The opening of Mexico’s Energy Sector

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Several reforms have changed the Mexican legal landscape in the past few months.

Above all the energy reform constitutes the “crown jewel” as it is expected to

jump-start the country’s economy alongside with an aggressive infrastructure plan.

This reform represents the most significant overhaul of Mexico energy industry since 1938 and it is currently under implementation.

Energy Reform (December 2013)

Education Reform (February 2013)

Telecommunications Reform (June 2013)

Banking & Finance Reform (January 2014)

Background

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MEXICO´S OIL & GAS PROVINCES

Significant drop in oil production

over the past 10 years driven the need to open the sector to private investment.

This reform is likely to have a

profound impact on long-term oil and gas production in Mexico.

Background

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The U.S. Energy Information Administration (the EIA) estimates that the reform could yield a potential

increase of 75% in Mexico’s long-term oil production, thus opening important opportunities for investors in the sector.

Oil & Gas

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Activities that until very recently were reserved to the Mexican government through Pemex are now open to private investment.

Pemex has been converted into a “productive state-owned company” and more independent from the Mexican government.

The Mexican State will be entitled to contract private companies to handle upstream, midstream and downstream activities in the oil and gas industries.

MIDSTREAM

UPSTREAM

DOWNSTREAM

ACTIVITIES

Upstream Activities

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Pemex was allowed to make initial bids over areas for exploration and development (the so-called Round Zero).

During Round Zero

Going Forward

Pemex will have to compete with private companies for access to new fields and areas. Pemex’s entitlements can be migrated into one of several types of contracts under the reform, thus allowing Pemex to partner with private companies.

Pemex asked to retain 380 producing fields and 165

exploration areas.

Pemex was allowed to retain 83% of the

country’s proven and probable reserves and 21% of its prospective

resources.

Pemex will be granted “entitlements” over

these areas – special titles to carry out exploration

and production activities.

Upstream Activities

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Private companies can participate in the upstream sector by entering into contracts with the government (Round One is currently in course). Under the reform, the following types of contracts are available to private companies:

• While reserves in the ground remain state property, contractors receive the hydrocarbons in-kind at the wellhead in exchange for certain cash payments (including an upfront signing bonus, exploratory phase fees, royalties, and a percentage of the operating profits).

License contracts

• Contractors recover their costs and keep a percentage of production or profits. In exchange, contractors must pay certain exploratory phase fees and royalties.

Profit-sharing/Production-

sharing contracts

• Contractors deliver all production to the government in exchange for a cash payment established in the contract.

Service contracts

Upstream Activities

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These contracts will be granted only to Mexican companies. Therefore foreign investors must incorporate Mexican entities to channel their investments. Also, contractors will be required to procure a percentage of their goods and services from Mexican providers- National Content- (the minimum percentage will increase gradually from 25% in 2015 to 35% in 2025).

Results of First Stage Round One (production sharing model), 2 blocks awarded.

Upstream Activities

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Results of Second Stage of Round One (production sharing model), 3 blocks awarded.

Third Stage of Round One is in process for land fields (Contract Type: license). Deep waters to come.

Midstream and Downstream Activities

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Oil refining

and treatment

• Private companies will be allowed to operate by permit.

• Permits will be available from the Energy Secretariat or the Energy Regulatory Commission.

• Private companies will be able to operate on their own or in association with Pemex.

• Also Pemex will be able to partner with private companies to build and operate new refineries in Mexico.

Oil transportation and storage infrastructure will be available to all users in

the country

• These services are currently controlled by Mexican state-owned companies.

• Under the reform, private companies will be entitled to participate in oil and gas transportation, storage and distribution activities under a permit granted by CRE.

The retail market will be liberalized

• As of 2016, any interested party can obtain a permit to set up service stations to sell fuels from any company; as of 2017, private companies can freely import oil products into Mexico; as of 2018, all price controls on fuels will be eliminated.

Shale Gas

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According to the EIA, Mexico has the sixth-largest reserve of technically recoverable shale gas in the world.

Currently, the gas transport infrastructure is controlled mostly by Pemex and the Comisión

Federal de Electricidad (CFE) and a few private companies. To incentivize domestic production, Mexico will improve the transport system for natural gas.

To improve competition, management of the integrated system of gas transportation and

storage will be handed over to the newly created National Natural Gas Control Center (CENAGAS).

Both Pemex and the CFE will transfer their existing gas transport and storage assets and contracts to CENAGAS. CENAGAS will tender gas infrastructure projects to private and state-owned companies.

