Mexico’s Energy Reform

May 2014www.reformaenergetica.gob.mx

1. Constitutional Energy Reform

2. Secondary Laws Proposal– Exploration and Production– Oil & Gas Fiscal System– Downstream and Midstream

3. Investment Opportunities

4. Expected Benefits of the Energy Reform

CONTENT

CONSTITUTIONAL AMENDMENT

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December 2013: a historic constitutional energy reform was passed in Mexico. This is the

most significant overhaul of the energy sector in the country in over half a century:

Twenty one transitory articles established provisions for the drafting of the secondary laws proposal, in order to implement the constitutional reform.

Article 27Article 25 Article 28

The Government will:

• Continue to be in charge of strategic areas

• Maintain ownership and control of public entities and new state-owned productive enterprises

• Provide the right conditions to include the private sector in national economic development

• Be in charge of energy planning, productivity and sustainability.

• All hydrocarbon resources will continue to be owned by Mexico

• Petroleum exploration and

extraction activities will be carried out by the State through entitlements and contracts

• Planning and control of the electric system will be carried out by the State

• Regarding transmission and distribution of electricity the State will be able to contract with the private sector

• The National Hydrocarbon Commission (CNH) and Energy Regulatory Commission (CRE) are significantly strengthened, becoming Coordinated Regulatory Entities

• The Mexican Petroleum Fund is established

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In order to consolidate a new legal framework for the energy sector, nine initiatives (comprising 21 existing and new laws) were sent to Congress on April 30, 2014:

  Legislation INICIATIVE

1.Hydrocarbon Law

1. HYDROCARBONS DECREE

 2.Foreign Investment Law

 3.Mining Law

 4.Law of Public and Private Associations

 5. Law of the Electric Industry

2. ELECTRIC DECREE

 6. Geothermal Energy Law

3. GEOTHERMAL DECREE

 7. National Water Law

 8.Law of the National Agency of Industrial Security and Environment Protection in the Hydrocarbon Sector

4. AGENCY DECREE

SECONDARY LEGISLATION

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  Legislation INICIATIVE

 9. Pemex Law

5. STATE-OWNED PRODUCTIVE ENTERPRISES DECREE

 10. Federal Electricity Commission Law 11. State Owned Enterprises (Paraestatales) Law 12. Public Sector Acquisitions, Leasing and Services Law

13.Public Works and Related Services Law

 14. Coordinated Regulatory Entities of the Energy Sector Law

6. REGULATORS DECREE

 15. Organic Law of the Federal Public Administration

 16. Hydrocarbon Revenue Law

7. FISCAL DECREE

 17.Federal Rights Law (Payments for the use of good or services provided by the State)

 18. Fiscal Coordination Law

19.

Mexican Petroleum Fund for Stabilization and Development Law 8. MEXICAN PETROLEUM FUND

DECREE

 20. Federal Law on Budget and Treasury Accountability9. BUDGET DECREE

 21. Public Debt General Law

SECONDARY LEGISLATION

Entitlements

• Right to explore and extract hydrocarbons on behalf of the State

• Exceptional mechanism allocated only to Pemex and state-owned enterprises

Contracts

• Signed with Pemex, Pemex in association with other companies, or private companies

• Awarded by tender to the best offer for the State

• Administrative revocation due to serious misconduct or nonfulfillment

• Arbitration according to Mexican laws (location is contractual)

• The owner of a mining concession may obtain a contract for the gas associated to his coal mine

• Report of expected benefits for accounting and financial purposes is allowed

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EXPLORATION AND PRODUCTION

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Transboundary fields

• The State can award strategic projects directly to Pemex (through entitlements)

• Contracts will include direct participation of State investment (at least 20%) in areas where there could be a cross-border site

• Exploitation will be conducted in accordance with international treaties

Superficial exploration

• Pemex, Pemex in association with other companies, or private companies

• CNH authorizes superficial studies

• Companies retain commercial rights of interpreted data

• All obtained information belongs to the State and must be submitted to CNH, who will manage it at the National Hydrocarbons Information Centre

Trading

• Contractors may freely trade the hydrocarbons they receive

• The State will trade its hydrocarbons through a retailer hired by CNH through public tender

• CNH may directly contract Pemex as retailer (until December 31, 2017)

EXPLORATION AND PRODUCTION

• A flexible contracting framework with standard, well-known-by-industry models will enable a better use of Mexico’s resources to maximize the State’s revenue: 

Contract’s fiscal terms:

i. License: Onerous transmission of hydrocarbons once they have been extracted from the subsoil

ii. Profit sharing: % of profits

iii. Production sharing: % of production

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   License Profit Sharing

Production Sharing

Where is it established?

