Mexican energy sector environment
Most of the energy sector’s companies have expressed that although the implementation of the Mexican energy reform has certainly been a challenge for the Mexican government, the execution and results of the bidding rounds so far in terms of reliability, transparency and economic conditions, to name a few, have had an overall positive balance. Cumulatively, 70% of the offered blocks have been awarded through seven tenders, representing 72 assigned contractual areas for development. With more than $61 billion in expected investments throughout the next 25 years, rounds 1, 2 and Pemex´s farm-outs have and will undoubtedly play an important role in the development of the sector and the Mexican economy for years to come, but how long will it take before this staggering expansion fades?
There is no question that the National Hydrocarbons Commission (CNH) is pushing to have the energy reform further transcend during the remainder of President Peña Nieto’s tenure. Identified by the sector as the Mexican “mega round”, round 2.4, for instance, will release 29 deep water blocks (that is almost three times more than those offered through deep water round 1.4), accounting for almost 64% of the prospective deep water marine resources comprised in CNH’s five-year plan, expected to bring in more than $31 billion in investments.
Understandably, this effort to meet most of the action items included in the government’s five-year plan could allegedly be attributed to, among others, the current Mexican electoral environment. Although hard to predict the position that a potential left wing party entering into office will take as it relates to the energy reform, it is not unreasonable to believe that things could get a lot slower during 2019, when it comes to the execution of new bidding rounds. In any case, we do consider that the risk of having these reforms repealed is practically non-existent, taking into account that supermajority in Congress is required to enforce major constitutional amendments, which is not going to be accomplished by any political force in Mexico on a stand-alone basis.
Recent tax developments
As it relates to potential tax reforms following the elections, it is important to mention that exploration & production (E&P) contracts do include a “tax stability clause” to cover contractors from any change in tax laws or any other state imposed contributions specifically applicable and intentionally directed to the E&P industry, a change of which might affect their economic position towards the development of such contracts as compared to their original position (at execution date). Note that this adjustment is triggered only to the extent that the change in law (E&P specific) causes an economic setback for the contractor. In case the modification represents a benefit, no adjustment would be made. However, it is important to bear in mind that if changes are made to the general tax regime applicable to all taxpayers, the tax stability clause would not come into play.
Other potential changes could come through reforms made to quotas or tariffs applicable to energy trade. Currently, Mexico does not impose any local import/export or storage quotas or tariffs on oil and gas trading activities. However, the Mexican Political Constitution and the Foreign Trade Law permit the Mexican government to impose such quotas or tariffs at any time if deemed necessary. In addition, the Ministry of Energy can determine public policy on energy matters which apply to the levels of storage and the guarantee of supply of hydrocarbons in order to safeguard national interests and security. Thus, this is something that should also be closely followed come the new government.
Not less important and a matter which is in fact attracting a lot attention from oil and gas multinationals is the ongoing NAFTA negotiation, a trade agreement which has excluded hydrocarbons historically (i.e., NAFTA Annex 602.3, 603.6), but which is nonetheless relevant for trade related to other energy products. It is clear that both Mexico’s and Canada’s positions towards supressing this fundamental commercial treaty are aligned as representatives from both governments keep making an untiring effort to preserve the status quo. President Trump’s administration, on the other hand, argues that trade with Mexico is one of the main contributors to a gaping US trade deficit. Well, as it relates to the energy sector, it is interesting to point out that different from what has been historically the norm, Mexico is currently the victim of an energy trade deficit. In any case, the sector’s petition is that if the agreement is not modernised, it should at least maintain its current position towards energy trade.
Another relevant tax development to highlight is President Trump’s Tax Cuts and Jobs Act. Following this sweeping reform, many countries are expected to enact reforms of their own in order to somehow supress the competitive disadvantages for attracting foreign investment, and Mexico should be no exception if we consider that 38% of its foreign investments come directly from our northern neighbour. It is rather early to predict the nature of the reforms that Mexico will have to enact as a response, but a potential reduction in corporate income tax rates, for instance, should not be disregarded. Although lower taxes are expected, specific tax impacts to the industry will need to be evaluated based on new rules in connection to deductions, NOL’s, among others.
Alongside these important developments, recent OECD BEPS actions should also be seriously considered by oil and gas companies investing in Mexico, in particular when it comes to the enforcement of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS to which Mexico is a signatory. This could impact current structures used to allow not only an efficient capital repatriation/divestment strategy, but also to carry out business activities in Mexico without creating undesired tax risks.
Finally, narrowing down into developments related to Mexican industry tax rules, authorities have recently tackled numerous grey areas (not all) that were creating uncertainty to sector companies through the issuance of new regulations. For instance, authorities have, for the first time, issued rules related to the tax compliance of consortiums operating E&P contracts through joint operating agreements, clarifying tax invoicing processes and formalities to be observed amongst them. Other rules include clarifications for VAT refunding and creditability applicable to companies in preoperative periods; the computation of E&P fees for companies carrying out exploration and production activities simultaneously; and other important issues that will provide more certainty for companies going forward.
All things considered, the success of upcoming bidding rounds is expected to mirror earlier bidding rounds and, while no material setbacks are expected from the developments discussed here, companies should follow them closely in order to timely address any issues as their projects progress.
Oscar A. López Velarde (email@example.com)
Juan José Paullada Eguirao (firstname.lastname@example.org)
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