Oil & Gas Deal-Doing in Mexico

Oil & Gas Deal-Doing in Mexico

Current Trends and Future Prospects

March 28, 2019

AGENDA

• Introduction • Political landscape and state of play • Deal doing in Mexico ‒ Overview of recent deal activity ‒ Regulatory considerations in deal structuring ‒ US-style PSAs vs English-style SPAs • Financing acquisitions or projects in Mexico • Anti-corruption enforcement in the US and Mexico • What next in Mexico?

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INTRODUCTION

THE MEXICAN OPPORTUNITY

Offshore Magazine, 1 June 2018

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LIBERALISATION OF THE MEXICAN ENERGY SECTOR

• Oil and gas exploration and production in Mexico has over 75 years of history. • For most of that period the Mexican market was closed to private investment. • Comprehensive reforms in late 2013. • Upstream exploration and production activities now available to international investors (but with Pemex maintaining a role). • Full liberalisation of midstream and downstream activities. • Since the reforms, international investment in Mexico has gained momentum, but there have been some recent challenges.

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UPSTREAM

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MIDSTREAM AND DOWNSTREAM

• As of November 2018, Mexico had a pipeline infrastructure of 9,933 mi. On that month, the government reported 1,790 mi under construction. In comparison, Texas reported in 2018 a pipeline system of 106,484 mi for natural gas distribution and an overall of 228,478 mi regulated intrastate. • Mexico has six current refineries in poor condition. • Bidding procedure for construction of new Dos Bocas refinery commenced on 18 March 2019. Estimated COD in 3 years • International players (e.g. BP, Total, Repsol, ExxonMobil, Glencore and Marathon Petroleum) import refined products and gasoline into Mexico • Several new storage terminals in Mexican ports under construction; but more logistics capacity is needed • Possible new LNG import terminals • More FPSOs in the mid term • Trafigura – State marketer under a 3-year contract; other traders already active in the market

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POLITICAL LANDSCAPE AND STATE OF PLAY

POLITICAL LANDSCAPE AND STATE OF PLAY

• National agenda set by the President, Andres Manuel Lopez Obrador (“AMLO”). • Landslide victory in Presidential elections and high approval ratings. • AMLO´s party (and allies) have a majority in Congress (enough for amending legislation but not the Constitution). • Contradictions between different departments/public officers are usual • Government has reversed decisions after public opposition is shown • Fight against corruption

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NEW ENERGY AGENDA

• Increased refining capability ‒ Government seeking to reduce the importation/exportation of hydrocarbons and oil products. • Strengthening Pemex ‒ reducing Pemex's tax burden ‒ Reducing CNH intervention in entering into private partnerships • Ongoing amendment / creation of new regulations • Is liberalisation on hold?

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DEAL DOING IN MEXICO

RECENT UPSTREAM DEAL ACTIVITY – PRIVATE A&D

• Vista Oil & Gas / Jaguar Exploraccion y Produccion (May 2018, approved by CNH in October 2018): In Mexico’s first private joint venture, Vista acquired a 50% stake in three of Jaguar’s onshore blocks. • Talos / Pan American Energy (October 2018): A Talos led consortium (Talos, Sierra & Premier) will exchange a 25% operating interest in Block 2 for a 25% stake in Hokchi’s AS-CS-15 assignment. • Eni / Lukoil (November 2018): Eni will assign to Lukoil a 20% stake in two PSCs, in exchange for a 40% stake in Lukoil’s Block 12 PSC. • Eni / Qatar Petroleum (December 2018): Qatar Petroleum will acquire a 35% interest Eni’s Block 1 development.

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PEMEX FARM-OUTS

• Trion (December 2016): BHP Billiton (now BHP) was awarded a 60% interest in and operatorship of blocks AE-0092 and AE-0093 containing the Trion discovery located in the deep-water Gulf of Mexico. • Cárdenas-Mora (October 2017): Cheiron Petroleum Corporation was awarded a 50% interest in and operatorship of onshore blocks Cárdenas-Mora. • Ogarrio (October 2017): DEA Deutsche Erdoel AG was awarded a 50% licence share and operatorship in the mature onshore field Ogarrio.

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APPLICABLE REGULATIONS: PRESCRIPTIVE BUT INCONSISTENT

• Hydrocarbons Law and Regulations

• Bid Rules

• Partnership Guidelines

• Terms of the Contract

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REGULATORS

English Name

Spanish Name

Abbreviation

Regulatory Responsibility

National Hydrocarbons Commission

Comisión Nacional de Hidrocarburos

CNH

Manages the upstream bidding process and ultimately awards the contracts.

