Energy: Oil & Gas 2020

Last Updated August 10, 2020

Mexico

Law and Practice

Authors



Baker McKenzie has a strong in presence in Mexico – with five offices in Mexico City, Guadalajara, Juarez, Monterrey and Tijuana – and has more than 50 years of experience in the field. The firm's energy, mining and infrastructure practice group in Mexico advises clients on private and public investments in different sectors and projects, such as exploration and exploitation of hydrocarbons, natural gas projects, power projects and in all kinds of infrastructure projects. The practice group assists clients in negotiating project documents such as contracts and concessions, including project finance documents. Within the group, lawyers and specialists have focused their practice on certain specific and relevant industries such as oil and gas, power and the infrastructure sector. Moreover, due to the relevance and complexity of each of these industries or sectors, members of the firm's other practice groups join its industry-focused efforts, contributing from their own particular legal background.

The Mexican Constitution provides that the Mexican state holds the exclusive direct domain and ownership over petroleum located in the subsoil. However, the Constitution allows the Mexican state to perform petroleum exploration and extraction activities through: (i) entitlements (asignaciones) to be granted in favour of SPCs (such as Pemex) or (ii) upstream E&E contracts with such SPCs or with private parties (by the contractual modalities provided under the Hydrocarbons Law, as explained in 1.4 Principal Petroleum Law(s) and Regulations). In any case, title to hydrocarbons in the subsoil remains with the Mexican state and such ownership condition must be clearly provided in each entitlement or upstream contract.

SENER

SENER is mainly regulated by the Organisational Law of the Federal Public Administration. It conducts and co-ordinates the energy policy and regulates the Mexican energy sector. Also, with the technical assistance of CNH, it may award the entitlements and select the contractual areas to be awarded through exploration and production contracts. SENER has additional attributions such as: (i) the determination of a five-year plan for bidding for contractual areas, (ii) and establishing a contracting model for each area. See: https://www.gob.mx/sener.

CRE

CRE is mainly regulated by the Law for the Co-ordinated Energy Regulatory Agencies (the "Regulatory Agencies Law"), that states that CRE shall regulate and promote the development of (i) transportation, storage, distribution, liquefaction, compression, regasification, retail to the public of oil, natural gas, liquefied petroleum gas, petroleum by-products and petrochemicals, as well as (ii) the transportation through pipelines, storage, distribution and retail to the public of biofuels. CRE is the agency which grants the corresponding permits for developing such activities. See: https://www.gob.mx/cre.

CNH

CNH is mainly regulated by the Regulatory Agencies Law, which provides that CNH shall (i) regulate and oversee surface studies and exploration activities as well the petroleum exploration and production; (ii) tendering and executing petroleum exploration and production contracts; (iii) technical management of the entitlements and contracts for petroleum exploration and production. See: https://www.gob.mx/cnh.

SHCP

Mainly regulated by the Organisational Law, SHCP is responsible for determining the economic and fiscal terms applicable to each exploration and production contract, particularly in respect of taxes, royalties, etc. See: https://www.gob.mx/hacienda.

CENAGAS

Mainly regulated by the Hydrocarbons Law, which provides that it is entrusted with operating and managing the national integrated system of natural gas pipeline transportation and storage, CENAGAS may issue a public tender for certain projects considered strategic in accordance with the Hydrocarbons Law, in which case the necessary infrastructure may be developed by third parties. See: https://www.gob.mx/cenagas.

ASEA

ASEA is mainly regulated by the ASEA Law, which grants it legal attributions to protect the environment and the safety of workers in the hydrocarbons sector, having a dual role as a regulator and permit issuer as well as an enforcer of applicable environmental laws. See: https://www.gob.mx/asea/.

The Fund

The Fund is mainly regulated by the Law of the Mexican Oil Stabilisation and Development Fund (the “Oil Fund Law”), that establishes that it is a public trust created by SHCP as settlor, and by the Bank of Mexico, as trustee. The Fund will serve to receive, manage and distribute revenue (with the exception of applicable taxes) derived from the exploration and production of hydrocarbons, resulting from contracts entered by the Mexican state with third parties or by the entitlements granted in favour of SPCs. See: https://www.fmped.org.mx/.

Pemex is the national oil company. It is regulated mainly by the Pemex Law, its Regulations, the General Procurement Provisions for Pemex and its subsidiary productive companies (DGC), and internal policies and manuals concerning corporate governance. Pemex has converted into an SPC, 100%-owned by the Mexican state.

Pemex's main purpose is to conduct the exploration and production of petroleum, as well as its recollection, sale and trading. Moreover, according to the Pemex Law, Pemex may also conduct the following main activities:

  • the refining, processing, transportation, storage, distribution, sale, export and import of petroleum, and the products obtained from their refining or processing and waste, as well as the provision of services related to such activities;
  • gas processing and industrial and commercial petrochemical activities;
  • the development and performance of engineering projects, research, geological and geophysical activities, supervision, provision of services to third parties and all those related to exploration, production and other activities comprised within its purpose, at market prices.

See also: http://www.pemex.com/.

The Constitution

The main articles of the Constitution, which regulate Mexico’s energy sector are the following.

Article 25 provides that the public sector will have the exclusive control of the strategic areas listed in Article 28 of the Mexican Constitution. It also states that regarding the exploration and production of hydrocarbons, the Mexican state will perform such activities pursuant to the terms of Article 27 of the Constitution.

Article 27 provides that the Mexican state is allowed to carry out the petroleum exploration and production activities through entitlements granted in favour of SPCs (such as Pemex) or through exploration and production contracts that might be entered with such SPCs or private companies.

Article 28 lists as strategic economic areas, the activities related to exploration and production of petroleum. In addition, it provides that the Executive Branch of the Federal Government will have Co-ordinated Energy Regulatory Agencies, which are the CRE and the CNH, under the terms established under the Regulatory Agencies Law.

