March 7, 2018 ENERGY ALERT CNH publishes the drafts of the bidding terms and License Contract for Round 3, Third Call / Contractual Area Misión Production Sharing Contract execution Summary Bidding terms and License Contract of Round 3, Third Call were published Contractual Area Misión Contract was executed On March 2 nd, 2018, the Mexican National Hydrocarbons Commission (CNH, per its acronym in Spanish) published the drafts of the bidding terms and License Contract for Round 3, Third Call in order to carry out hydrocarbon exploration and extraction activities in 9 conventional and unconventional onshore blocks. Below is a summary of the most important terms and conditions of the aforementioned documents. These documents are published and accessible to the public in CNH s webpage (http://rondasmexico.gob.mx/). Bidding terms The interested participant will be able to participate as an Operator or Non-Operator, as an Individual Bidder or in the form of a Consortium Consortiums must be incorporated with at least one Operator. Consortiums with more than one Operator, may define the Designated Operator after being awarded with the Contract, but prior its execution. Bidding and Contract terms may be subject to non-substantial modifications at any point in time before their final publication. The bidding process for Round 3.3 blocks will occur in the following stages: i) publication of bidding terms, ii) access to data rooms, iii) on-site visits to the Contractual Areas, iv) registration, v) clarifications to the bidding terms, vi) prequalification, vii) filing of proposals, viii) awarding of Contracts, and ix) execution of the Contract.
The following payments will apply for participating in Bidding Round 3.3: Registration fee - $898,000 MXP. It is worth mentioning that such payment was established during the call s announcement; however, the amount is pending to be set forth in the bidding terms. License for the use of information from the National Center of Information on Hydrocarbons (CNIH) - $2,500,000 MXP (~133,000 USD). This payment is only mandatory for the Operator. It is worth mentioning that companies which previously acquired the License codes for the use of the information that corresponds to this bidding are not be required to make this payment. If an interested participant prequalifies as a Non-Operator, only the registration fee payment must be made. Non-Operator participants can access the data room through the Operators of their Consortiums. For purposes of the Q&A process, there will be three clarification stages: i) questions regarding the payment process for the access to the data room information (license for the use of information) and registration, ii) questions regarding the prequalification process, bidding structure,and iii) filing out of proposals, and Contract. The following timeline indicates the most relevant dates of the bidding process: To prequalify for any of the bidding process, Interested parties must demonstrate compliance with, among others, the following requirements: 1. Legal requirements Should be filed by parties interested in prequalifying as Operators or Non-Operators 2. Technical requirements Operators: Demonstrate: Experience as an Operator in at least one onshore Hydrocarbon Exploration and/or Extraction project in the last 5 years, or The proposed personnel for key managerial positions who will be in charge of the operations have at least 10 years of managerial and operational experience in onshore projects for the exploration and/or extraction of hydrocarbons, or Capital investments in hydrocarbon exploration and/or extraction projects for at least USD $100 million, and Demonstrate that the company or the proposed personnel have experience in the implementation and operation of industrial and environmental, health and safety programs during the last five (5) years in exploration and/or extraction project
3. Financial requirements Operators: Shall demonstrate economic capacity, meaning any of the following two requirements: 1) shareholders equity of at least USD $100 million; or, 2) investment in assets of at least USD $500 million, and an investment credit rating. Non-operators: Shall demonstrate economic capacity, meaning that their shareholders equity is at least USD $50 million. The legal, financial, technical or experience requirements for either of these two bids can be met with the documentation provided by the participants for purposes of Rounds 1.1, 1.2, 1.4, 2.1, 2.2, 2.3, 2.4, 3.1, and/or Farm Outs for Trion, Ayin Batsil, Cardenas-Mora, Ogarrio. In this case, it will be only necessary to file Form CNH-8 in order to confirm to CNH that the documentation previously submitted has not changed as of the date of this bidding procedure. Unlike previous License Contract bidding processes, for Round 3.3, the bidding factor for determining the winner of each area will be calculated considering the percentage of Operating Profit offered to the Government and an Additional Investment Factor, which may only take values from 0 to 45,000 Work Units. In this