Dallas Parker and Gabriel Salinas, of law firm Mayer Brown, explain the main points of Mexico’s new exploration and production contracts, as well as the Hydrocarbons law and Hydrocarbons Revenues Law that became effective August 2014.
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Mexico’s new exploration and production (E&P) contracts will be granted through a competitive bidding process, organized and regulated by the Ministry of Energy (SENER), the Secretary of Finance and the National Hydrocarbons Commission (CNH). The Ministry of Finance will establish the economic variables to be evaluated, which will be the percentage of the value of production or percentage of production to be received by the nation, the investment amounts committed by the contractor, or a combination of both.
The new contract models for E&P activities are license contracts, production-sharing contracts, profit-sharing contracts and service contracts.
On December 11, 2014, the CNH published the bidding terms for the first 14 oil and gas areas in shallow waters that will be awarded under production-sharing contracts.
License contracts
Pursuant to the Hydrocarbons Revenues Law, the license contracts shall provide for the following payments in favor of the nation:
In the license contract model, the contractor may take and own the hydrocarbons in-kind at the wellhead. All of the above payments shall be paid in cash by the contractor. These payments are in addition to any taxes owed by the contractor pursuant to the Mexican Income Tax Law or other tax laws.
The signing bonus amount shall be established by the Ministry of Finance in the bid terms for each tender process. The signing bonus is to be paid to the newly established Mexico Oil Fund. The signing bonus will be paid at the moment and under the terms established in the specific tender process. The signing bonus amount will be fixed and will be determined in the bid terms. It will not be a factor in awarding the contract. The signing bonus is not expected to represent a significant percentage of the resources to be received by the nation but, rather, a mechanism to guarantee the seriousness of the economic bids.
In addition, license contracts shall establish a monthly payment during the exploratory phase with respect to non-producing areas. The concept is similar to the delay rentals usually established under oil and gas leases in the US. The exploratory phase monthly fees increase starting from month 61 of the contract term. The purpose of these payments is to provide an incentive to the contractor to move promptly to the production phase. The exploratory phase fees are to be paid to the newly established Mexico Oil Fund.
Furthermore, license contracts shall establish royalties in favor of the nation that will vary depending on the type and market price of the particular hydrocarbon (crude oil, associated and non-associated natural gas, or condensates) effectively produced. Royalties are payable in cash. Royalty payments shall be determined based on the “contract value” of produced hydrocarbons, which is calculated by multiplying the volume of production by its “contract price.” The contract price for each type of hydrocarbon is its market price in US dollars, as adjusted pursuant to a mechanism to be established in each E&P contract. The mechanism will take into account the hydrocarbon’s quality, API gravity, marketing, and transportation and logistical costs, among other factors.
Finally, the license contracts shall provide for a payment to be established on a contract-by-contract basis by the Ministry of Finance, depending on the type of project, consisting of a percentage of the contract value of hydrocarbons produced. This percentage, as offered in the bid process, would be a contract award criterion. In addition, the contractor may be subject to minimum investments or work programs committed during the bidding process.
Production-sharing contracts
Pursuant to the Hydrocarbons Revenues Law, production-sharing contracts shall establish the following payments in favor of the nation: (i) exploratory phase fees (same as those applicable to licenses), (ii) royalties (same as those applicable to licenses) and (iii) a payment that consists of a percentage of operating profits. The exploratory phase fees are paid in cash, and the royalties and share of operating profits are paid in-kind. These payments are in addition to any taxes owed by the contractor pursuant to the Mexican Income Tax Law or other tax laws.
Depending on the fiscal terms established in each contract by the Ministry of Finance, the contractor receives in-kind either (i) the cost recovery plus the balance of the operating profits or (ii) all production net of the production paid to the nation.
The operating profits shall generally be calculated by subtracting the following amounts from the contract value of the hydrocarbons produced: (i) the royalty amount paid by the contractor and (ii) the costs incurred by the contractor. Article 19 of the Hydrocarbons Revenues Law lists the costs that may not be deducted for purposes of calculating the operating profits.
Under the production-sharing contracts, the contractor retains in-kind production with a value equal to the recoverable costs and its share of operating profits. The production equivalent in value to the state’s share of profits is to be delivered to the marketing firm retained by the CNH.
These contracts will include an adjustment mechanism for the profit split rates so that the Mexican state “may capture the extraordinary profitability” from production.
Profit-sharing contracts
Pursuant to the Hydrocarbons Revenues Law, profit-sharing contracts shall establish the following payments in favor of the nation: (i) exploratory phase fees (same as those applicable to licenses), (ii) royalties (same as those applicable to licenses) and (iii) a payment that consists of a percentage of operating profits. These payments are in addition to any taxes owed by the contractor pursuant to the Mexican Income Tax Law or other tax laws.
As consideration, the contractor has the right to (i) recover costs as established by such law and (ii) receive a payment that will consist of the balance of the operating profits after paying the specified percentage of operating profits to the nation.
The contractor will deliver all of the production to the marketing firm retained by the CNH, which shall pay the sale proceeds to the Mexico Oil Fund. The Mexico Oil Fund shall retain the amounts belonging to the nation and shall pay the contractor the cost recovery and its share of profits in cash on a monthly basis.
These contracts will include an adjustment mechanism for the profit split rates so that the Mexican state “may capture the extraordinary profitability” from production.
Service contracts
Under service contracts, contractors will deliver all production to the state, and fee payments shall only be made in cash as established in each contract. Exploratory phase fees and royalties will not apply to service contracts. Payment to the contractor shall be made by the Mexican Oil Fund with the proceeds from the sale of the production derived from the respective service contract.
Dallas Parker is a partner in Mayer Brown’s corporate & securities practice and serves as co-leader of the practice in the Houston office. Parker represents clients in a wide range of corporate and securities law matters with a career-long focus on the oil and gas industry. He earned a BA from Vanderbilt University and a JD from The University of Texas School of Law.
Gabriel Salinas is a senior associate in Mayer Brown’s Houston office and has extensive experience representing companies in international energy transactions and projects throughout Latin America with a focus on Mexico. He earned a BA from Elmhurst College, a JD from Facultad Libre de Derecho de Monterrey and an LLM from Harvard Law School.
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