MEXICO ENERGY REFORM: DISPUTE RESOLUTION FOR OPERATORS FACING ADMINISTRATIVE RESCISSION OF THEIR EXPLORATION AND PRODUCTION AGREEMENTS.

• Author: Cano-Lasa, Fernando

1. THE NEW OIL AND GAS SCENARIOS IN MEXICO II. THE LEGAL CHANGES III. UPSTREAM IN MEXICO AFTER THE ENERGY REFORM OF 2013 IV. THE ADMINISTRATIVE RESCISSION IN COMMISA V. PEP V. THE ADMINISTRATIVE RESCISSION IN THE NEW FRAMEWORK A. The Constitution B. The Hydrocarbons Law C. The Executive Regulations on the Hydrocarbons Law D. The Exploration and Production Agreements VI. REMEDIES A. Standard of Proof B. The Specific Procedure Before the Mexican Courts C. Bilateral Investment Treaties (BITs) VII. CONCLUSION A. Administration of the Exploration and Production Agreement B. Investigation Period C. The Administrative Rescission Procedure D. File Amparo E. Claim for Damages in Federal Court F. File BIT Arbitration I. THE NEW ON, AND GAS SCENARIOS IN MEXICO

   December 20, 2013 was likely the most significant date for the Mexican oil and gas industries in the past 100 years. The decree issued by the Mexican President Enrique Pena Nieto appeared in the afternoon publication of the Mexican Official Gazette, which formally amended the Mexican Constitution to allow the participation of the private sector in all activities of the hydrocarbons industry of the country. (1)

   Although most analysts expected such an amendment to occur in some capacity in Mexico, it was a real surprise that the end result, at least on paper, was a 180-degree transformation of the industry. No one would have predicted a reform of this depth after the major failure of the 2008 reform. (2)

   The next major milestone regarding the implementation of the Reform occurred in August 2014. Well short of a year from the approval of the constitutional amendment, the Mexican Congress approved the core secondary or implementing legislation to bring into life the core provisions of the Carta Magna amendment. (3)

   After the publication of these implementing laws, I devoted a significant amount of time to understanding the real effect of the Reform. At that time, I created the following charts which remain valid and useful to visually understand what happened. Prior to the Reform, the Mexican oil and gas arena looked like this:

   The core concepts associated with this initial chart are as follows: (i) the entire industry was Pemex Centered, (4) (ii) regulators were poorly structured and had no real authority against the monopolist and absolute power of Pemex, (5) (iii) upstream activities were completely prohibited for private investors, (6) and (iv) midstream and downstream had minimal private investment which also led to lack of infrastructure.

   After the Reform, the new map looks like this:

   The core concept, as seen in this chart, is that the Mexican State reassumes its position in the center as the owner of the reserves. For the first time in years Pemex is not at the core of the industry, but is instead seen as one additional actor--a critical and significant one, but one more. The regulators have now grown teeth and have full authority to rule over private parties and governmental entities. (7) Private investment is now permitted, one way or another, in all sectors of the map: upstream, midstream, and downstream. (8)

   One critical regulator for upstream that is also critical to understanding the content of this article is the National Hydrocarbons Commission (Comision Nacional de Hidrocarburos or CNH). This regulator is the technical expert of the upstream industry and it is in charge, along with others, of (i) conducting all bidding procedures for the award of upstream fields in the country, and (ii) signing and administering all exploration and production agreements awarded by the Mexican government. (9)

2. THE LEGAL CHANGES

   Legally speaking, the Reform is understood by considering the upstream scenario on one hand and everything else on the other. Upstream is now the only Strategic oil and gas constitutional activity. For years, Article 28 of the Mexican Constitution included a distinction between Strategic (Estrategicas), Priority (Prioritarias), and other activities. (10) The explanation of such concepts was included in the Constitution, Mexican case law, and the non-binding opinions of Mexican legal experts and analysts. (11) Strategic activities were those expressly mentioned in the Constitution that the Mexican State was mandated to execute directly without the assistance of private investors. (12) Priority activities were those that the Mexican State could execute with the assistance of private and social sectors. (13) All other thinkable activities could be freely developed by either the Mexican State or any private party. (14)