regard, the Ministry of Finance will establish minimum and maximum values for the Government participation on the Operating Profit variable, no later than 10 working days prior the proposals opening date. In case of a tie in the value of economic proposal between two or more bids, the cash payment offered initially to the State ( Signing Bonus ) before the Contract s execution will serve as a tiebreaker. If the tie persist, then a raffle will be carried out to choose the winning bidder. Furthermore, just with the fact of bidding the maximum bid variables of Government participation on the Operating Profit (pending to be published by the Ministry of Finance) and the Additional Investment Factor (investment equivalent to 45,000 Work Units), the Signing Bonus that is offered in case of a tie will automatically become part of the Economic Value of the Proposal. In other words, even in the case that there is no tie in the value of economic proposals, with only the fact of bidding the maximum bid variables, the Bidder will have the obligation to pay the Signing Bonus. The Minimum Work Program obligation included in the Contract for each Contractual Area is 3,000 Work Units. Contractors must file a Performance Bond to cover their obligations related to the Minimum Work Program. The amount of said bond shall be the result of multiplying the reference value of the Work Unit by 75% of the Work Units corresponding to the Minimum Work Program, Increase to the Work Program and the Additional Commitment for additional exploration periods. The Performance Bond may be submitted either, in the form of a standby letter of credit or a bond. Contracts will be awarded on September 5th, 2018 and should be executed within 140 natural days after they have been awarded. License Contract The CNH will bid 9 conventional and unconventional onshore blocks, all located in the Sabinas-Burgos oil province, as detailed below:
Moreover, the types of hydrocarbons expected from these Contractual Areas will be distributed by type of resource (conventional / unconventional) in the following manner: The term of each License Contract is 30 years and may be extended for two additional 5-year periods, subject to CNH approval. Contracts consider an Exploration and an Appraisal Period. Within the 180 days following the Contract execution, the Contractor shall file an Exploration Plan. Furthermore, in case of a discovery within the Exploration Period, the Contractor shall present an Appraisal Plan within the following 90 days after the discovery notification. Contracts include an Initial Transition Phase of 180 days, which may be extended for an additional period of up to 90 additional days. In such period, the Contractor must document the status and integrity of the fields and the equipment, and initiate a social impact and environmental study to establish the base line. In the event that any discovery is classified as Commercial, the Contractor shall submit notification during the Appraisal Period or up to a maximum of 60 days following the end of such Appraisal Period. The Contractor will have the obligation to file a Development Plan within 120 days following the notification of a Commercial Discovery. Provisions related to relinquishment and unitization are included. In general terms, subject to CNH approval, the Contractor will be required to relinquish any part of the Contractual Area not included as part of the Development Plan. As in prior License Contracts, the Contractor shall be required to keep an operating account where all transactions related to the Contract must be recorded. Additionally, the Contractors will be required to file indicative budgets and work programs. The volume of hydrocarbons will be measured at the measurement point, which may be inside or outside the blocks. Along with the filing of the Development Plan, Contractors will have to propose the procedures for storing, measuring and monitoring the quality of the hydrocarbons. As in prior License Contracts, the Government take will include, among others, the i) Contractual Quota for the Exploration Period, and ii) Base Royalties. Said Government considerations must be calculated by the Contractor and paid in cash to the Mexican Petroleum Fund on a monthly basis on the 17th day of the subsequent month. However, unlike previous License Contracts, the Consideration that shall be paid to the Government will be a % of the Operating Profit (i.e. bidding variable for awarding the Contracts). o The Operating Profit shall be calculated on an annual basis in accordance with the following formula: Where: OP n = Operating Profit of period n t n = Number of k periods corresponding to year n CVH k = Contractual Value of Hydrocarbons of period k CT k = Recognizable Costs incurred during period k CP k = Base Royalties and Contractual Quota for the Exploration Period payments made during period k EPT k = Exploration and Production Tax payments made during period k o Payments considering the Government participation on the Operating Profit shall also be performed on a yearly basis.