“with 10bn barrels of proved oil reserves and potentially large volumes of hydrocarbon resources in Mexican territory

in the deep-water Gulf of Mexico, the potential is enormous, and successful implementation of the energy reforms could substantially transform the outlook for Mexico’s oil production.”

EIA

Electric Industry

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Since the 1930s, CFE has dominated Mexico’s electricity sector providing generation,

transmission and distribution services to the entire country.

The price of electricity in Mexico is 73% more expensive than in the United States of

America.

Important burden for Mexico’s industrial development and competitiveness since

electricity is essential for industrial activities.

Huge deficit of transmission

lines in Mexico.

.

Background

Electric Industry

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Seeks to attract private capital in the electric industry. Provides a new paradigm. Establishes that transmission and distribution of electricity are retained

exclusively by the Mexican State. CFE has also been converted into a “productive state-owned company” and

more independent from the Mexican government. It allows the Mexican State to enter into contracts with private parties to

carry out activities of financing, maintenance, operation, and expansion of infrastructure.

Allows participation of private investment in generation and commercialization.

The private sector may build and operate new generation plants to sell the power into the Wholesale Electric Market to be implemented.

The model will require CFE to compete with all other power producers.

The Reform:

Electric Industry

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An independent autonomous governmental body (CENACE) will control and operate the Wholesale Electric Market.

National Grid Development Plan

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The Ministry of Energy recently presented the

National Grid Development Plan

(PRODESEN) 2015-2029

Prodesen foresees required investment in

generation, transmission and

distribution activities in the amount of USD$62

Billion USD.

Generation capacity growth by 68% is

estimated.

The Ministry of Energy will determine the type

of association or contract to develop

each project

Takeaways

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In accordance with EIA, Mexico is among the largest sources of U.S. oil imports (11% of U.S. crude oil imports).

Production of oil has been significantly declining over the past 10 years. Participation of

private sector in upstream, midstream and downstream activities is perceived as the key for a sustainable turnaround.

The fourth phase of Round One includes the lucrative deep-water blocks and is expected to

draw attention from the major international players. The Reform allows the free participation of domestic and foreign investment in the

commercialization of gasoline and distribution of liquefied petroleum gas (propane). The Reform allows free participation of domestic and foreign investment in the

construction of pipelines for transportation of oil as well as oil and gas drilling activities.

The Reform creates an electric market that facilitates the free participation of domestic and foreign investment through contracts with the Mexican Government.

The Reform allows domestic and foreign investment in the transmission and distribution of

electric energy.

Takeaways

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The Reform introduces new transparency, accountability and anticorruption mechanisms. The procedures for contract bids will be public and transparent.

Contracts will have transparency clauses, which will be available for consultation. Citizens will be able to verify payments to companies.

There will be also external audits that will oversee the recovery of incurred costs

and other accounting related to the operation of such contracts. It provides for specific procedures to secure the acquisition and use of land as

exploration and extraction of oil and the public service of transmission of electricity are considered as high public and social interest.

Legal mechanisms will be established to prevent, identify and prosecute acts of

corruption in the energy industry.

Infrastructure; Energy & PPP Projects

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Mexican Government has designed an aggressive and ambitious infrastructure plan for 2014-2018 in areas such as:

Energy Health

Communications Housing

Tourism

The budget for infrastructure totals an amount of approximately USD$441 Billion Dollars. 50% of this amount is destined to energy projects alone. A large portion of the investment is expected from the private sector.

Infrastructure; Energy & PPP Projects

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Mexico has recently passed a law that promotes and encourages public-private partnership in infrastructure projects. The enactment of this law is intended to detonate the development of infrastructure in Mexico in line with the national infrastructure plan and it is undoubtedly one of the pillars for the implementation of the energy reform. It is contemplated that the number of PPP projects will importantly increase in Mexico as a mean to supplement governmental tax resources.

Key features of the PPP Model: • Its focus is development and maintenance of infrastructure through long-term services contracts. • It requires prior studies proving social and economic advantages with respect to other contracting models

as well as legal and legal viability. • The budget for each project is approved by Congress. • The law provides for the so-called unsolicited proposals in order to encourage implementation of these

types of projects. The government would reimburse developers for the costs and expenses of studies presented in connection with projects that are approved for implementation.

• The law provides for specific protections in favor of creditors financing PPP Projects including the possibility

to create liens over the collection rights deriving from the project and all assets of the project including the underlying permits and concessions. The law also allows step-in rights in favor of creditors so that creditors may take temporary control of the project to ensure repayment of the financing.