Mexico: Contracts and black gold

Author: | Published: 1 Jun 2011
Email a friend

Please enter a maximum of 5 recipients. Use ; to separate more than one email address.

On November 24 2010, the board of directors of Petróleos Mexicanos, or Pemex, approved a new contract model to be used in contracting services for the evaluation, development and production of hydrocarbons. This Model Contract was published as part of a recent legal reform meant to afford Pemex more flexibility in the procurement of goods and services through third parties, with the intention of attracting private contractors to assist it in the exploration and production of oil fields, although the control of these activities are still exclusively reserved to the Mexican State.

With the participation of private investment in exploration and production activities through integrated service contracts, the government is seeking to raise production of mature oil fields in Mexico and maximise the oil and gas reserves.

The Model Contract has been designed to grant Pemex more flexibility in the contracting of services and the payment of consideration, and to allow it access to the latest technologies in order to optimise the existing wells through third-party service providers in exchange for performance incentives.

On the same date the Model Contract was published, Pemex-Exploración y Producción (PEP), which is the Pemex entity in charge of the exploration and production activities, published through its website the draft bid guidelines for the international public tender processes to award the first three service contracts for the evaluation, development and production of hydrocarbon activities. The first three services contracts to be tendered relate to the areas known as Magallanes, Carrizo and Santuario in the southern part of the country and are expected to be awarded sometime during the third quarter of 2011 to the bidder offering the lowest fee per barrel in US dollars.

On March 1 2011, PEP published in the Federal Gazette the call for these three service contracts. As of this date, several clarification meetings have taken place, as well as workshops organised by PEP where potential bidders discuss the available information on the project, and provide PEP with opinions and comments to the draft documents.

Among the contractors that have shown interest in these tender processes by acquiring the bid guidelines and/or actively participating in the clarification meetings are Apache Corporation, BP Exploration México Limited, Halliburton de México, Maersk Oil Hourston, Repsol Exploración México, Burgos Oil Services, Pacific Rubiales Energy Corp, Pluspetrol Resources Corp, Petrofac Facilities Management, GPA Energy, and D&S Petroleum.

PEP has said that the contract area for the Carrizo project will be 13 km squared, with reported oil reserves estimated at 49 million barrels and gas reserves of an amount of 5.8 billion square feet. The contract area for the Santuario project will be 17.6 km squared, with oil reserves estimated at 39.6 million barrels and gas reserves of 25.5 billion square feet. Finally, the contract area for the Magallanes project will be more than 169 km squared, with estimated oil reserves of 92 million barrels and gas reserves to the amount of 93 billion square feet.

Once these three tender processes conclude, Pemex's intention is to call for new tender processes for contracts in the northern part of Mexico. The third and fourth stages will encompass the areas of Chicontepec and the deep waters in the Gulf of Mexico.

Scope

The scope of the services focuses on the evaluation, development and production of hydrocarbons (mainly oil and gas) within a specific surface of land, known as a contract area, where the contractor is to perform these services. The contractor is solely responsible for obtaining any financing required to comply with its contractual obligations.

The matter most emphasised by PEP is that the contractor will not have ownership rights over the hydrocarbons or minerals found and extracted, which will remain at all times property of the Mexican State.

In exchange for the services provided, PEP will pay to the contractor a monetary consideration which results from the fee proposal submitted as part of the tender process. However, PEP does not guarantee the contractor that the income obtained from a specific project will be enough to cover the expenses arising from the provision of the services.

The contractor may be a Mexican company (specific purpose vehicle) formed by members of a consortium which will remain jointly and severally liable to PEP. The consortium members must appoint a leader to represent them before PEP on all contractual matters.

Term

The contractual term is 25 years, divided in two stages: evaluation and development. During the evaluation stage, which according to the bid guidelines published by PEP may not last longer than 24 months, the contractor must provide evaluation services consisting of the activities necessary to determine the boundaries and production capacity of a field within a contract area. If the results obtained during the evaluation stage are favourable, the contractor will notify PEP of its availability to continue with the development stage (through a continuation notice), in the understanding that if the contractor does not provide PEP with a continuation notice, then the contractor will be deemed to have waived all its rights under the contract without having the right to receive any consideration.

