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Written By: Sergio Mario Ostos and Antonio Franck

Cacheaux Cavazos & Newton

Mexico City, Mexico

On December 21, 2013, the decree that reformed Articles 25, 27 and 28 of the Mexican Constitution relating to the energy, electric and hydrocarbon sectors came into effect. This decree is best known as the "Energy Reform."

In addition to reforming the three constitutional articles cited above, the Energy Reform decree contains 21 transitory articles which establish, among other things, that within the following 120 days, Congress must make the necessary modifications to applicable secondary legislation in order to fully implement the new Energy Reform decree. The Energy Reform encompasses both hydrocarbons and electricity.

(A) Hydrocarbons:

The Energy Reform does not open Petróleos Mexicanos ("PEMEX") to direct private ownership and investment; however, it will allow PEMEX to develop as a "productive entity of the state" in conjunction with private, domestic and foreign entities. Consequently, the Energy Reform will allow domestic and/or foreign companies to join PEMEX as participants in developing new oil and gas exploration and extraction projects. Similarly, the Energy Regulation Commission (Comisión Reguladora de Energía ["CRE"]) is authorized to grant to PEMEX and/or certain companies various permits for refining, petrochemical production, transportation, and storage of such hydrocarbons and their derivatives, including regulation for third party access to pipelines and first hand sale of such products.

The Energy Reform allows private sector investment in exploration and extraction of oil and hydrocarbons in solid, liquid or gas form by means of certain flexible contracts, the same which are standard in this branch of the industry. In accordance with the decree, such contracts may be for: (i) services; (ii) profit or production sharing; or (iii) licenses. Similarly, and in relation to such contracts, the Energy Reform also contemplates the following potential forms of payment/consideration: (a) cash, for service contracts; (b) a percentage of profits for profit sharing contracts; (c) a percentage of production obtained for shared production contracts; (d) transfers of hydrocarbons in exchange for good and valuable consideration once extracted from the subsurface pursuant to license contracts; and (e) any combination of such forms of consideration.

During the next few months, various amendments will be made to the secondary legislation in order to regulate the mentioned contracts mentioned, including the tax regime applicable to such contracts and the private investment companies that may be formed for such purposes. It is important to note that, to date, it is uncertain whether the production of oil and/or gas will be subject to the application of any tax such as: (i) a tax on profits, such as the income tax (Impuesto Sobre la Renta ["ISR"]); (ii) royalties or tax on consumption, meaning a percentage of the value of production; (iii) a bonus; and/or (iv) a combination of the prior items.

The Energy Reform will also create three important new entities: (i) the Center for Control of Natural Gas (Centro de Control de Gas Natural ["CENEGAS"]), which will be responsible for the operation of the national system of pipelines for transportation and storage of natural gas; (ii) the Mexican Oil Stabilization and Development Fund (Fondo Mexicano del Petróleo para la Estabilización y el Desarrollo ["FMPED"]), which will be in the form of a public trust in which the Mexican Central Bank (Banco de México) will act as trustee; and (iii) the National Agency for Industrial Safety and Environmental Protection in the Hydrocarbon Sector (Agencia Nacional de Seguridad Industrial y de Protección al Medio Ambiente del Sector Hidrocarburos), which will be responsible for regulating and supervising the facilities and activities of such sector with respect to industrial and operational safety and environmental protection.

(B) Electric Energy:

With respect to electric energy, the Energy Reform allows for individuals to participate in the generation of electricity. Under the new law, electricity generators will have open access, without discrimination, to Mexico's electricity transmission and distribution networks.

Even though the government will maintain exclusive control of the National Electrical System, including the public services necessary for the country's electricity transmission and distribution networks, individuals will now be allowed, by means of contracts with the government, to perform financing, installation, maintenance, management, operation and expansion activities of infrastructure to provide public services for the transmission and distribution of electrical energy.

Under the new law, the Federal Electricity Commission must also convert itself into a "productive company of the State" within the following two years, which will strengthen its operating and organizational structure and serve to make its services more efficient and lower in cost.

The creation of the National Energy Control Center is contemplated, the same which will be in charge of the operating controls for the National Electrical System, operating the electrical wholesale market and open access, without discrimination, to the national transmission of electricity and the general electricity distribution networks.

The technological development and adoption of lower cost and cleaner energy sources will be developed, such as gas, solar and wind energy, as well as to regulate the exploration and exploitation of geothermal resources in order to take advantage of underground energy to generate electrical energy or to designate it for various uses.

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