The Gold Strip, An Overview of the Mexican Energy Reform. Services Contract, The New PEMEX

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1 The Gold Strip, 1933 An Overview of the Mexican Energy Reform Dr. Verónica de la Rosa Jaimes CENOVUS CONTINUING LEGAL EDUCATION PROGRAM Source: Jonathan Charles Brown Petróleo y revolución en México, Siglo XXI Editores Peak in El Potrero del Llano, 117 million barrels in 28 years Cerro Azul, 89 million barrels in 21 years Juan Casiano,75 million barrels in 9 years , the Mexican oil fields produced billion barrels. Source: Silva Herzog Nationalization of the Mexican petroleum industry, 1938 Services Contract, 2002 Multiple Service Contract Program: Development work Infrastructure work Maintenance work All equipment, tools, materials, and labor required were provided by the Contractor New Oil & Gas Legal Framework, 2013 A complete transformation of PEMEX: from monopoly to a productive state enterprise. The opening of the upstream, midstream, and downstream sectors to private participation. The New PEMEX Budgetary authority and operational control Joint operating agreements: technology, resources and expertise Its debt will no longer be considered public debt Two subsidiaries: primary production & industrial transformation 1

2 Round Zero PEMEX was awarded: Proven and probable reserves (2P) 100% Prospective reserves 67% PEMEX will control 83% 2P and 21% of prospective resources: 90,000 km billion barrels of oil 2.5 million barrels/day over 5 years of exploration and 15 years of drilling Round Zero Projects that require the participation of the private sector: Mature fields Marine oil fields with heavy crude oil Enormous deep water gas fields Developing recently discovered deep water fields. Expected investment of US$ billion during the next 5 to 10 years Round One Opportunities E&P Contracts License Contracts Signing Bonus Exploratory phase fees Royalties Percentage of operating process Production Sharing/Profit Sharing Contracts Service Contracts Source: Ministry of Energy SENER Round One Timelines New Sector Regulators Ministry of Energy Ministry of Finance National Hydrocarbons Commission National Energy Regulatory Commission National Agency of Industrial Safety and Environmental Protection Source:PEMEX 2

3 National Hydrocarbons Commission Upstream activities Supervise projects to ensure maximum recovery Ensure the use of suitable technology for exploration and extraction National Center of Hydrocarbon Information. National Agency for Industrial Security and Environmental Protection of the Hydrocarbons Sector Regulate, supervise and enforce industrial, operative and environmental protection matters Prevention and containment of HC spills and leaks Physical and operational integrity of the facilities Protection, conservation and restoration of ecosystems and natural resources Control of polluting emissions Waste management Land Issues Hydrocarbon activities are public interest activities, they prevail Establishment of legal easements Use of privately owned land in connection with the performance of hydrocarbon activities Negotiations between property owners and the contractors or State Productive Enterprise Social Issues Social impact study of the relevant area prior to the granting of any entitlement or bid publication for E&P Social consultation to reach agreement or consent of vulnerable social groups Companies interested in midstream and downstream projects shall deliver a social impact evaluation Transparency New Institutional Framework Ministry of Energy, Finance and NHC shall publish information on a monthly basis: Contract areas offered E&P contracts and entitlements granted Permits approved Oil revenues received Payments made to contractors Sanctions for private parties or public officials conducting corrupt acts. Source: Ministry of Energy, Mexico (SENER) 3

4 An Overview of the Mexican Energy Reform Annethe Rodríguez Lomelí CENOVUS CONTINUING LEGAL EDUCATION PROGRAM Electricity Sector Ley de la Industria Electrica ( Electricity Industry Act ) published in the Mexican Gazzette (DOF) on August 11, The Electricity Industry Act regulates articles 25 paragraph 4; 27 paragraph 6; and 28 paragraph 4 of the Political Constitution of the Mexican United States (Mexican Constitution), and aims to regulate (i) the planning and control of the National Electricity System (SEN), (ii) the Public Service of Transmission, and (iii) the distribution of electricity, amongst other activities of the electrical industry. Electricity Sector The Power Supply is a service of public interest. Generation and commercialization of electricity are services provided in a system of free competition. The State shall establish and implement policy, regulation and supervise the electricity industry through SENER and CRE. Electricity Sector Ley de la Comision Federal de Electricidad ( CFE Act ) published in the Mexican Gazzette (DOF) on August 11, States that CFE: will generate economic value to the Mexican State, improve productivity and minimize the electricity industry costs for the benefit of the population. will seek open access, efficient operation of the electricity sector and the competition, maintain strict legal separation between units, as determined by the Ministry of Energy. may carry out the necessary activities to generate, transport, distribute, import, export and sell electricity. Electricity Sector may import, export, transport and store natural gas, coal and other fuels; as well as develop and manage real estate and technologies that enable the delivery of additional services, such as construction, leasing and telecommunications. may execute contracts with individuals in the public service of Transmission & Distribution of power, under schemes that generate higher productivity, and are in accordance with the Electricity Industry Act. Before the Reform The Mexican electrical power sector was controlled by the CFE (Comision Federal de Electricidad), a state-owned, vertically integrated electric utility providing services to all of Mexico. Was the only entity that could legally undertake the transmission, distribution and marketing of electrical power in Mexico. Maintained a dominant position in power generation (approximately 85% of generation owned or controlled by CFE). Controlled the planning for new generation projects and expansion of the transmission grid. 4