Following the delivery of a continuation notice, the contractor will be required to submit a development programmeme for the services to be provided during the development stage and until the expiration of the term. As part of those services, the contractor must, at its own expense, construct, install, maintain and operate the delivery facilities, including those already existing within the contract area.

If the contract area is expanded, or if PEP's economic interests so require it, the contract may be amended in order to extend the term, accordingly.

Work programmes

According to the Model Contract, the contract areas will be exploited based on work programmes that the contractor submits for PEP's prior approval by June 30 of each year. The work programmes shall contain a description of (i) the status of the minimum evaluation programme and the development plan which make reference to investment obligations; (ii) the services to be provided; and (iii) a forecast of the monthly production and the yearly production for the next five years, as well as the total expected production of the fields within a contract area.

Along with each work programme, the contractor must also submit a budget of so-called eligible expenses which may be recovered from PEP as part of the consideration to be paid. Under the Model Contract, eligible expenses shall only be considered recoverable expenses once all the requirements set forth in the Financial Registry Proceedings, attached to each services contract, have been complied with.

The following matters will not be considered recoverable expenses: (i) technical specifications; (ii) design of wells and facilities; and (iii) engineering, design or construction of wells and the collection and production facilities within a contract area, as well as proposals to operate them.

Consideration

Under the Model Contract, the contractor is entitled to receive a consideration from PEP from the moment it begins to deliver hydrocarbons at the metering points. Such consideration will be calculated based on a formula to be set out in the contract.

One of the factors taken into consideration to calculate the consideration is eligible expenses: only eligible expenses may be considered recoverable expenses from PEP. The following may be considered eligible expenses:

(i) payments directly attributable to owners for the acquisition, access, use and superficial occupation of land required to provide the services;

(ii) expenses related to personnel;

(iii) expenses related to services such as legal, accounting, computer, scientific or technical services;

(iv) expenses related to materials bought or leased by the contractor;

(v) operation and maintenance expenses;

(vi) expenses related to storage;

(vii) expenses related to environmental and safety;

(viii) expenses related to the abandonment of a contract area;

(ix) expenses related to insurances;

(x) expenses related to replacement or repair of damages;

(xi) administrative expenses incurred by the contractor in Mexico;

(xii) expenses related to training and technology transfer; and

(xiii) expenses related to communication systems, including radio, microwave and satellite.

The Model Contract emphasises the fact that the consideration shall be the sole payment to which the contractor is entitled for providing the Services, and that PEP does not guarantee the project's profitability or that the contractor will recover all its expenses.

One of the main changes in this new contracting regime, however, is that the calculation of the consideration payable to the contractor may include production incentives calculated according to the industry's practices, and may also include additional compensations if Pemex' costs are reduced by reason of efficiency or the use of new technologies.

Guarantees

Under the Model Contract, the contractor must deliver to PEP at the time of execution of the contract a corporate guarantee and a performance guarantee in the form of a stand-by letter of credit issued by a financial institution operating in Mexico.

Those guarantees will allow PEP to collect damages and lost profits, recoup payments made in excess, and enforce indemnities and any other amount owed by contractor under the contract.

Termination

The Model Contract provides that PEP has the right to administratively rescind/terminate the contract if the contractor defaults from its obligations under the contract. The Model Contract provides a list of those defaulting events. Before rescinding the contract, the Model Contract foresees that PEP grants to the contractor a 60-day cure period, without prejudice of PEP executing the corresponding guarantees.

On the other hand, PEP is also entitled to exercise, at any time, its early termination right of the contract: (i) for force majeure; (ii) in the event the duration of a force majeure event cannot be determined; (iii) for causes impeding the execution of the contract; or (iv) if the contract becomes unprofitable or inconvenient pursuant to PEP's economic model.