Hydrocarbons Law and its Regulations

The Hydrocarbons Law regulates the legal framework for the exploration and production of petroleum in Mexico, as well as the treatment and refining of oil and processing of natural gas. It also provides the regulation for transportation, storage, distribution, compression, liquefaction, decompression, regasification, commercialisation and retail to the public of hydrocarbons, oil by-products and petrochemicals. The Hydrocarbons Law confirms the nation's ownership of hydrocarbons within the subsoil.

The Regulations to the Hydrocarbons Law provide a more detailed regulatory framework for the activities provided under the Hydrocarbons Law, including without limitation the legal processes to award the hydrocarbons exploration and production activities which will be performed in Mexico.

The Regulations for the Activities under Title Third of the Hydrocarbons Law (the "LH Title Third Regulations"), govern the activities under the Hydrocarbons Law which relate to midstream and downstream sectors, as well as the procedures and requirements to obtain permits for the development of such activities (as further explained below).

Hydrocarbons Revenue Law and its Regulations

The main purpose of the Hydrocarbons Revenue Law is to establish the regime applicable to the revenue obtained by the Mexican state from contracts executed with private parties or from entitlements granted in favour of SPCs to carry out the exploration and production of petroleum.

The Hydrocarbons Revenue Law establishes the concepts and mechanisms whereby the Mexican state will obtain revenue from hydrocarbon exploration and production activities, resulting from contracts models to be executed with private companies or entitlements granted in favour of the SPCs (such as Pemex).

The Hydrocarbons Revenue Law specifically provides the tax obligations applicable to contractors and/or the SPCs under the Income Tax Law and other laws.

The Regulations to the Hydrocarbons Revenue Law provide further regulatory provisions in connection with the economic conditions and fiscal terms of the contracting modalities set out in the Hydrocarbons Law.

Pemex Law, its Regulations and the DGC

The Pemex Law regulates the organisation, procurement of goods provisions, management, operation, control, assessment and accountability of Pemex.

Regulations to the Pemex Law mainly provide the rules for the appointment and removal of members of the board of directors.

The DGC will regulate jointly with the Pemex Law and its Regulations the acquisition, leases, service procurements and work executions to be performed by Pemex and its subsidiary productive companies.

Regulatory Agencies Law

Pursuant to such law, the Co-ordinated Energy Regulatory Agencies are CNH and CRE (the "Regulatory Agencies"). Such agencies will have technical, operative and management autonomy, as well as legal capacity. Also, the regulatory agencies may use the revenue obtained from the duties collected for their provision of services.

Moreover, it is provided that the regulatory agencies should be controlled by a governance body, comprised by seven commissioners (including the President), as well as an executive secretary. The commissioners and public officers of the regulatory agencies will be subject to an ethical code of conduct to be issued by the governance body.

Mexican Energy Reform of 2013 and its implementation during the subsequent years introduced contractual schemes, allowing private parties to develop petroleum exploration and production activities in Mexico. In certain contracting models (as explained below), private parties will be able to obtain as consideration the extracted hydrocarbons. The granting of contracts to SPCs or private companies for exploration and production of petroleum will be carried out through public tenders issued and conducted by CNH.

The Hydrocarbons Law and the Hydrocarbons Revenue Law provide four types of contracts that the Mexican state (through CNH) may enter into with SPCs or private companies for the development of the petroleum exploration and production activities. These are as follows.

  • profit-sharing contracts – the consideration to contractors is paid in cash but, unlike service contracts, the consideration will consist of a certain percentage of the net income obtained from the sale of petroleum;
  • production-sharing contracts – the consideration payable to contractors is based on a percentage of the hydrocarbons production obtained, the same as that which is delivered to the contractor in kind; 
  • licence contracts – similar to other jurisdictions, there are royalties paid to the state which vary in each case (the so-called "government take"), and a further consideration payable to contractors with the onerous conveyance of the hydrocarbons, once they are extracted from the subsoil;
  • service contracts – the consideration to contractors is paid in cash and the amount should be established in the contract according to the industry’s standards.

Pemex may either farm-out or farm-in, as well as enter into alliances or partnerships to participate in the bidding processes for such contracts.

Upstream licences in Mexico are: (i) entitlements which the executive branch through SENER directly award to SPCs; and (ii) any of the contractual modalities for the petroleum exploration and production mentioned above.

The main provisions regulating tender procedures for the award of exploration and production contracts are: (i) the Hydrocarbons Law; (ii) the Hydrocarbons Law Regulations; and (iii) the Administrative Provisions for Tenders regarding Hydrocarbons Exploration and Production issued by CNH on 28 November 2014.

The main stages for this type of tender procedures are as follows.

Publication of Call for Tenders

CNH publishes in the Mexican Federal Official Gazette the corresponding call for tenders, inviting private companies and SPCs to participate in tenders for the award of petroleum exploration and production contracts.

Publication of the Bidding Guidelines

The bidding guidelines contain all the rules, provisions and requirements that interested parties should consider when participating in tenders. Bidding guidelines are usually issued on the same date when the call for tenders is published. 

Data Room Access

The data room will contain the available information of the contractual areas to be awarded under each tender and that should be considered for interested parties when submitting their proposals. Interested parties should make a payment in favour of CNH to access the data room. Once the payment is made, interested parties will have physical and/or electronic (remote) access to the information of the data room.

Clarification Stages

In these stages, CNH must respond to questions submitted by parties interested in participating or already participating in the tender. The questions should be specifically related to certain stage of the tender process. Responses by CNH to these questions must be published in the web page of the tender.

Prequalification

Under this stage, interested parties are required to submit to CNH the information and documentation evidencing its experience, as well as its technical, financial, legal and operating capacity.

Submission and Opening of Proposals

Only prequalified parties may submit economic proposals and only one proposal per contractual area may be submitted by each party. The bidding guidelines of each tender should specify the requirements for submitting proposals.

Award

Once proposals are submitted by each party and evaluated by CNH, such entity must issue the award minutes on the date provided in the calendar of the bidding guidelines of each tender, indicating the name of winning bidder. CNH may revoke the award if the winning bidder submits false information.