o The Over Royalty (i.e. consideration to the Government calculated as a % of the Contractual Value of the Hydrocarbons) is set forth to be 0% for the all the Contract term. o It is important to highlight that the only payments that shall be made on a monthly basis are: the Base Royalties, the Contractual Quota for the Exploration Period and the Exploration and Production Tax. The consideration in return for the Contractor will be the transfer of the hydrocarbons. The hydrocarbons will be distributed on a continuous basis to the Contractor to the extent it is up to date on its payments to the Government. The Adjustment Mechanism (i.e. R Factor) will also be determined on a yearly basis. Unlike previous License Contracts, the R Factor in Round 3.3 will be calculated based on an accumulated profitability factor (i.e. (Contractual Value of Hydrocarbons net from Royalties and E&P Tax/Recognizable Costs). In this regard, when the factor is greater or equal than 1, the % Operating Profit for the Government shall be adjusted according to an Operating Margin (Operating profit / Contractual Value of Hydrocarbons). It is worth mentioning that for purposes of calculating the R Factor, the Contract does not establish the minimum value the Operating Margin may take (such minimum value will be established in the final version of the Contract). Decommissioning provisions are included. The Contractor must incorporate an abandonment fund once the Development Plan is approved. The Contractor shall deposit ¼ of the annual amount at the end of each quarter. The ultimate holding parent should submit a Corporate Guarantee in order to ensure that all the Contractual obligations will be met. If the guarantor is not the ultimate parent company, such guarantor must submit to the CNH its duly audited consolidated financial statements that evidence a shareholder s equity equal to its Working Interest times USD $500 million USD. Local Content obligations are included: for purposes of the activities carried out during the exploration phase, the percentage will be 26%. For activities carried out during the appraisal phase, the percentage will be 24%, and for activities carried out during the development phase, the percentages will be 21% during the first two years and shall then increase periodically up to 38% in a period that does not exceed 8 years. Penalties will be applicable if the Ministry of Economy determines noncompliance with these percentages as a result of an audit. Execution of Production Sharing Contract for Contractual Area Mision On another note, CNH carried out the signing process of the Production Sharing Contract (PSC) for Contractual Area Misión between Pemex Exploración y Producción (PEP) and Servicios Múltiples de Burgos (Tecpetrol). In this regard, below is a summary of the most important terms and conditions described in said Contract: Contractual Area Mision has an approximate surface of 1,692.752 km 2. The Participating Interest will be: PEP: 51% Tecpetrol: 49% Tecpetrol has been designated as the Operator. From the execution of the Contract, the Contractor shall carry out the activities set forth on the Provisional Plan approved by CNH. The Contract contemplates the following periods: Duration of the Contract: 25 years starting on execution of the Contract, with 2 possible extensions of additional 5 years each. Initial Transition phase: up to 180 days from the execution of the Contract and may be extended once for a period of up to 90 additional days. Exploration period: 4 years with a possible extension of 2 years starting with the approval of the Exploration Plan (extension will only be applicable if the Contractor has i) fulfilled all exploration activities of the Minimum Work Program, and ii) compromises to carry out additional investments equivalent to 1 exploratory well during said Additional Exploration Period). Appraisal Period: 2 years with a possible extension of 1 year starting with the approval of the Appraisal Plan. In the event that any discovery is classified as Commercial, the Contractor shall submit notification during the Appraisal Period and up to maximum 60 days following the end of the Appraisal Period. The Contractor will have the obligation to file a Development Plan within 120 days following the Effective Date. The Contractor shall file Work Programs of each oil activity for CNH approval. In this regard, i) Initial Work Program goes along with the submission of the Exploration