If the contract is terminated early due to a force majeure event, the contractor will not be entitled to claim any kind of payment. The only payment that the contractor would be entitled to receive is the payment calculated as part of the settlement. Principal and financing costs could be included if these have been recognised by Pemex and such amounts were actually used in the development of a project, are reasonable (in market terms and adequate under industry standards) and duly documented (in the financing documents or elsewhere).

The interpretation of the last assumption under which PEP may terminate the contract if it becomes unprofitable or inconvenient pursuant to PEP's economic model could be very broad and seems that the determination of the profitability and convenience of the contract will be at PEP's discretion. In addition, the contract does not provide a definition of what "convenient" will mean.

Notwithstanding, in the event PEP gets its economic model wrong and decides to exercise its early termination right or rescind the contract, the project manager is required to provide sound legal arguments and justifications to its resolution and such resolution must be authorised by the public officer hierarchically above the project manager.

As soon as the contract is early-terminated or rescinded, the parties shall proceed to prepare a settlement determining the amounts owed by each party and executed within a term of one year, which may be extended as required.

One of the matters which is important to emphasise is that neither the Pemex legal framework nor the Model Contract provides a definition of "recoverable expenses" or what these encompass and that could be recovered if the contract is early terminated or rescinded. In the authors' opinion, financing costs should be eventually recovered from Pemex, so long as the contractor can adequately evidence that such amounts were actually used in the development of a project, are reasonable (in market terms and adequate under industry standards) and duly documented (in the financing documents or elsewhere).

A practice followed by most participants in large public bidding procedures has been to file very thorough questions during the clarification meetings addressing these matters and attempt to have these explicitly set out in the final contract. If this cannot be achieved, there has been some success in addressing these issues to lenders' satisfaction through clarification memoranda where the relevant governmental entity agrees to more explicit terms, conditions and consequences of an early termination of the contract and the recoverable costs and expenses.

Finally, under the Model Contract the contractor is also entitled to request the rescission of the contract before a competent authority: (i) if PEP defaults its payment obligations; (ii) if PEP does not make available to the contractor the contractor area; or (iii) if PEP does not obtain the permits, licences and authorisations for which it is liable.

In addition, if a force majeure event lasts more than 180 consecutive days, the contractor is entitled to request the early termination of the contract. As described above, the only payment that the contractor would be entitled to receive is the payment calculated as part of the settlement.

Other relevant matters

One of the relevant matters that will allow contractor to provide the necessary services is the obtaining of access rights, rights of way, easements and occupation surface. Under the Model Contract, although PEP will cooperate with the contractor to obtain all of these, it is the contractor which is solely responsible for obtaining them.

The contractor is responsible for complying with all environmental obligations, commitments and conditions, and for the remediation and restoration of areas where the services are provided, as well as any claims arising during the term of the contract. Before a contract area is abandoned, the contractor must, at its own cost, perform any actions required to remediate and rehabilitate.

PEP is responsible for its own personnel, whether affiliated to the Pemex union or not. Personnel performing operation and maintenance activities at the contract area at the time the contract is executed will continue to be PEP's responsibility. The contractor will be liable for all labour matters relating to its employees and will be responsible for indemnifying Pemex for any labour liability.

PEP's main obligations under the Model Contract are to transfer the contract area to the contractor and to receive, at its own cost, the hydrocarbons at the metering points. PEP will be responsible for the construction, installation and operation of the necessary facilities after the metering point.

In addition, PEP is responsible for timely obtaining any authorisations that are its responsibility and for cooperating, at the contractor's request, in obtaining access rights and occupational surfaces, rights of way and easements required to provide the services.

The ownership of all the equipment used by the contractor to provide the services must be transferred to PEP immediately after their installation or after their construction within the contract area (facilities, drilling equipment and machinery, and so on). Once title over the equipment has been transferred to PEP, the contractor will be entitled to use it free of charge in order to provide the services.

