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Energy Law Exchange

October 15, 2019

Integrated Exploration and Extraction Services Contracts vs. Exploration and Production Contracts - Mexico 2020 (or back to 2009?)


As part of the recently published Pemex Business Plan 2019-2023, Pemex announced that it will increase production of hydrocarbons through Integrated Exploration and Extraction Services Contracts (“CSIEE” acronym in Spanish). CSIEEs are service contracts for the provision of E&P services in exchange for a fee limited to the Available Cash Flow (“ACF”). Payments will be made in US Dollars, through a trust, and the goal is for contractors to make a reasonable profit, but contractors will not receive hydrocarbons as consideration. This is an enormous shift in the Mexican government’s E&P strategy after the success of the energy reform which allowed for private participation in E&P activities through exploration and production contracts—licenses and production sharing agreements.

A radical change in strategy

In implementation of the 2013 energy reform, the National Hydrocarbons Commission (“CNH”) conducted successful oil rounds and awarded 107 exploration and production agreements (license and production sharing agreements) to private investors and Pemex in Mexico. The energy reform allowed, for the first time since the nationalization of the oil and gas industry in Mexico in 1938, the full participation of private investment in upstream E&P activities.  Additionally, Pemex executed Joint Operation Agreements with private investors for the development of the Trion, Cardenas Mora and Ogarrio oil fields via exploration and production license agreements with CNH where the private investor is the operator.  The E&P agreements allocate exploration risk to the private investors, require minimum work obligations and, once production begins, the private investors have the right to take their participating interest share of production and market it, pursuant to the terms of each agreement

The current administration suspended the oil rounds and farmouts with Pemex, and threatened that it would review each E&P to determine its validity and benefit to the country. But so far, the conclusion has been that these E&P contracts were a good deal for Mexico and no contract has been challenged.  Despite this success, the new administration decided that Pemex will develop E&P activities through CSIEEs with a term between 15 and 25 years, where Pemex will remain as operator of the relevant oil fields and payment to the service provider will be in cash, not in hydrocarbons.

Under the CSIEEs the service providers will provide E&P services, bear 100% of the capital expenditures (Capex) and the operating expenditures (Opex) and receive a payment in cash depending on the volumes of produced hydrocarbons. The new administration seeks to ensure that CSIEEs are financially feasible (e.g. improvement in the tax regime, separation of accounts or trusts, variable rates based on market indexes).

According to the Pemex Business Plan, Pemex intends to develop 20 new oil fields through CSIEEs in order to reclassify probable and possible reserves to proven reserves and increase production.

CSIEE’s key terms

It is not the first time that services agreements for E&P are used in Mexico.  Integral service agreements were launched in 2008 and there was limited interest from international oil companies and independents to enter the Mexican E&P market.  The 2015-2018 oil rounds were incomparably successful resulting in contributions to the State in the amount of US$ 3.1 billion, during 2017 and 2018, as reported by CNH, including through signature bonuses and government take under the CNH contracts. 

Other than for ideological and nationalistic reasons, it is unclear why CSIEEs will now be used. 

The main terms and conditions of the CSIEEs are:

  • The service provider will bear all Capex and Opex.
  • Pemex is the Operator of the oil field.
  • Payments to the service provider are limited to the Available Cash Flow. If the amount of the ACF is lower than the amount of payments to be paid to the service provider, there will be a carry.
  • The consideration for the service provider will be determined by the production of hydrocarbons, depending on the performance standards established in the CSIEE.
  • To calculate the ACF, a payment waterfall will be established prioritizing payments of taxes, transport costs and labor, the remaining amount will be the ACF.
  • The service provider will bear part of the production risk (and receive a tariff per hydrocarbons produced) and may choose to bear part of the market risk (and receive a percentage of the profits of the produced hydrocarbons).
  • The term of the contracts will depend on the complexity of the project to allow the service provider to have a reasonable profit.

Pemex launched a public consultation regarding the CSIEE for interested parties to give feedback on the terms and conditions of such contracts at https://www.pemex.com/nuestro-negocio/pep/Paginas/csiee-encuesta.aspx

Services agreements prior to the energy reform: good intentions, unsuccessful results. Lessons learned?

Before 2008, Pemex entered into certain Multiple Services Contracts (“CSMs”) and Public Works Financed Contracts (“COPFs”) with private parties to perform E&P services in Mexico. The scope of the CSMs did not include integrated services; therefore, various CSMs with different contractors needed to be executed for each oil field. The COPF established that the service provider had to finance and construct the project and would receive payment only after the project was completed, which had to be approved by Pemex, but such payment was not determined by the volumes of produced hydrocarbons.

In 2008, the Integrated Exploration and Production Contracts (“CIEPs”) were approved as a new contractual modality for Pemex to increase production and be more efficient. The CIEPs included cost recovery of Capex and the payment of a fee per barrel. Pemex conducted three mature oil fields tender rounds to award CIEPs to private companies.

For various reasons, including not having a minimum tariff per barrel produced, the CIEPs did not achieve the expected results. Therefore, under the transitory regime of the energy reform, the parties that had executed CIEPs and COPFs prior to the enactment of the Hydrocarbons Law, have the option to request the migration of such contracts into the new regime and their conversion into a license or production sharing agreement without a tender procedure.

As of today, Pemex has only completed the migration of 5 out of 22 contracts to the new regime, but the new administration also suspended this process. Pemex has indicated that the CIEPs migration into E&P agreements has been cancelled.  Additionally, on August 28, 2019, the Ministry of Energy authorized Pemex to perform E&P activities in 64 new oil fields. All these measures are in line with the Government’s goal of strengthening Pemex.  At this point, it is unclear whether Pemex has the financial capacity to assume the operation of these additional fields, or whether it makes any sense for it to do so.

The strategy of the new administration to increase Pemex’s technical, financial and execution capabilities, to share the risks of E&P activities with private parties, and to revert the decline in oil production, by accelerating the exploration strategy, incorporating secondary and improved recovery projects is now through the execution of CSIEEs. At this point, the success of the CSIEEs is too early to call because the CSIEE’s terms are still under public consultation and it is unclear whether there will be any interest by private parties. But, it is an opportunity for industry players to provide feedback regarding this new business model proposed by Pemex.  The bidding terms for the CSIEEs are expected to be published in November 2019 and the CSIEEs are to be awarded in June 2020.

The big challenge is the change in strategy after six successful years of the energy reform.  Oil and gas investors require clear rules and stability to make investments.  A drastic change in policy in these early stages of the energy reform creates uncertainty.  Most CNH contracts are still in exploration/appraisal stages and their impact on the Mexican oil and gas industry could be outstanding. Pemex should address comments/concerns provided by the industry to possibly make CSIEEs an attractive opportunity for private investment and if there is no positive reaction, it should reconsider the change in strategy.

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