Pemex: new contract rules come into effect - International Law Office

Introduction
Contracting Administrative Provisions
Changes to contracting practices
Comment


Introduction

As part of ongoing energy reform regulations (for further details please see "Energy reform: President's promulgation starts the clock of implementation"), on July 13 2010 the board of natural oil company Petróleos Mexicanos (Pemex) formed the Committee of Strategy and Investments and the Committee of Acquisitions, Leases, Works and Services of its four subsidiaries, as required under the Pemex Law.

Pursuant to the Pemex Law, the Investments Committee will be in charge of, among other things, analysing the relevant subsidiaries' business plan and investments portfolio, as well as the follow-up and evaluation of investments being made. The Acquisitions Committee will have, among other things, the authority to review programmes and budgets for acquisitions, leases, services and public works. More importantly, it will also have the authority to oversee, approve and propose modifications to new rules governing the bidding, award and performance of contracts for Pemex projects.

As required by the Pemex Law, the committees are formed by representatives of the federal government, representatives of Pemex and two independent professionals with relevant experience in the oil and gas sector (or in the field of business and administration), one of whom is appointed as the chairman of the corresponding committee.

Contracting Administrative Provisions

The formation of the committees brought into effect the 2009 Contracting Administrative Provisions for Pemex and its subsidiaries. These provisions govern services and public works related to productive activities as part of the ongoing energy reform. The provisions constitute a major change, as they replace the more rigid government procurement laws (ie, the Law of Public Works and the Law of Acquisitions) that Pemex had to apply under the previous regime.

Changes to contracting practices

The first signs of progress on changing Pemex contracting practices are being seen with projects that are governed by the provisions. These projects are expected to initiate a path to a more productive and competitive era for Pemex and its subsidiaries.

The provisions are the first step for Pemex to make contracts consistent with international industry practices. It has been released from its prior contracting scheme that was used for all federal government and instrumentalities, and has been granted sufficient contracting autonomy to make oil and gas projects more efficient at a lesser cost.

According to Pemex's former contracting framework, many restrictions were applicable against adopting commercially acceptable contractual standards, jointly with liability caps and guarantee requirements which, most of the time, were inconsistent with international industry practices. An issue that commonly affected market participants in Pemex's projects was Pemex's statutory right of early and unilateral termination of the contract for general interest reasons – in such circumstances, only certain limited expenses were payable to the contractor. Another important restriction applied to cost adjustment mechanisms and the adoption of compensation formulae, which were not based on performance criteria, but rather on costs and prices, regardless of whether the contractor was successful in a project. As a result of these statutory limitations, each unnecessary risk that was passed through to contractors by the operation of the law was turned into automatic quote increases payable to contractors by Pemex.

On the contrary, under the provisions, Pemex's contracting scheme has been drastically modified, mainly because Pemex contracts are now (except in limited cases) governed by general Mexican contract law. This releases the contracts from the limiting administrative contracting framework, which provides Pemex with liberal contracting rules that are, for the most part, based on the parties' free will as the supreme law.

The provisions also apply to bidding. Pemex will continue to launch public bids as its main contracting scheme, but for the purposes of the award, Pemex is no longer obliged to grant the contract to the bidder with the lowest price; instead, it is entitled to award the contract to the bidder offering the best conditions.

The provisions give Pemex the right to agree freely on matters such as liability limitations, cost adjustments, mechanisms for change orders, standby costs, sole remedy clauses and contract assignment. Another important change brought about by the provisions, is that Pemex is entitled to modify contracts while in effect, provided that the economic model used to determine the development of the project is considered and the subject matter of the contract is not substantially modified.

Under the provisions, Pemex may provide for the early termination of a contract, but it must include a method of termination that includes clear rules for payment of termination costs. Moreover, Pemex projects will now have a project manager (as the Pemex representative) that will ultimately approve the terms and conditions applicable to a specific project contract, including the type and terms of the guarantees to be granted by the contractor, and take decisions on project execution.

With respect to liability limitations, the provisions provide for no specific minimum or maximum limits, but rather leave the freedom to determine liability caps based on project risk assessment to Pemex. Under the provisions, contracts will include cure periods with regard to defaults and rescission.

Comment

The results of new projects under the new framework will be closely monitored to assess Pemex's progress in its contracting scheme, and the development of the sector as a result of the recent energy reform.

For further information on this topic please contact Rogelio López-Velarde or Ruben Almaraz at López Velarde, Heftye y Soria by telephone (+52 55 3685 3334), fax (+52 55 3685 3399) or email (rlopezv@lvhs.com.mx or ramlaraz@lvhs.com.mx).