5 Some private sector involvement in generation was allowed through: Private sector generation was limited, due to three main reasons: special permits for self-supply (generating electricity for the generator's own use), co-generation, production for export, small production, or independent power production (for sale of electricity solely to CFE). Large scale generation projects dependent on CFE planning and federal budget restrictions; Limited economic attractiveness of building new generation other than for self-supply due to CFE as sole buyer, and absence of a competitive market for acquisition of new capacity; and Aging and an insufficiently integrated national transmission network resulted in barriers to interconnection of potential new generation projects. After the Reform One of the consequences - a considerable amount of electricity in Mexico was generated from fuel oil and diesel. Fuel oil and diesel have a high-cost compared to cleaner energy sources. Contributed to the high cost of electricity in Mexico, where average rates are more than 25% higher than in the U.S., even though there are significant government subsidies. Without the subsidies average rates would be 73% higher than in the U.S. New Industry Structure: CFE will continue to supply electrical service at regulated rates to Basic Users. Basic Users: residential users and small and mediumsized commercial and industrial users. CFE will continue to participate in each others segments of the industry through separate, independent subsidiaries or affiliates that will ultimately remain state-owned. CFE is not privatized. Opportunities for Private Parties to compete with CFE and/or with each other in: generating electricity for sale in a competitive, open market; entering into public-private partnerships with the federal government for generation of electrical power; acting as suppliers of electricity service to large-scale end users, competing on equal terms with the marketing subsidiaries or affiliates of CFE; and entering into contracts and JVs with the state for the construction, financing, operation and/or maintenance of transmission and distribution network infrastructure, also into contracts to provide services relating to billing and collection, and to the operation of the wholesale electricity market. In order to ensure open access and efficient operation of the electrical power industry, the Electricity Industry Act establishes as a general principle that the functions of generation, transmission, distribution, marketing and supplying primary inputs to power plants, each must be carried out independently and with strict legal separation from the other functions. 5

6 The Federal Economic Competition Commission (Comision Federal de Competencia Economica) is Mexico's antitrust regulator, with respect to monopolistic and anti-competitive practices in Mexico. Without limiting the general authority of Federal Economic Competition Commission, the Ministry of Energy (Secretaria de Energia) will now be required to establish legal separation among the various power industry functions, and to monitor compliance and enforce these rules, including by ordering the divestiture of assets, rights or equity interests. National Energy Control Center To allow generators of electricity to offer their output for sale in open competition under fair and impartial rules, the Electricity Industry Act requires the establishment of a wholesale market for electricity in Mexico. The Wholesale Electricity Market (WEM) is operated by the National Energy Control Center ( CENACE Centro Nacional de Control de Energia) based on new market rules. CENACE will set the spot price for electricity in the WEM based on supply and demand information provided by market participants. CENACE will ensure that the demand for electricity is met at the lowest possible cost in accordance with the market rules. CENACE is currently part of CFE, but it will become a separate, neutral and independent governmental entity. CENACE will ensure the open and nondiscriminatory access to the transmission and distribution networks, will maintain system reliability, and will propose plans for transmission and distribution expansion to the Ministry of Energy. CENACE will be permitted to enter into agreements with private parties for the provision of services relating to the operation of the WEM. Three types of entities will be permitted to participate in the WEM by entering into market participant agreements with CENACE: 1. Generators: including private sector generators and CFE, will be able to offer electricity for sale through the WEM by submitting bids based on their operating costs. 2. Qualified Users: including entities whose electricity demand exceeds a threshold set by the Ministry of Energy, existing self supply, cogeneration and importation users. May purchase power directly in the WEM or indirectly through a "Supplier" of electricity service. It is required to report their demand to CENACE. 3. Commercializers (Suppliers and Non-Supplier). Entities that provide electricity to end users and "represent" Qualified Users in the WEM are referred to in the Electricity Industry Act as "Suppliers" and include: (i) private sector companies that supply Qualified Users, and (ii) CFE or its commercialization subsidiaries, which will provide this service to Qualified Users and Basic Users. May purchase electrical power in the WEM to satisfy the requirements of their customers. It is required to report their demand to CENACE. CFE is transformed into a productive state enterprise with subsidiaries and affiliates, subject to functional separation and independence. CFE is similar to an independently managed power company with a board of directors (10 members), with three support committees: Audit, Human Resources and Compensation Committees. CFE has greater budgetary autonomy consistent with the principle of separation of ownership from management. 6