   With the Reform, the legal concept and its content changed. We still do not know the extent of such change, but future writings or theses in Mexico and the United States will likely focus on shedding some light on the new understanding of what a Strategic activity in Mexico is. Even though the Constitution classifies upstream as strategic, the transitory provisions of the constitutional amendment and the secondary, or implementing, legislation expressly allow for private investment in such activities. (15) The distinction may now be focused on the high regulation of strategic activities to maintain the highest level of control by the Mexican State, rather than prohibiting private parties from associating with the government. This need to maintain and assure control is consistent with the new upstream opportunities, which are to be mandatorily awarded via public tender. (16)

   Midstream and downstream activities are now linked to two core concepts. First, just like in the United States, there is a regulator in the middle of the spectrum that exclusively regulates the actors and their ideas, projects, and business strategies instead of directing the market or creating tendencies or strategies for directing the market. (17) Second, the scheme is based on the Mexican legal regime used for the transportation and commercialization of natural gas, which had been open to private investment in the country for years, and was expanded into all midstream and downstream activities. (18) Generally, Mexico has a free market (19) scenario for midstream and downstream activities, conditioned or limited by a strong regulator--either the Comision Reguladora de Energia (CRE) or the Ministry of Energy, depending on the matter--who has the authority to issue the corresponding permits. (20)

3. UPSTREAM IN MEXICO AFTER THE ENERGY REFORM OF 2013

   After the enactment of the Reform in 2013, the first step taken by the Mexican government with respect to upstream in Mexico was known as Round Zero. This round constituted a process by which Pemex filed a request with the Ministry of Energy to obtain the direct assignment of oil and gas fields and assets prior to any private tender procedure to be issued on the matter. (21) Pemex requested 83 percent of the 2P reserves of the country, plus 31 percent of the prospective resources. (22) The government granted Pemex 100 percent of the 2P reserves, plus 67 percent of the requested prospective resources. (23) Based on these assignments, the government estimated that Pemex was awarded reserves of about 44 mmbboe which would allow the company to produce at a rate of 2.5 mmb per day for 20.5 years. (24) In addition, Pemex, like any other interested investor, now had the flexibility to bid for new blocks and fields issued by the Mexican government and to also perform oil and gas activities in any other country in the world. (25)

   As soon as Round Zero concluded (one month before the scheduled date (26)), the government immediately started the process known as Round OneP Unlike Round Zero, this new round was directed to any investor, including Pemex. (28) Although the calendar for Round One was originally different, it ended up considering four different bidding procedures: (i) R1.L1--shallow waters for exploration, (ii) R1.L2--shallow waters for production, (iii) R1.L3--onshore fields for production, and (iv) R1.L4--deep waters for exploration. (29)

   The government used different types of contracts for these biddings included in Round One. For biddings R1.L1 and R1.L2 the government used a Production Sharing Agreement (PSA), while for biddings R1.L3 and R1.L4 a License Agreement was used. (30) While one would love to think that the use of different contracts was due to a deep analysis of the resources and the best alternative for their exploitation, that was not the case. The government, specifically the CNH, followed a brilliant approach when implementing the Reform. Most analysts in the oil and gas industries agreed that deep water resources were the most attractive that Mexico could offer. (31) While the government understood this, they were also humble enough to recognize that they lacked the necessary expertise to conduct complex bidding procedures, instead opting to start with the less attractive resources and concluding with the cherry on top.

   R1.L1 and R1.L2 generated a significant level of interest by both national and international investors. Companies like BHP Billiton, Chevron, Diavaz, ENI, Exxon Mobil, Hess, Hunt, Lukoil, Maersk, Pacific Rubiales, Pemex, Petrobal, Shell, Sierra Oil & Gas, Statoil, and Total actively participated and were pre-qualified by the government to submit bids. (32) However, most of them did not bid in any of the rounds. (33) Many analysts, myself included, believe that these companies used the process for two purposes: (i) to understand and get acquainted with the new bidding procedure in Mexico; and (ii) to define whether or not the process was fair, equitable, and worth taking into consideration on their investment portfolio when more attractive resources were put for bid. (34)

   Due to the unattractiveness of the resources and a poor effort by the Tax Ministry (Secretaria de Hacienda y Credito Publico) in setting the minimum acceptable economic standards for each field, only two out of fourteen blocks were awarded in R1.L1 --both to the same group of companies. (35) The...