Plan, ii) Initial Work Programs of each Development Period go along with the corresponding Development Plan. Work Programs must include a detailed list of activities to be carried out and the estimated time for performing them. In this regard, since the Contractor foresees Commercial Production, the former shall include in the Work Programs the information related to production forecasts. The Contractor shall submit budgets for CNH approval, no later than September 30th of each year. Additionally, i) initial budget shall go along with the submission of the Exploration Plan; ii) initial budgets of each Development Period go along with the corresponding Development Plan. It is worth mentioning that, each budget shall be submitted at the same time as the corresponding Work Program. Items included or excluded in the Cost Recovery and the applicable procedure are properly described on Appendix 4 of the PSC. It is worth mentioning that as in Santuario PSC, for purposes of Cost Recovery, the non-depreciated value of the investments performed for acquiring the physical assets located in the Contractual Area prior the execution of the PSC, subject to verification by the Ministry of Finance will be recognized as Eligible Costs (hence potentially recoverable). In this sense, according to Annex 9, the value of the physical assets located in the Contractual Area is $258,893,111.58. Cost Recovery of the corresponding period (month) will be limited to the 80% of the Contractual Value of Hydrocarbons. Please be aware that for the determination of the recoverable costs, an additional premium of 25% on the exploration investments performed under Minimum Work Program will be granted. As in prior PSC s, the considerations that the Mexican Petroleum Fund will pay in kind to the Government, are the Government participation on Operating Profit (i.e. 35%) and the Base Royalty determined per type of hydrocarbon. In addition, the Government should receive in cash from the Contractor, the Contractual Quota for the Exploration Period and the Exploration and Extraction Tax. It is important to mention that the Government participation on Operating may be increased in accordance with the R Factor formula included in this Contract, which is similar to the one included in previous PSC s (i.e. thresholds of 25% and 40%). On the other hand, the considerations that the Mexican Petroleum Fund will pay in kind to the Contractor, will be the remaining percentage on the Operating Profit (i.e. 65%) and the Cost Recovery according to the procedure and requirements described above. R-factor shall be computed based on an adjusted IRR before Corporate Income Tax of the Contractor as in previous PSC s. However, it is important to take into account the following considerations: For period 1, it is recognized as an expense the non-depreciated value of the investments performed for acquiring the physical assets located in the Contractual Area prior the execution of the PSC, subject to verification by the Ministry of Finance. It is provided a premium to the Contractor of 3 times the Eligible Exploration Costs corresponding to investment made under Minimum Work Program. Such Costs shall comply with the requirements established in Annex 4 and the guidelines established by the Ministry of Finance. The ultimate holding parent shall submit a Corporate Guarantee in order to ensure that all the Contractual obligations will be met. If the guarantor is not the ultimate parent company, such guarantor must submit to the CNH its duly audited consolidated financial statements that evidence a shareholder s equity equal to its Working Interest times USD $500 million USD. Misión PSC establishes that the Contractor shall comply with Minimum Work Program obligations for exploration and development activities in accordance with the following table:
The Contractor shall present a Performance Bond with a value of $28,378,932 that must cover the total Work Units corresponding the Minimum Work Program. The amount of said bond shall be the result of multiplying the reference value of the Work Unit (i.e. $1083) by the Work Units corresponding to the Minimum Work Program (i.e. 26,204 WU). The Performance Bond may be submitted either, in the form of a standby letter of credit or a bond. Decommissioning provisions are included. The Contractor must incorporate an abandonment fund once the Development Plan is approved. The Contractor shall deposit ¼ of the annual amount at the end of each quarter. Local Content obligations are included: for purposes of the activities carried out during the exploration phase, the percentage will be 26%. For activities carried out during the appraisal phase, the percentage will be 26%, and for activities carried out during the development phase, the percentages will be 27% during the first year and shall then increase periodically up to 38% in year 2025. Penalties will be applicable if the Ministry of Economy determines noncompliance with these percentages as a result of an audit. Contacts: Alfredo Álvarez Mexico City Office - Energy Leader alfredo.alvarez@mx.ey.com Rodrigo Ochoa Mexico City Office Oil & Gas Tax Leader rodrigo.ochoa@mx.ey.com Enrique Pérez Grovas New York City Office - Tax enrique.perezgrovas@ey.com Javier Noguez Houston Office - Tax javier.noguez@ey.com Yuri Barrueco Mexico City Office Tax yuri.barrueco@mx.ey.com Mario Karim Mexico City Office Tax mario.karim@mx.ey.com Salvador Meljem Mexico City Office Tax salvador.meljem@mx.ey.com Jimena González de Cossío Mexico City Office - Legal jimena.gonzalez@mx.ey.com Jeffrey Helm Mexico City Office Tax Modelling jeffrey.helm1@mx.ey.com