Ministry of Energy

Secretaría de Energía

SENER

Main authority and coordinating agency of the energy sector. Additionally, grants permits for import/export, refining and processing. Grants permits for other midstream and downstream activities.

Energy Regulatory Commission

Comisión Reguladora de Energía

CRE

Ministry of Finance

Secretaria de Hacienda y Crédito Público

SHCP

Determines the fiscal and economic terms for the applicable contracts.

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CONTRACT TYPES: THE BASICS

CONTRACT TYPE

DESCRIPTION

PAYMENTS TO THE CONTRACTOR

PAYMENTS TO THE STATE

 After payment of a royalty, the “contractor” parties retain a share of production to cover their accumulated costs  The remaining production is shared between the contractor parties and the State in accordance with the PSC  Contractor parties can market their shares of hydrocarbon production independently  The State’s share of production is marketed by an agent appointed by CNH, and Mexico’s petroleum fund receives the proceeds from the sale of such production  The contractor parties own the hydrocarbons once extracted    

A monthly “quota” (rental payment) during the exploration period Royalties on production once production begins (which increases with oil price) Variable percentage share of production in cash or kind, based on “operating profit” (value of hydrocarbons less contractor parties’ cost recovery less royalties paid) An upfront signing bonus determined by the Ministry of Finance  A monthly “quota” (rental payment) during the exploration period  Royalties on production once production begins  Compensation based on either operating profit or the value of the hydrocarbons produced

 Share of hydrocarbons as cost recovery pursuant to the Ministry of Finance rules  Variable percentage share of production based on “operating profit” (value of hydrocarbons less contractor parties’ cost recovery less royalties paid)

PSC

 Investor may take all the hydrocarbons in-kind at the wellhead

LICENCE

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CONTRACT TYPES: THE BASICS

CONTRACT TYPE PROFIT SHARING CONTRACT

DESCRIPTION

PAYMENTS TO THE CONTRACTOR Share of hydrocarbons as cost recovery pursuant to the Ministry of Finance rules  Distribution of profits to contractor on a monthly basis from Mexico’s petroleum fund, based on revenue generated by the CNH marketer from the hydrocarbons delivered to it

PAYMENTS TO THE STATE

 The contractor parties deliver all production to CNH’s marketing agent, which will deliver the revenues to Mexico’s petroleum fund  The fund will distribute the profits to the contractor parties in cash on a monthly basis

 A monthly “quota” (rental payment) during the exploration period  Royalties on production once production begins  Compensation determined as a percentage of operating profit 

The contractor parties will deliver all production to the State, which shall pay the investor in cash an amount established by the terms of the contract 

All hydrocarbons will be delivered to the State  No other fees or royalties will be included in service contracts 

Cash payments to be provided in each contract

SERVICE CONTRACT



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KEY DEAL-DOING CONSIDERATIONS

• Prequalification – Mexican subsidiary required • Sole vs multiple contractor • Corporate guarantee and performance guarantees o Unlimited or limited guarantee (based on net worth criteria) o Re-issuing the performance guarantee (Standby letter of credit in respect of minimum work obligations) o Cross indemnity deed • Transfer of title o CNH consent (if required)

o Deed of assignment o Contract amendment

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WHEN IS CNH CONSENT REQUIRED IN ASSET DEALS?

Transferee

Pre-15 December 2017 contracts

Post-15 December 2017 contracts

Existing party (change of operatorship/control)





Existing party (no change of operatorship/control)

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Notification only

Third party (change of operatorship/control)







Third party (no change of operatorship/control)



(based on CNH practice)

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KEY DEAL-DOING CONSIDERATIONS

• COFECE competition approval ‒ Low thresholds ‒ Timing impact

• Partner consents • Tailoring the JOA • Governing law and dispute resolution

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AVOIDING CULTURAL MISUNDERSTANDINGS

US style deals

English style deals

• Accuracy of warranties and performance of covenants as a condition precedent • General material adverse change • Repetition of all warranties at completion • Warranties also representations • Limited and specific disclosure • Damages on an indemnity basis • De minimis on a deductibles basis

• Accuracy of warranties rarely a condition precedent • Specific material adverse change • Only fundamental warranties repeated at completion • Warranties not “representations” • General disclosure against all warranties • Damages on contractual basis • De minimis on a “tipping basket” basis

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FINANCING ACQUISITIONS OR PROJECTS IN MEXICO

FINANCING MEXICAN UPSTREAM

• State owns reserves in the ground – the PSC “Contractor” only takes title as hydrocarbons are produced.

