Presentation to API–Houston: Mexico's Energy Reform LegislationPetroleum Club, 800 Bell Street, 43rd Floor, Houston, TX 77002

David D. HanssFulbright & Jaworski LLPApril 8, 2014

Mexico: the past, the present and the future• Backdrop for Action

– Strict limits on particpation by foreign oil companies– Declining production requires large capital investments– Low levels of innovation

• The Immediate Present

– December 2013 Constitutional Reform– Secondary legislation and administrative regulations pending– Key Government Actors

• The Hopefully Not too Distant Future

– Types of contracts and remuneration– Bidding and booking– Opportunities for investment

Neftegaz2

Backdrop for Action

– Private investors which had been constitutionally banned from truly participating in the upstream sector since 1938– New and alternative resources present important technical and financial challenges

which require the resources and expertise of IOCs.

– For optimal performance, the Mexican E&P industry currently needs $60 billion per year of investment, of which Pemex only can count on about $20 billion.

– Mexico has become a net importer of refined petroleum products and natural gas.

– Since hydrocarbons are of strategic importance to the economy of Mexico, these issues put reforming the energy-related provisions of the Constitution “on the table”

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Pemex Trails Private and State Peers in Innovation– State-owned oil firms trail Majors in innovation– Pemex trails even among state-owned firms

Source: Graphic - The Economist; Data - Nelson Mojarro, Oxford Institute of Energy Studies4

Pemex Production Declining

– The decline in production from the Cantarell field (located in only 115’ of water) marked an end to the era of easy and accessible oil for Mexico.

– Cantarell – 2.1 mbpd in 2003, 0.4 mbpd in 2013

Source: EIA5

Large Potential for Exploration in Mexico

Sources: EIA, Tudor Pickering Holt, HPDI, Oilfield Review6

100

150

200

250

1993 1998 2003 2008 2013

Net

Cons

umpt

ion

(BkW

h)

7,000

5

Total Wells

200

1

Current Rig Count

Oil Wells

Oil/Gas Wells

Gas Wells

USEagle Ford

USMexico Shale

USEagle Ford

USMexico Shale

Demand for Power in Mexico

The Immediate Present

• December 2013: Constitutional reform approved– The amendments became constitutional on December 16 as the majority of the

Mexican state legislatures approved the decree and entered into force the day afterpublication in the Official Federal Gazette on December 21.

– Within a period of two years of passage, PEMEX is required to become a state owned,for-profit “State Productive Enterprise.”

El País7

Constitutional Reform Approved in Late 2013• The intent behind this amendment is to reform the energy sector in the country,

namely with regard to hydrocarbons and electric power. – The guiding principle in the Constitutional amendments is to "maximize[e] the

Nation's revenues, in order to achieve the greatest benefit for long-termdevelopment."

– The amendments allow for investors – whether national or foreign- to participate inthe upstream, midstream and downstream sectors, thus ending the monopoly thatPEMEX has enjoyed in the sector for 75 years.

– Notably, the exploration and production of hydrocarbons is declared of socialinterest and public order and will henceforth be prioritized for land use purposes.

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Key Government Actors• The amendments to the Constitution allow for the State to contract

with SPCs such as Pemex, and with private investors, for the exploration, production and refining of hydrocarbons.

• These contracts will be granted by the Secretary of Energy (SENER) / National Hydrocarbons Commission (CNH)

• The National Hydrocarbon Commission (CNH) – responsible for conducting the bidding processes and entering into and administering the

related E&P contracts with private parties

– Ministry of Finance – responsible for establishing the economic terms for such contracts, such as the relevant

royalty rates, tax levels and other aspects.

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Amendments Create New Gov’t. Agencies, Cont.• The amendment also provides for the creation of several government

agencies which are mandated to oversee, control and regulate the energy sector, including:

• The National Agency for Industrial Security and Protection of the Hydrocarbons Sector

• will regulate and oversee the installment and abandonment of facilities and the overall control of waste products from operations

• The National Center of Natural Gas• shall be responsible for the transportation and storage of natural gas and

the operation of the national gas pipeline system• Stabilization and Development Fund of Mexico

• will be established with the Mexican Central Bank to make payments and manage gov’t cash flows.

• to be modeled on the successful, transparent Norwegian Oljefondet (Oil Fund)

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The Hopefully Not too Distant Future• There are four types of contracts envisioned at this time. When choosing a type of

contract, Mexico must seek to maximize the long term development of the State.