Execution of the Contract

In the term provided under the award minute, winning bidders should enter into the contract for the petroleum exploration and production. In accordance with the provisions of the Hydrocarbons Law, this type of contracts must only be entered with SPCs or Mexican companies. The corporate purpose of said special purpose company shall be exclusively related to the exploration and extraction of hydrocarbons.

The considerations to be received by the Mexican state and contractors under each of the new forms of hydrocarbon exploration and extraction contracting, are as follows.

Licence Contracts

Payable to the Mexican state:

  • a signing bonus that will be calculated by SHCP for each contract;
  • a contractual fee for exploratory phase;
  • royalties, which are calculated on the basis of the contractual value of the hydrocarbons; and
  • a consideration to be determined under the contracts, the same as that which will consist of a rate on the contractual value of the hydrocarbons.

Payable to the contractor:

  • the transfer for consideration of the hydrocarbons once they are extracted from the subsoil, provided that the Mexican state has received its corresponding consideration.

Profit-Sharing Contracts

Payable to the Mexican state:

  • a contractual fee for exploratory phase;
  • royalties, which are calculated on the basis of the contractual value of the hydrocarbons; and
  • a consideration to be determined by applying a percentage of the operating profit (the result of subtracting to the contractual value of the hydrocarbons the royalties paid and the consideration corresponding to the cost recovery).

Payable to the contractor:

  • the cost recovery; and
  • consideration (currency) that should be the remaining operating profit after covering the consideration payable to the Mexican state.

Production-Sharing Contracts

Payable to the Mexican state:

  • a contractual fee for exploratory phase;
  • royalties, which are calculated on the basis of the contractual value of the hydrocarbons; and
  • a consideration to be determined by applying a percentage of the operating profit.

Payable to the contractor:

  • the cost recovery; and
  • consideration (production) that should be the remaining operating profit after covering the consideration payable to the Mexican state.

Service Contracts

Payable to the Mexican state:

  • all the contractual production.

Payable to the contractor:

  • service fee in cash.

In addition to the tax obligations applicable to contractors and/or entitlement holders under the Hydrocarbons Revenue Law, they are subject to the tax obligations under the Income Tax Law. Residents in Mexico are subject to income tax at the rate of 30% on their worldwide net income – that is, their gross income minus allowable deductions and the previous year’s net operating losses.

Permitted deductions include:

  • returns, discounts, and rebates;
  • cost of goods sold;
  • expenses, net of discounts, bonuses, or returns;
  • depreciation and amortisation;
  • bad debts;
  • certain losses;
  • accrued ordinary interest and penalty interest with certain requirements;
  • annual inflationary adjustment; and
  • net operating losses.

It is important to mention that contractors and/or entitlement holders are subject to special tax rules related to ring fencing, tax losses from deep-water projects, depreciation rates, special permanent establishment regime, among others.

In addition to the above, the Hydrocarbons Revenue Law provides that exploration and production activities are zero-rated for value added tax purposes. The 0% rates only apply to contracts between the Mexican state and contractors and/or assignees, and do not apply to any other contract executed with third parties.

The Executive Branch, through SENER, may directly grant (without the conduction of a public tender) to Pemex or any other SPCs entitlements by means of which Pemex or the applicable SPC (currently Pemex is the only SPC) may perform petroleum exploration and production activities within the corresponding area encompassed by the entitlement.

Furthermore, the Hydrocarbons Law provides a mandatory participation of Pemex or any other SPC in those exploration and production contracts covering contractual areas where there is a possibility of finding cross-border oil reserves. In such event, the participation of Pemex or any other SPC will be of at least 20% of the project investment.

The Hydrocarbons Law also provides certain scenarios in which the Mexican state, through (i) Pemex; (ii) any SPC; or (iii) a specialised financial vehicle owned by the Mexican state, may have a participation in the exploration and production contracts. Such scenarios are:

  • when the tendered contractual area coexists, in a different depth, with an entitled area (those granted in favour of Pemex or other SPCs);
  • when there are opportunities for the development and transfer of knowledge and technology in favour of Pemex or any other SPC;
  • when the contractual area is related to projects to be developed through a specialised financial vehicle owned by the Mexican state.

In connection with the second and third scenario listed above, the participation under the petroleum exploration and production contracts that Pemex, any other SPC or a specialised financial vehicle owned by the Mexican state may have, must not exceed 30% of the investment in the corresponding project.

The Hydrocarbons Law provides that exploration and production activities must reach, on average, a local content of 35%. Such percentage does not apply to exploration and production activities on deep waters and ultra-deep waters. The national content percentage is not fixed; the Ministry of Economy, with the opinion of SENER, must determine a specific local content percentage in accordance with the characteristics of such activities.

The requirements for a private party to proceed with the development and production of petroleum after a commercial discovery is made in a certain contractual area, will depend on the modality of contract that is executed with CNH, and the terms that are agreed with CNH for such purposes since the contract is executed – this is made through the exploration and exploitation plans which shall be approved by the CNH. 

Production-sharing Contract

Pursuant to the latest production-sharing contract model, no later than 60 days after the completion of an evaluation period, the contractor must inform CNH if there is a commercial discovery. If that is the case, the contractor will have to submit a development plan for the commercial discovery, notwithstanding that the contractor will have to remain performing the surface acknowledgement and exploration activities, the corresponding exploration and evaluation in the rest of the contractual area, until the exploration period or the corresponding minimum work programme is concluded. With the declaration of commercial discovery, the contractor should establish a delimitation of the development area, which will have to be approved by CNH.

Within the 18 months following the commercial discovery, the contractor will have to submit before CNH the development plan to be approved.

CNH will approve or deny the development plan proposed within 120 days following the reception of the required information.

The Licence Contract

Pursuant to the latest licence contract model released by CNH, it provides that a contractor must inform CNH no later than 90 days after completion of the evaluation period, if the contractor considers that a discovery is a commercial discovery. In the event the contractor provides such notice to CNH, it should submit its development plan for such commercial discovery before CNH, notwithstanding that the contractor will have to remain performing the surface acknowledgement and exploration activities, the corresponding exploration and evaluation in the rest of the contractual area, until the exploration period or the corresponding minimum work programme is concluded. With the declaration of a commercial discovery, the contractor should establish a delimitation of the development area, which will have to be approved by CNH.

