRL for each model.

The study made for the exploitation of a new field based on a model developed in 2020 within Cayros Group Mexico’s C-Fields software, which allows for the integration of CAPEX and OPEX, demonstrates that  production-sharing and licensing models are the best schemes for exploitation, especially  under current low hydrocarbon price market conditions and the exchange rate between the peso and the dollar. The study demonstrates that these models allow contractors to recoup costs in a short period of time, guaranteeing profit maximization at the start of production. 

The main advantage of the C-Fields software is that it allows for the integration of information from a variety of different disciplines implicated in the generation and optimization of development plans for both new and mature fields. This allows for the realization of an interactive analysis of different feasible scenarios that are later hierarchized according to different combinations of technical and economic criteria that take into account fiscal models and risk models. This is done with the objective of identifying and documenting the best option in the least possible time. 

While Cayros’ study is not meant to be the final word on the matter, it does present a fascinating opportunity to rethink old ideas about the best way to make a profit in the Mexican oil and gas industry, as it repaves its path toward a new future.