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Production SharingContracts

Profit SharingContracts

Licenses

Service Contracts

Characteristics of Contemplated Contract Options

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Contracttype

ExplorationRights

Title toProduction

Type of Payment StateControl

ServiceContracts

State State cash High

ProfitSharingContracts

State State a percentage of profit Medium

ProductionSharingContracts

State Shared a percentage of production

Medium

Licenses Shared? State orCompany? Transfer at thewellhead?

“the onerous transmission of hydrocarbons after their extraction from the subsoil”

Mediumto low

Bidding on Contracts and Booking Reserves

•The new contracts will be granted by SENER/CNH and Hacienda. However, details on the bidding rules are yet to be defined by subsequent legislation.

– approval of the fine print of energy overhaul will likely be delayed until at least May 2014

•SPCs and private investors will be able to “report” such contracts, and expected economic benefits, for accounting and financial purposes … as long as the contracts explicitly stipulate that all hydrocarbons within the subsoil remain the property of the State.

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Pemex Bids Aggressively in “Round Zero”•“Round Zero” – allowed Pemex first right to select assets it wishes to retain

– List was submitted in late March 2014– Pemex’s proposed to keep:

– 83% of the country's proven and probable reserves, including some deep-water projects where it has already made commercially viable discoveries, while ceding the remaining 17%.

– In exploration, Pemex has requested 31% of the country's potential hydrocarbon resources.

– Pemex (as expected) seeks to surrender parts of the large, technically demanding Chicontepec field, which has long underperformed expectations

•Pemex's request would leave open about half of the country's prospective deep-water resources of about 50 billion barrels of crude-oil equivalent, per Pemex.

– Pemex is seeking exclusive rights in only about 15% of prospective shale-rock resources.

Sources: Reuters; WSJ14

Pemex Bids Aggressively in “Round Zero”, cont.•Remainder of assets will revert to the State to be put out to tenders

– expected to attract international oil majors and companies from around the globe– first tender of these assets is likely to be held by June 2015

•The Energy Ministry must decide by Sept. 17, 2014 which assets Pemex may retain, taking into account the state company's technical and financial capabilities.

– Unclear whether the Ministry will rule on assets “case-by-case” or all at once

•Even if Pemex gets to keep everything it has asked for, the company likely is not precluded from seeking to negotiate partnerships for those fields at a later stage

– allowing them to keep control of the asset while teaming up with companies that would bring extra money and technology.

• Post-Round Zero, Mexico will launch international bid rounds for oil and gas development rights each year through 2019, each covering about 7,722 sq miles

Sources: Reuters; WSJ; FT15

Opportunities for Service Companies and Independents

•The reforms could attract as much as $1.2 trillion in economic activity to the region in the next decade, and create 2.5 million jobs in Mexico by 2025, per BBVA Compass

– “NAFTA” level impact on Mexican economy (1.5% to 2.3% estimated potential increase in annual GDP)

•Oilfield service companies will be able to take advantage of the new opportunities for investments as well as a potential increase in the complexity of E&P activities as they move towards deepwater and shale.

•Round Zero Assets - PEMEX may choose to exploit the resource itself, or enter into joint venture with private companies for the development of fields on the basis of a contract for profit.

– PEMEX willingness to enter into joint ventures with U.S. ‘independents’ could produce sophisticated technology and know-how that PEMEX presently lacks and allow it to develop half-exploited fields, known as “bitten apples.”

– Edgar Rangel, a CNH commissioner, told a conference this month: “I think, as a general rule, that Pemex should have associations in everything in deep-water . . . whatever the stake, but they should be there.”

Sources: BBVA16

Many Questions Remain Unanswered

•The power of the National Hydrocarbons Commission (CNH) as a regulator

• Forms of Contracts to be Used

•Tax regime details – Mix of taxes and royalties? Negotiators have closely

studied Colombia’s tax regime

•National content requirements – Both PRI and PAN favor flexibility on how much the

minimum national content should be– Desire to avoid “Brazilian” model

•Security situation– Eagle Ford/Burgos

– 343 tcft “technically” recoverable

WSJ; Houston Chronicle (map)17

Norton Rose Fulbright – Law Around the World

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Additional information: Detailed article on Norton Rose Fulbright’s website, “Mexico’s Realization of a Re-Energized Industry”

David D. HanssFulbright & Jaworski LLPApril 8, 2014