Corporate Tax (ISR) Hydrocarbons

Income Law

Surface exploration fee Hydrocarbons

Income Law

Royalty Hydrocarbons

Income Law

Signature bonus Contract

State income

(Net

Profit Oil Tax)

(Gross

Profit Oil Tax)

Tender

(bidding variable)

State share Tender

(bidding variable)

Cost recovery Contract% Cost limit ContractAdjustment mechanism Contract

OIL AND GAS FISCAL SYSTEM

• Specific values for the fiscal terms will be determined case by case, according to the specific characteristics of each field

• Contracts will have an adjustment mechanism to control extraordinary profitability• License’s fiscal terms will include a signature bonus indicative of the seriousness of the offer,

that will:- Increase the cost of entry, reducing moral hazard and preventing speculation- Provide a financial incentive, although minor, to seek an early production and recover

the investment

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OIL AND GAS FISCAL SYSTEM

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• Chooses blocks for bidding rounds (companies may propose areas of interest)

• Defines contract type and contractual terms according to each area’s geological features

• Designs bid terms

• Approves exploration and development plans

• Allocates and revokes entitlements

• Conducts bidding rounds

• Awards and signs contracts

• Manages and supervises contracts

• Evaluates and supervises exploration and development plan

• Authorizes well-drilling (exploration, deep water, and typical well)

• Authorizes seismic studies

• Manages sector information

• Determines fiscal terms of contracts and bids

• Establishes tender’s awarding variable

• Supervises accounting costs

• Income and sales taxes go to the Treasury

• Contributions related to the economic rent of oil go to the National Petroleum Fund (Bank of Mexico)

HYDROCARBONS EXPLORATION AND PRODUCTION

NATURAL GAS

Rules

• Open access to pipelines, subject to CRE’s certification and regulation

• Unused reserve capacity must be offered to the market under an open season modality

• The owners of pipeline permits are not allowed to trade the hydrocarbon

• The CRE will regulate and supervise the performance of the National Center for Control of Natural Gas (CENAGAS)

• Pemex will transfer to CENAGAS its pipeline infrastructure in natural gas as well as the contracts reserving capacity

• Main duties:

o Management of the pipeline network and storage infrastructure of natural gas

o Propose to SENER the expansion and optimization plans for the pipeline network and storage infrastructure

o Coordinate maintenance plans

o Provide transportation services with its own infrastructure

CENAGAS

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GASOLINE AND DIESEL

• Refine oil and import gasoline and diesel (private companies can import after 2019)• Transport and storage fuel • Have open access to pipelines and storage terminals.

PEMEX and private companies will:

Fuels market will have the following characteristics:

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• Maintains sales tax on gasoline and diesel

• Grants permits for oil refining and natural gas processing

• Grants permits for:

- Commercialization of gasoline and diesel

- Transportation, storage and distribution of hydrocarbons

- Price regulation of hydrocarbons and tariff of permits

• Retail sales under Pemex franchise

• Possibility to sale Pemex products under other brands after 2017; maximum price adjusted by price index

• Retail sale of other products starting 2019

• Gradual transition to price liberalization of gasoline and diesel; free prices in 2020

Gas Stations

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GASOLINE AND DIESEL

INVESTMENT OPPORTUNITIES

Transportation,

Storage, Distribution and Commercialization

Exploration and Production

Refining and Natural Gas Processing

• Construction and operation of pipelines and storage terminals

• Construction and operation of refineries and petrochemical centers

• Onshore and shallow waters in conventional resources

• Shale oil & gas• Deep water

Services

• Materials supply for the extraction of hydrocarbons

• Maintenance of existing infrastructure

• Pipeline construction

• Platform construction

• Other services to the industry

In oil and gas, resources available for bidding will be the equivalent to at least 38 years of Mexico’s current production

Opportunity for private investment: In natural gas, 29% of consumption is imported In gasoline, 45% of consumption is imported In petrochemicals, 75% of consumption is

imported

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EXPECTED BENEFITS OF THE ENERGY REFORM

Benefits 2013 2018 2025

Oil production(million barrels per day) 2.5 3.0 3.5

Natural gas production(million cubic feet per day) 5,700 8,000 10,400

• Additional 1% of GDP in economic growth by 2018 (3% by 2025).

• At least 10 billion dollars per year of foreign direct investment (upstream)

• 500,000 additional jobs by 2018 and 2.5 million by 2025

• Lower price of electricity and natural gas

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Mexico’s Energy Reform

May 6, 2014www.reformaenergetica.gob.mx