• This is typical approach in non-US petroleum regimes and does not prevent international RBL financing.

• First upstream debt financing in Mexico has closed.

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KEY RISKS FOR UPSTREAM LENDERS

• Change of control in a Contractor requires prior CNH consent – this impacts the enforceability of share security over Contractor borrower o Not uncommon - authorities typically insist on approval rights for changes to ownership structures to Contractor persons o This mirrors the restrictions on assignments of the PSC • Termination of the PSC o Certain “Administrative Rescission” termination events are potentially wider than typically found in other jurisdictions and extend to potentially non-fundamental defaults o Contractor members are jointly and severally liable under the PSC – breach by one member gives rise to a termination of the entire PSC

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AVAILABLE UPSTREAM SECURITY PACKAGE IN MEXICO

• Pledge over 100% of shares in Borrower • Pledge over Borrower’s contractual rights (but not obligations) under the PSC/License, JOA and any key Mexican law field contracts (e.g. lifting agreements) • Pledge / Account security over any bank account into which proceeds of offtake sales are paid • Assignment / other relevant security over key insurances • License/PSC-acquired materials not subject to lien

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ANTI-CORRUPTION ENFORCEMENT IN THE US AND MEXICO

OVERVIEW OF THE FCPA

• Anti-bribery provisions ‒ General prohibitions ‒ To whom do they apply? ‒ US nexus • Accounting provisions ‒ “Books and records” provision ‒ “Internal controls” provision

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MEXICO-RELATED FCPA INVESTIGATIONS

Key Energy • Key Energy, a Houston-based firm providing onshore energy production services, reported in a June 2014 SEC filing that it is conducting an internal investigation concerning allegations of bribery involving its Mexico-based operations. Wal-Mart • DOJ and the SEC are investigating bribe payments to Mexican officials used to obtain building permits for new stores. Mexican officials are also conducting their own investigation of the alleged bribery. • The company essentially shut down any substantive internal investigation until a 2012 New York Times series exposed the bribery scheme and how it was handled by the company.

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RECENT MEXICO-RELATED FCPA PROCEEDINGS

Biomet (2012 to present ) – $22 mil DOJ/SEC Settlement in 2012 • In March 2015, DOJ extended Biomet’s DPA and external compliance monitoring for one year after disclosure of questionable payments in Mexico and Brazil. Hewlett-Packard Mexico (2014) – $36.5 mil DOJ/SEC settlement • HP Mexico paid inflated commissions to a consulting company that was affiliated with the Chief Operating Officer of Pemex to help it win a $6 million IT contract. $125,000 went to an entity controlled by the Pemex official. ABB Ltd. and ABB Inc. (2010) – $58.3 mil DOJ/SEC Settlement • Texas-based ABB Inc., the U.S. subsidiary of Swiss energy company ABB Ltd., paid nearly $1.9 million bribes through intermediaries to secure approximately $81 million in contracts from CFE over a seven-year period.

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RECENT MEXICO-RELATED FCPA PROCEEDINGS, CONT.

Lindsey Manufacturing (2008) – Dismissal (following trial conviction) • Lindsey, an electric utility equipment manufacturer, gave $6 mil to a consultant connected with CFE’s director of operations, paying a 30% commission on CFE contracts obtained, knowing some or all would be passed on to CFE officials. Siemens AK (2008) – $800 mil DOJ/SEC Settlement • As part of a global, systemic practice of bribery, Siemens allegedly paid $2.6 million in bribes to a consultant in Mexico, some of which was paid to a senior Pemex official. Paradigm B.V. (2007) – $1 mil DOJ Settlement • Paradigm paid commissions to an unauthorized agent in connection with a $1.5 million subcontract with the Mexican Bureau of Geophysical Contracting on a Pemex project and $22,000 in T&E expenses for a Pemex official.