No later than two years following the declaration of commercial discovery, the contractor shall submit before CNH the corresponding development plan to be approved.

CNH will approve or reject the development plan proposal within 120 days following the receipt of the required information.

Key terms may vary depending on the model of contract approved and issued by SENER and CNH for each tender.

Production-Sharing Contract

Term of the contract

The production-sharing contract provides a term of 30 years as of its execution date and two options of renewal of five years each.

Exploration plan

The contractor is required to submit to CNH the exploration plan within the next 180 days of the execution date of the production-sharing contract, in order to be approved by CNH. The exploration plan shall consider, at least, the performance of all the activities provided in the exploration period. CNH will approve or reject the proposal of the exploration plan within 120 days, following the receipt of the required information.

Exploration period

The initial exploration period will last up to four years as of the approval of the exploration plan. The contractor shall be obliged to complete, at least, the minimum work programme during the initial exploration period. 

The contractor may request before CNH two extensions of the initial exploration period by a written notice, made with at least 60 days prior to the termination of the initial exploration period and the first additional exploration period. The said extensions will be for two more years following the expiration of the initial exploration period and the first additional exploration period.

Relinquishment of the contractor

The contractor may relinquish all or a part of the contractual area through the submission before CNH of an irrevocable written notice with three months in advance to the effective date of such relinquishment. Such relinquishment will not affect the obligations of the contractor related to:

  • the completion of the minimum work programme;
  • the increase of such minimum work programme;
  • the minimum commitments for the first and second exploration additional periods (if any);
  • the payment of contractual penalties;
  • the abandonment and delivery of the contractual area; and
  • the relinquishment and return of the contractual area.

The early termination of the contract given a contractor’s relinquishment should not grant to contractor any right to be indemnified.

Abandonment of the contractual area

The contractor must perform all the activities regarding the abandonment of the contractual area. Furthermore, the development plan, as well as every work and budget programme, should include a section regarding the abandonment of the contractual area.

Once the development plan has been approved by CNH, the contractor will have to establish an abandonment investment trust fund with an acknowledged banking institution, selected by the contractor with the favourable opinion of CNH, in order to fund the activities of the abandonment of the contractual area.

Licence Contract

Term of the contract

The licence contract provides a term of 35 years as of its execution date and two options of renewal of five years each one.

Exploration plan

The contractor is required to submit to CNH the exploration plan within the next 180 days of the execution date of the licence contract, in order to be approved by CNH. The exploration plan shall consider, at least, the performance of all the activities provided in the exploration period. CNH will approve or reject the proposal of the exploration plan within 120 days, following the receipt of the required information.

Exploration period

The initial exploration period will last up to four years as of the approval of the exploration plan. The contractor shall be obliged to complete, at least, the minimum work programme and the increase of the minimum work programme during the initial exploration period. 

The contractor may request before CNH two extensions of the initial exploration period by a written notice, made with at least 60 days prior to the termination of the initial exploration period and the first additional exploration period. The said extensions will be for three more years following the expiration of the initial exploration period and the first additional exploration period.

Relinquishment of the contractor

The contractor may relinquish all or part of the contractual area, through the submission before CNH of an irrevocable written notice with three months in advance to the effective date of such relinquishment. Such relinquishment should not affect the obligations of contractor related to:

  • the completion of the minimum work programme;
  • the increase of the minimum work programme;
  • the minimum commitments for the first and second exploration additional periods (if any);
  • the payments of the contractual penalties; and
  • the abandonment obligations.

The early termination of the contract, given the contractor’s relinquishment, should not grant the contractor any right to be indemnified.

Abandonment of the contractual area

The contractor shall be obliged to carry out all the operations related to the abandonment of the contractual area. The development plan submitted for approval before CNH by the contractor, as well as the work programmes and indicative budgets shall contain one section related to the abandonment.

Furthermore, the contractor will have to establish an investment abandonment trust in an acknowledged Mexican banking institution, selected by the contractor with the favourable opinion of the CNH, to fund the activities of abandonment of the contractual area.

CNH may authorise alliances or associations by which the corporate control, management and operational control of the contractual areas managed by contractors is transferred to third parties. This authorisation by CNH is granted pursuant to, and to the extent that all requirements and procedures set forth in the applicable CNH's guidelines are followed.

For the authorisation of the transfer of operational control in upstream licences, CNH should consider the new operator's experience and its technical and financing capabilities to carry out the activities comprised in the upstream licences.

Moreover, upstream licences allow to assign or create liens upon the participating interest of any participating company, prior written authorisation from CNH. The permissibility of creating liens upon a party's participating interest has played a key role in recent years as many contractors and operators have sought financing of their E&E activities through reserve-based lending schemes.

In the event of assignment of participating interest, the assignee shall evidence certain legal requirements and prove technical and financing capabilities evidenced by the assignor during the pre-qualification process.

There are no legal or regulatory restrictions on production rates. Whereas Mexico participates as an OPEC+ country, it can only respond to restrictions or reduction on production rates or quotas with and/or on behalf of Pemex; should restrictions or reduction on production quotas be imposed because an agreement with multilateral organisations is reached (such as OPEC+), they would likely not apply to private operators or developers. For instance, this happened in April 2020 when Mexico agreed to cut production – given the COVID-19 pandemic – but only Pemex's production was affected (not production from private operators and developers).

The Hydrocarbons Law allows private investment in downstream operations, such as treatment and refining of petroleum, processing of natural gas, export and import of hydrocarbons and petroleum products, as well as transportation, storage, distribution, compression, liquefaction, decompression, regasification, marketing and retailing to the public of hydrocarbons, petroleum products or petrochemicals.