7 CFE will pay an annual dividend to the State in an amount determined by the Ministry of Finance and Public Credit (Secretaria de Hacienda y Credito Publico). CFE is required increased transparency and public disclosure of information based on the requirements imposed to publicly traded companies under the Mexican Securities Market Act (Ley del Mercado de Valores). CFE is further strength by CFE Act and Electricity Industry Act which allow it, through its subsidiaries, to enter into agreements and JVs with private parties for the financing, installation, maintenance, management, operation and expansion of the transmission and distribution networks. Contracts must be awarded by competitive bidding processes that guarantee open and free competition, and absolute transparency. The intention is to provide CFE with access to experience and technology not available in Mexico. The Comision Reguladora de Energía also known as CRE is the Mexican Energy Regulator. At a high level CRE s responsibilities can be divided in the following areas: 1) Business operations; grants permits for natural gas and LPG distribution via pipelines, 2) Commercial operations; approves rates as well as terms and conditions of service, regulates prices and rates charged to final users by natural gas distributors, 3) Technical operations; regulates and verifies compliance of technical operations to standards, and 4) Safety operations; regulates and verifies compliance of safety standards. In a disaggregated electrical power industry with new participants and complex transactions to regulate, CRE requires to be well positioned to fulfill its new role. The government seeks to strengthen CRE by: Increasing its budgetary, technical and management autonomy, Make it complicated for regulated entities to initiate legal claims against CRE actions, Calling for increased openness and transparency in its regulatory decision making, and Creating mechanisms to guarantee CRE s activities are in line with Mexico s energy policies. Energy Sector Coordination Council (Consejo de Coordinacion del Sector Energetico) Ensures that the programs of the coordinated bodies are in line with the objectives and targets of Mexico s energy policies. Makes recommendations and approves liaison procedures to comply with Mexico s energy policies. Includes members from: CENAGAS, Commissioners Chairman of CRE & CNH Head of Ministry of Energy Directors of CENACE & CENAGAS 7

8 Transition Period - Electricity Industry Act During the electricity industry restructuring period, CFE and CENACE, as it may apply, will continue to provide the generation, transmission, distribution, commercialization and operative control of the National Electric System. SENER will coordinate the restructuring of the electric industry, will define the terms for such restructuring and will establish policies and actions for its implementation. SENER, will issue the first Marker rules. SENER Transition Period - CFE Act CFE is transformed into a productive state enterprise once the Act enters into force. CENACE shall separate from CFE within twelve months following the Electricity Industry Act enters into force. In the meantime CFE and CENACE will continue to provide its services to ensure continuity thereof. The transference of resources from CFE to new decentralized public body will take place gradually, allowing CENACE to continue providing services to CFE. The Act imposes on CFE a period of two years for the separation of generation, transmission, distribution and marketing, in accordance with the provisions established by the regulations and by the Ministry of Energy. Transition Period - CFE Act The contracts or other legal instruments executed by CFE before its transformation shall survive to respect the autonomy of the contracting parties. CFE is exempt from profit sharing with their workers. The exemption is justified by fundamental differences with respect to any other Private company. Creates the new figure dividend state where productive state enterprises will give the State each year, in its capacity as "owner", a percentage of "utilities (determined according to CFE Act, and the amount is integrated into budgetary provisions approved by Congress). Challenges & Risks Every investment is associated with a certain risk. When investing in foreign countries different challenges can be anticipated, such as language barriers, cultural shock, different legal frameworks, and levels of bureaucracy, amongst many others. Challenges & Risks In the case of Mexico the main risks that we encounter are: Corruption, Political unrest, and Development of a new legal framework Gaps between legislation and regulations to be discovered later on. CFE as a productive state enterprise with budgetary autonomy, poses a risk to private investors as CFE s obligations under contracts are no longer guaranteed by the State. CRE s changes pose risks as it will be complicated for private companies to challenge CRE s decisions. 8