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RECENTLY ENACTED ANTI-CORRUPTION LAWS IN MEXICO

• Federal Anti-Corruption Law for Public Contracts (enacted in 2012): Criminalizes promising, offering, or delivering money or gifts to a public official or third party so that the official will either act or refrain from acting in his or her official capacity, in order to obtain or maintain an advantage in procuring a public contract. • Federal Criminal Code: Criminalizes both the person offering the bribe and official receiving the bribe, whether a domestic or foreign public official. Applies to both individuals and corporations. • Law on Accountability of Public Officials: Prohibits public officials from soliciting or accepting gifts, services, employment or commissions from parties who are linked, regulated, or supervised by the public official and involves a conflict of interest.

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ANTICIPATED ANTI-CORRUPTION LAWS IN MEXICO

The National Anti-Corruption System (“SNA”) • The Mexican Congress and a majority of state legislatures have approved comprehensive legislative and institutional reforms that would create the SNA, a system to coordinate enforcement of anti-corruption laws and oversight of public funds. • Reforms include enhanced investigative and audit authority, additional sanctions for corporations and individuals engaging in bribery, and whistleblower provisions, among others. • Began in 2015, new law enacted in 2017, and began implementation in 2018. • Maria de la Luz Mijangos Borja appointed as the first Chief Anti-corruption Prosecutor

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WHAT IS NEXT IN MEXICO?

Forum discussion

WHAT IS NEXT IN MEXICO?

• Targeting increased production – 2.6 mmbpd by 2024

• Suspension of CNH’s bidding procedures (including Pemex farmouts)

• Secondary markets – farmout of current CNH Contracts

• Construction of new refinery @ Dos Bocas, Tabasco

• New Pemex service contracts

• Issuance of Pemex bonds on the Mexican Stock Exchange

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UNTAPPED POTENTIAL

Offshore Magazine, 1 June 2018

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CONTACTS

Manuel Cervantes Senior Partner, Owner +(52 55) 5925.7772

Manuel Vera Partner

+1.713.221.1325 manuel.vera@bracewell.com

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manuel.cervantes@mcmlawyers.com

mcmlawyers.com/en/profesionistas.php

bracewell.com/vera

As a lawyer licensed in Mexico, Manuel represents U.S. financial service institutions, energy companies and investment firms in acquisitions in Mexico and Latin America, also guiding them through cross- border project finance transactions and joint ventures. Manuel has worked with clients on projects in more than a dozen Latin American countries, with a special emphasis on Mexico, Central America, Venezuela, Colombia, Brazil, Chile and Argentina, as well as Spain.

With close to 20 years of experience in the energy sector, Manuel has provided legal advice to operators, investment funds and service companies in major upstream, midstream and downstream projects, including farmouts, RBL, M&A, disputes and Constitutional and administrative litigation. He has advised international companies in Pemex's bids, and also to obtain Production Sharing Contracts and Licenses in all CNH’s bid rounds, assisting on contractual, regulatory and compliance matters relating to Exploration, Appraisal and Development Plans.

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Adam Blythe Partner

Darren Spalding Partner

+44.(0).207.448.4247 adam.blythe@bracewell.com

+44.(0).207.448.4209 darren.spalding@bracewell.com

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bracewell.com/blythe

bracewell.com/dspalding

Darren is a corporate lawyer dedicated to the energy sector. He advises clients on oil and gas M&A transactions and projects across the upstream, midstream and downstream value chain, with a particular focus on cross-border matters, having worked on deals and projects in more than 30 jurisdictions. Darren is regularly called upon to advise on, and negotiate, all of the key documents relating to the oil and gas industry, including PSCs, JOAs and crude oil and gas sales and transportation agreements.

Adam focuses on oil and gas related transactions. He has experience working on mergers and acquisitions, project development, joint venturing and other commercial arrangements in the upstream, midstream and downstream sectors. Adam has particular experience in African and cross-border transactions.

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Jeffery Vaden Partner

+1.713.221.1501 jeff.vaden@bracewell.com

T: E:

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bracewell.com/vaden

At the U.S. Attorney’s Office, Jeff was responsible for directing criminal prosecutions and grand jury investigations in areas including U.S. export controls and sanctions, bank fraud, public corruption, immigration, money laundering, counterterrorism, and national security. In private practice he has represented companies and individuals in FCPA matters and internal investigations involving Mexico, Canada, Iraq, Indonesia, Equatorial Guinea, South Africa, and Kazakhstan.

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This presentation is provided for informational purposes only and should not be considered specific legal advice on any subject matter. You should contact your attorney to obtain advice with respect to any particular issue or problem. The content of this presentation contains general information and may not reflect current legal developments, verdicts or settlements. Use of and access to this presentation does not create an attorney-client relationship between you and Bracewell.