In order to perform the above-mentioned downstream activities, Pemex, other SPCs and private parties shall request and obtain a permit from SENER or CRE, depending on the nature of the downstream activities intended. When issuing the corresponding permits, SENER or CRE, as the case may be, will consider: (i) the design of the facilities or equipment related to the activities of the permit; and (ii) the appropriate conditions provided by the interested party to guarantee the continuity of the downstream operations.

Prior to the Energy Reform, Pemex controlled the national pipeline gas system, which is the main pipeline system in Mexico. Currently, as the result of such reform, CENAGAS is in charge of the operation and management of the national pipeline gas system, which means that Pemex no longer acts as a national monopoly in downstream operations.

Moreover, the Hydrocarbons Law provides that Pemex may hold a permit to perform downstream operations, regardless of the possibility that other SPCs and private parties may also perform downstream operations, under an open-access basis.

As further explained below, the access to any downstream operation in Mexico should be open to any party, without denying the provision of the service under a discriminatory basis. Likewise, there will be a regulated tariff to be determined by CRE through the issuance of general administrative provisions for the regulated activities under the Hydrocarbons Law and its Regulations, except for the activities of commercialisation and retailing to the public of petroleum liquefied gas, gasoline and diesel, whose prices will be determined pursuant to the market conditions.

Downstream activities require prior permit from the CRE, and in some cases, from SENER (eg, import/export of fuels, social impact surveys, among others). Any individual or entity may apply to obtain the permit provided that the corresponding requirements and formalities are met. In addition to the CRE permits and – as applicable, the authorisations from SENER – a downstream project would require authorisations from environmental authorities and from the ASEA on environmental, health and safety matters (eg, SASISOPA). 

Pursuant to the Hydrocarbons Law and the LH Title Third Regulations, SENER issues permits for the following activities:

  • treatment and refining of petroleum;
  • processing of natural gas; and
  • the exportation and importation of hydrocarbons and petroleum products.

On the other hand, CRE issues permits for the following activities:

  • transportation;
  • storage;
  • distribution;
  • compression;
  • liquefaction;
  • decompression;
  • regasification;
  • commercialisation;
  • retailing to the public of hydrocarbons, petroleum products or petrochemicals.

Downstream operations are not subject to the obligations set forth under the Hydrocarbons Revenue Law. However, in order to obtain a permit to perform downstream operations, entities or individuals must pay a fee before the corresponding federal government agency.

The fee to be paid may vary depending on the downstream activity to be made.

On the other hand, the Directive about the Determination of Tariffs and for the Transfer of Prices for the Activities Regulated on Natural Gas DIR-GAS-001-2007 (the "Directive") provides the methodology for determining tariffs in downstream operations regarding natural gas. In general terms, the Directive provides that the permit-holders when establishing the considerations for the downstream operations of transportation and distribution should consider the maximum tariffs established by CRE pursuant the Directive, notwithstanding that the permit-holders along with the users of the downstream operations (the "users") may also negotiate under certain cases, conventional tariffs.

The tax regime applicable to entities engaged in downstream operations is the general tax regime applicable to legal entities, value added tax (VAT) and the special tax on production and services (the IEPS) which, similarly to VAT, is passed-through to the ultimate end-user. 

Entities engaged in downstream operations are subject to tax obligations under the Income Tax Law. Residents in Mexico are subject to income tax at the rate of 30% on their worldwide net income – that is, their gross income minus allowable deductions and the previous year’s net operating losses.

The allowable deductions include:

  • returns, discounts, and rebates;
  • cost of goods sold;
  • expenses, net of discounts, bonuses, or returns; depreciation and amortisation;
  • bad debts;
  • certain losses;
  • accrued ordinary interest and penalty interest with certain requirements;
  • annual inflationary adjustment; and
  • net operating losses.

The entities engaged in downstream operation will also be subject to other significant taxes such as, value added tax, excise tax, property tax (municipal level tax that is levied on individuals or companies who own, and in some states are in possession of, real property located within a given municipality), payroll tax, among others, depending on the specific case.

Legally or regulatorily speaking, there are no special rights granted to Pemex or any other SPC in connection with downstream permits; nevertheless, a few policies and special orders from SENER and the CRE have allowed Pemex to recuperate market share and had been given a head-start on price fixing midstream and downstream activities, since certain restrictions and asymmetrical regulation imposed on Pemex to foster competition, were lifted.

The Hydrocarbons Law provides that downstream permits may be secured by Pemex and any other SPC in accordance with the Hydrocarbons Law and its Regulations regarding the activities referred under Third Title of the Hydrocarbons Law, either from CRE or SENER as it may correspond, following the same procedure described above.

For downstream operations there are no specific local content requirements established in the Hydrocarbons Law and its Regulations regarding the activities referred under Third Title of the Hydrocarbons Law. Nevertheless, when a government agency or any other SPC engages private parties for construction of a particular system or facility (eg, petroleum transportation pipelines) or for the provision of downstream services, usually a minimum percentage of local content is required (at least in respect of labour).

Term

Permits to perform downstream activities should remain in force for up to 30 years, as of their granting date. Such permits may be extended once, at the permit-holder’s request, for up to the half of the time of validity of its original term.

Termination, Expiration or Revocation of Downstream Permits

Downstream permits may be terminated for any of the following scenarios:

  • by expiration of its original term or its extension, as may apply;
  • by permit-holder’s relinquishment, without affecting third parties;
  • by expiration of rights (caducidad);
  • by revocation;
  • when the purpose of the permit has disappeared;
  • in the event of dissolution, liquidation or bankruptcy of the permit holder;
  • by a court resolution or an order from competent authority; or
  • by any other cause provided under the permits.

Downstream permits should be subject to expiration of rights (caducidad) if the permit-holder:

  • does not exercise the rights granted in the permit as follows:
    1. within the term determined for such purpose in the permit; or
    2. in the absence of a given term, within 365 consecutive calendar days;
  • incurs in other conditions triggering expiration of rights as set forth in the respective permit.