If the contractor leases instead of buying the equipment, the above mentioned requirement will only apply if the equipment is the property of related companies. In this case, the contractor must make its best efforts to negotiate with the subcontractors or lessors in order to include in the corresponding use or lease agreement an assignment clause in favour of PEP that may be exercised either by the contractor or by PEP.

Assignment/change of control

One of the new matters that Pemex incorporated into the Model Contract is the fact that the contractor will be entitled to assign, encumber or transfer, either totally or partially, their rights and obligations under the contract, including collection rights, with prior written consent from PEP. This right will be subject to evidencing that the new assignee does have the technical and financial abilities to comply with the obligations under the contract.

In the past, the contractor was only allowed to assign its collection rights with prior written consent from PEP.

Dispute resolution

The service contracts are subject to the regulation of Mexican law and disputes arising from them will be resolved by means of arbitration proceeding carried out based on the Arbitration Regulations of the International Chamber of Commerce.

It is believed that the publication of the Model Contract and the commencement of the tender process for the first three projects is a solid step to bring greater production efficiencies to the Mexican oil industry, and afford Pemex greater operational flexibility to compete worldwide. Nevertheless, there are still many issues to be resolved if Mexico wants to keep up with the evolution in the global markets, and meet the expectations that the Mexican population has of Pemex.

About the author

Santiago Sepulveda is a partner with Creel García-Cuéllar Aiza y Enríquez in Mexico City. Santiago leads the energy and infrastructure practice group, and has substantial experience representing Mexican and transnational clients in the structuring, financing and implementation of large gas, electricity, telecommunication and infrastructure projects in Mexico, as well as specialised M&A transactions and private equity investments. Santiago worked as a foreign associate in the New York office of Mayer Brown. He has been named one of the world´s leading lawyers in his field by Chambers Global: The World´s Leading Lawyers for Business, and is ranked as a leader in his field by www.bestlawyers.com

He represents major energy companies, project developers, engineering and construction companies, as well as lenders and investors in infrastructure projects in Mexico. Recently, Santiago has acted as Mexican counsel to the consortium formed by Mitsui & Co, Korea Gas Corporation and Samsung Corporation in connection with the development and financing of an LNG Storage Terminal located in Manzanillo, Colima, as well as counsel to Abener Abengoa Mexico and GE Energy Financial Services in the development and financing of the Nuevo Pemex gas-processing complex in Tabasco. He is also counsel to Sempra Energy in all of its projects in Mexico. Finally, he has represented various financial institutions in their participation in the financing of Mexican energy and infrastructure projects whether as direct lenders, as agents or as credit-enhancers.

Contact information

Santiago Sepulveda
Creel García-Cuéllar Aiza y Enríquez

Paseo de los Tamarindos 60, Piso 3
Col. Bosques de las Lomas
05120 México, D.F.

t: +52 55 1105  0613
f: +52 55 1105 0690
e: santiago.sepulveda@creelmx.com
w: www.creelmx.com


About the author

Vanessa Gimenez is an associate with Creel García-Cuéllar Aiza y Enríquez in Mexico City, where she specialises in energy and infrastructure transactions. She has represented Mexican and transnational participants in the energy sector, such as major energy companies, project developers, engineering and construction companies, as well as lenders and investors. She has been involved in all aspects of project development. Vanessa worked as foreign associate in Clifford Chance´s energy and infrastructure group, based in the Washington DC office.

She has been counsel in the development and financing of the Nuevo Pemex gas-processing complex in Tabasco; counsel to Gas Natural SDG, in the acquisition from Electricité de France International of its five power-generation projects and related natural gas pipeline located in Mexico; and counsel to Sempra Energy in all regulatory and commercial aspects of their various projects in Mexico.

Contact information

Vanessa Gimenez
Creel García-Cuéllar Aiza y Enríquez

Paseo de los Tamarindos 60, Piso 3
Col. Bosques de las Lomas
05120 México, D.F.
t: +52 55 1105 0604
f: +52 55 1105 0690
e: vanessa.gimenez@creelmx.com
w: www.creelmx.com