SENER and CRE may, within the scope of their jurisdiction, revoke the granted downstream permits, if the permit-holder falls, among others, in any of the following events:

  • fails to comply with the purpose, obligations, or conditions of the downstream permit, without cause;
  • assigns or encumbers the downstream permits, the rights granted in them, or the property used for their execution
  • not granting or not maintaining in force the relevant guarantees or insurances, including those necessary to cover damages to third parties, pursuant to the regulations issued for such purpose;
  • interrupts, for a term of at least 30 continuous calendar days, the activities subject to the downstream licences, without cause, at the discretion of the SENER or CRE, as applicable;
  • fails to comply with the resolutions that, within the sphere of its jurisdiction, are issued by the Federal Antitrust Commission;
  • any other provided under the downstream permits. 

Temporary Occupation and Authority Intervention

In connection with the downstream permits granted by SENER or CRE, as may correspond, such agencies may carry out a temporary occupation, or intervention, for the purpose of guaranteeing the interests of the Mexican nation, provided that third-party rights should be protected.

Moreover, for continuity of the operation of the activities provided in the permits, the authority may contract SPCs, or third parties, with a technical capacity to manage and control the occupied or intervened facilities.

Relevant Obligations for the Permit-older

The Hydrocarbons Law and its Regulations regarding the activities referred under Third Title of the Hydrocarbons Law provide the main obligations that a permit-holder should comply, includingthe following:

  • comply with the terms and conditions set forth in the downstream permits;
  • refrain from assigning, conveying, transferring or imposing a lien on the rights and obligations of the permits;
  • deliver the quantity and quality of hydrocarbons, petroleum products and petrochemicals as set forth in the applicable legal provisions.

Pursuant to the Hydrocarbons Law, exploration and production of hydrocarbons (upstream activities) are considered of social and public interest, hence, they should prevail over any other activity implying the exploitation of the surface or subsoil of lands affected by the same. As part of the Energy Reform, the hydrocarbons ROW (servidumbre de hidrocarburos) was incorporated as a new right and feature in civil laws and the Hydrocarbons Law.

In connection therewith and pursuant to the terms of the Hydrocarbons Law and its Regulations, for the activities of exploration and production of hydrocarbons petroleum, the terms, conditions as well as the consideration for using, enjoying, or affectation of the lands, assets or rights necessary to perform such activities, shall be negotiated by the contractors or entitlement holders (“interested party”) with the owner of the land, or with the holders of the rights or assets (the "owner").

Furthermore, if the land, assets and rights are comprised within any of the regimes of the Agrarian Law, the provisions of such law will also apply.

The contract reached between the interested party and the owner should be submitted before a civil District Judge, or before a Unitary Agrarian Court in order to have full validity, by considering it as res judicata. The courts will validate whether the contract complied with the requirements provided by the applicable regulations.

The Mexican hydrocarbons sector abides by and applies open-access rules in all such projects and infrastructure which, by law, regulation and under the applicable permit, is an open-access facility. Therefore, protection thereto is afforded to users and to any party asking for services to be provided. However, open-access rules are limited; limitations comprise the offering of them being rendered on a not unduly discriminatory basis, and whether the provision of the service is physically, technically and economically feasible. 

According to the Hydrocarbons Law, permit-holders providing to downstream services of transportation and distribution through pipelines, as well as storage of hydrocarbons, petroleum products and petrochemicals to third parties, are obliged to provide not unduly discriminatory open access to their facilities and services, subject to the availability of capacity in their systems, in terms of the regulation issued by CRE.

Permit-holders which have available capacity that is not contracted, or that is contracted but unused, should allow third parties to have access to such capacity. For such purposes, the permit-holder should make public such availability through electronic bulletins to allow third parties to use such available capacity, prior the payment of the authorised tariff and in accordance with the conditions for the service provision established by the CRE. 

The permit-holders of pipeline transportation or storage who are subject to the open access obligation shall not sell or commercialise hydrocarbons, petroleum products nor petrochemicals which have been transported or stored in their systems, except when it is necessary to resolve an operational emergency situation, acts of God or force majeure.

The Hydrocarbons Law provides that in order to sell hydrocarbons, petroleum products and petrochemicals in the local market, a commercialisation permit should be obtained from CRE.

Furthermore, the Hydrocarbons Law provides that as a general rule, a strict legal separation must exist between the downstream permit-holders; for such purposes, CRE will issue, prior to the opinion of the Federal Antitrust Commission, the administrative provisions to promote the efficient development of competitive markets of the downstream sector to be complied with by permit-holders of transportation, storage, distribution, retail and commercialisation of hydrocarbons, petroleum products and petrochemicals as well as the users of such products and services.

The Hydrocarbons Law provides that the export of hydrocarbons and refined petroleum products require a permit issued by SENER, known as a permiso previo. The export of hydrocarbons and petrochemicals shall be made in terms of the Mexican Foreign Trade Law with the assistance of the Ministry of Economy.

Moreover, Regulations regarding the activities referred under Third Title of the Hydrocarbons Law provides that the granting of an exportation permit of hydrocarbons and petroleum products does not comprise the authorisation to carry out the other downstream activities regulated under the Hydrocarbons Law and the above-mentioned Regulations. The performance of such activities would require the corresponding permits or the contracting of permit-holder services.

Furthermore, the Mexican Custom Law Regulation states that any entity that decides to extract or introduce goods through pipelines to or from the country, shall obtain a previous authorisation by the Mexican Tax Administration Service (SAT). For such authorisation, the entity shall submit before SAT the type and amount of product to be imported or exported through the pipeline.

In the event of entities which will export or import through pipelines, such entities shall be incorporated pursuant to Mexican laws, shall be in compliance with its tax obligations and shall evidence the legal use of the means to be used to conduct the corresponding goods to be imported or exported through pipelines, as well as the compliance of the further requirements provided by the SAT through the applicable rules.

The General Taxes on Importation and Exportation Law indicates a table with tax rate for every importation and exportation according to each product tariff code. All of the refined petroleum products are exempt from any exportation tax.

Notwithstanding that the current legal and regulatory framework allows particular individuals and entities to obtain a permit for the exportation of hydrocarbons and petroleum products, in our experience there can be some bureaucratic difficulties in the obtaining of this type of permits.

In accordance with the Hydrocarbons Law, the transfer of interest in downstream permits should only be made upon prior authorisation of SENER or CRE, depending on the nature of the activities under the permit. Permit-holders may assign (i) its downstream permits; or (ii) the performance of the activities regulated under such permits. Such assignment should be authorised by SENER or CRE as may correspond, provided that

  • the permits are in full force and effect;
  • the assignor has complied with all of its obligations under the permit; and
  • the assignee meets the requirements to become permit-holder and undertakes to comply with the obligations provided under the corresponding downstream permit.

The Foreign Investment Law provides that the exploration and extraction of hydrocarbons should be subject to provisions of the Constitution, as well as the corresponding secondary legislation, as explained above.

Notwithstanding that there is no particular restriction as to foreign investment applicable to the upstream sector, the Foreign Investment Law provides some restrictions and limitations of foreign investment for navigation companies operating in Mexican waters, that may be applicable to companies participating in the upstream industry regarding the use and operation of vessels, oil rigs and other type of naval vessel. These restrictions consist of a 49% limitation to foreign investment in Mexican navigation companies dedicated to either interior or cabotage navigation.

Principal Environmental Laws

General Ecological Balance and Environmental Protection Law

The General Ecological Balance and Environmental Protection Law (the "General Law") oversees in a broad manner all aspects of environmental regulation and compliance, such as environmental impact permitting, water quality, prevention and control of air pollution, land use, soil contamination and hazardous waste-handling transportation and disposal.

The General Law's Regulations are the following:

  • Environmental Impact Evaluation – establishes the guidelines that shall be followed to secure environmental impact authorisations subject to federal oversight, such as upstream and downstream operations;
  • Prevention and Control of Air Pollution – regulates in general terms air quality and establishes a licensing system for stationary air emission sources subject to federal oversight, as in the case of all activities involved with hydrocarbons;
  • Emissions Registration and Pollutants Transfer – requires stationary and mobile air emission sources to report their greenhouse gases, stemming from direct and indirect air emissions.

Federal Environmental Liability Law

The Federal Environmental Liability Law establishes a procedural system of access to environmental justice, enabling any person that may be affected by any activity that causes environmental harm to bring a civil action, seeking compensation or the restoration of affected areas or the ecosystem.

General Climate Change Law

The General Climate Change Law (the "Climate Change Law"), establishes Mexico's commitments and policies to fight climate change.

General Law for the Prevention and Integral Management of Waste and its Regulations

This contains the requirements that all hazardous waste generators and producers must meet, in the areas of generation, reporting, transportation and disposal. It also contains provisions addressing prevention and control soil contamination.

General Law of Sustainable Forestry Development and its Regulations

This establishes the requirements that must be met in order to secure forestry land-use change approvals whenever a project involving hydrocarbons will be undertaken in an area outside of an urban centre.

General Wildlife Law and its Regulations

The General Wildlife Law and its Regulations contain the legal obligations that must be met when encountering protected or endangered flora and fauna in a project area.

National Water Law and its Regulations

The National Water Law and its Regulations establish the legal concession regime relating to the use and exploitation of all water resources in Mexico (land or marine waters) as well as the requirements for securing waste water discharge permits.

Major Regulators

ASEA

ASEA, an autonomous agency of SEMARNAT, it has oversight over the following:

  • all environmental permitting and compliance aspects in the area of oil and gas exploration and exploitation, whether upstream or downstream, including the granting of authorisations, permits, licences and registrations in the area of environmental impact, forestry land use change, air emissions and waste management;
  • conducting regulatory inspections;
  • imposing administrative penalties for breach of all relevant environmental laws and regulations and ordering remediation or compensation activities;
  • filing civil actions for environmental harm; and
  • filing criminal complaints before the Federal Prosecutor's Office.

For further details, see: www.asea.gob.mx.

CONAGUA

CONAGUA is entrusted with regulating all aspects associated to national water, including the issuance of groundwater exploitation and use concessions as well as concessions for the use and exploitation of federal waters (including marine waters). For further details, see: www.conagua.gob.mx.

Prior to initiating a major petroleum project, an environmental impact authorisation (EIA) must be secured from ASEA, in compliance with the requirements of the General Ecological Balance and Environmental Protection Law and its Regulations in the area of Environmental Impact Evaluation.

To secure an EIA, the interested party must submit an environmental impact manifest and, in some cases, a risk study. Once ASEA has received the manifest, it may take from 60 to 120 business days to issue the approval, provided all relevant information has been provided by the submitter; in practice, it may take from eight months to a year to secure an EIA.

Part of the environmental impact permitting process involves disclosing relevant portions of the project to persons that may be affected by the work or activity. An extract of the environmental impact manifest must be published in a large circulation local newspaper.

At the request of any citizen that may be affected by the project under analysis, a public hearing may be organised by ASEA. In the hearing, the private investor is required to explain the project and the environmental mitigating or compensatory measures to be adopted.

A social impact study must also be submitted prior to initiating a project. Likewise, the private investor is required to secure a forestry land use change authorisation from ASEA, after submitting a "justifying technical study".

There are no specific health and safety requirements that must be met with regard to offshore projects. However, work performed in abnormal environmental conditions or in confined spaces must abide by the requirements established in the H&S Regulations as well as in the following Mexican official standards:

  • Draft Standard NOM-033-STPS-2014 – "Safety conditions for performing work in confined spaces";
  • NOM-199.-STPS-1999 – "Exposure to abnormal environmental conditions. Safety and health requirements".

Also, the project developer must have in place an industrial and operative safety plan, as well as SASISOPA that may be subject to oversight on the part of ASEA.

There are no specific statutory requirements in the area of decommissioning. However, an EIA will establish the specific decommissioning and dismantling activities that a project developer will have to undertake at the end of the useful life of a project.

It is important to mention that, under Mexican law, a party that causes soil or water contamination is liable for remediation, along with the owner of a contaminated site or a concession holder, regardless of fault. In addition, there are certain decommissioning actions and responsibilities that are contractually provided under the contracts governing the corresponding upstream operations, as described above.

Under the exploration and extraction contracts granted by the Mexican state, the decommissioning represents all the activities related to the removal and dismantling of materials including, without limitation, the definitive plugging and technical closure of the wells, disassembly and removal of all the plants, platforms, facilities, machinery and equipment supplied or used by the contractor in the performance of the petroleum activities, as well as the restoration of environmental damages in the contractual area affected by the contractor as a result of the petroleum activities, in accordance with the terms of the contract, the best industry practices, the applicable legislation and the management system.

The Climate Change Law states that it is in Mexico's strategic interest to carry out actions designed to mitigate or compensate for climate change and to develop the corresponding technical, as well as economic, instruments. Also, as a signatory to the Paris Climate Agreement, Mexico has agreed to contribute to fighting climate change and reducing greenhouse gas (GHG) emissions within the country and to implement mitigation and compensation policies.

The Climate Change Law sets an aspirational 30% greenhouse gas reduction target by 2020, increasing to 50% by 2050 with regard to the year 2000 emissions. These targets may be achieved if an international regime is in place that provides for financial and technological support afforded by developed countries. Currently, the government has a target for 35% of the nation's energy output to come from renewable or "clean" sources by the year 2024.

The Mexican government is requiring that emitters of a minimum of 50,000 MT of GHGs a year report their emissions. This is widely seen as a prelude to a future emissions trading scheme.

There are currently no specific climate-change provisions or restrictions applying to the oil and gas industry.

The Mexican Constitution grants local governments (such as municipalities) a mandate to regulate zoning and land-use. This means that even though they are not entrusted with overseeing oil and gas projects from a regulatory or permitting standpoint, they can establish restrictions or prohibitions, based on state or municipal zoning regulations.

State or municipal governments may enact regulations that prohibit the establishment of oil and gas projects in certain areas zoned for housing, light industry or tourism projects. This is why it is always advisable to review local zoning regulations prior to acquiring or leasing a site for an oil and gas project.

Despite the Energy Reform, no specific regulations for unconventional gas resources (such as shale gas) have yet been developed in Mexico, and so the Hydrocarbons Law, which applies to conventional oil and gas projects, will also regulate shale gas exploration and production.

There are no special regulations for the liquefied natural gas projects. LNG storage and regasification, and liquefaction of natural gas are regulated activities which require prior permit from the CRE. Imports and exports on LNG receive similar treatment and requirements as those for natural gas, but no other special regulation or permit is required for development of an LNG project in Mexico.

Five years ago, Mexico opened its hydrocarbon sector to investment by private oil and gas companies after being subject for the past 70 years to a state monopoly held by Pemex. There are now two main areas of opportunity for investment by the private sector in oil and gas in Mexico. 

The first is the bid rounds to award exploration and production rights over areas onshore and offshore Mexico not retained by Pemex. The second is joint private industry/Pemex arrangements to develop Pemex acreage for which Pemex does not have the capital. This potential for increased development of hydrocarbon resources in Mexico offers unique opportunities to meet the legal service needs that will be generated by that activity. The downstream sector also offers opportunities for the oil and gas private investment.

Furthermore, in Mexico – although there are limitations on title to the hydrocarbons still in the subsoil – the CNH has adopted a business-oriented view and have assisted operators and contractors by being flexible and allowing them to have room for manoeuvre and to operate as in other jurisdictions. The best example of this would be the acknowledgement (and permission granted) so that operators could obtain financing for their E&E activities through a bank finance/loan by collateralising the production; this is not exactly the "reserves" since, as explained above, title to any hydrocarbons still in the subsoil remains with the Mexican state.

No material changes in oil and gas laws or regulations have occurred over the past year. Certain criteria and opinions have been rendered by the authorities in their respective fields – for example, CNH's criteria for allowing the reserve-based lending financing scheme, the CRE's criteria on applicability of the policy on minimum inventories, among others.

Further, in the upstream industry there have been certain mergers and acquisitions, the most relevant being the acquisition by Wintershall DEA of Sierra Oil & Gas corporate group, including the six companies belonging to Sierra Oil & Gas group which have entered six E&P contracts with the Mexican state; Baker & McKenzie assisted Wintershall DEA in this acquisition transaction. Moreover, the French E&P company Total resigned to the deep-water block awarded by the Mexican state in Round 1.4. Finally, the companies ENI and Repsol announced commercial discoveries in the blocks awarded to them, as part of the activities under their exploration plans.

In the midstream and downstream industries, we have faced certain administrative procedures initiated by SENER for the termination of certain permits. Particularly, we have assisted several clients who are holders of importation permits of refined petroleum products who were recently subject to termination procedures related to their permits, for reasons such as the non-performance during certain period of time of the activities authorised under the permit.

Baker McKenzie (Mexico)

Edificio Virreyes. Pedregal 24
12th floor Lomas Virreyes
Col. Molino del Rey 11040
Mexico City

+52 55 5279 2959

+52 55 5279 2999

Gonzalo.Martinez@bakermckenzie.com www.bakermckenzie.com
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Law and Practice

Authors



Baker McKenzie has a strong in presence in Mexico – with five offices in Mexico City, Guadalajara, Juarez, Monterrey and Tijuana – and has more than 50 years of experience in the field. The firm's energy, mining and infrastructure practice group in Mexico advises clients on private and public investments in different sectors and projects, such as exploration and exploitation of hydrocarbons, natural gas projects, power projects and in all kinds of infrastructure projects. The practice group assists clients in negotiating project documents such as contracts and concessions, including project finance documents. Within the group, lawyers and specialists have focused their practice on certain specific and relevant industries such as oil and gas, power and the infrastructure sector. Moreover, due to the relevance and complexity of each of these industries or sectors, members of the firm's other practice groups join its industry-focused efforts, contributing from their own particular legal background.

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