Reform Seeks to Lower Pemex Tax While Raising Other Sectors

Mexican President Enrique Pena Nieto’s recently proposed Hydrocarbon Revenues Law – which would create a new fiscal regime for state hydrocarbon earnings and exploration and production activities by state-owned oil company Petroleos Mexicanos (PEMEX) – would reduce the tax obligation of PEMEX while raising government revenue through other tax measures, according to an Oct. 7 legal update from law firm Mayer Brown.

The goal of the tax reform is to increase the government’s tax take, to have people pay their taxes, and to find ways that taxes and their payment are more easily tracked and enforced.

“Mexico is thought to be a country in which there are very significant uncollected taxes, even if the law were not reformed,” said Dallas Parker, Houston-based partner in Mayer Brown’s global energy practice and co-leader of the firm’s oil & gas group.

At the same time, the tax reform also seeks to entice PEMEX to produce more oil by the often-used government approach of incentives. Right now, essentially 100 percent of PEMEX’s revenues after expenses goes to the Mexican government, leaving little incentive for PEMEX to operate efficiently, Parker noted.

“If anyone produces more revenue and 100 percent of it goes to the government, what real economic incentive is there to produce more? Certainly there are patriots who want to provide for Mexico, but this is different from the usual profit motive,” Parker noted.

Under the tax reform, the state dividend of PEMEX revenues would be gradually decreased over time. The state dividend in 2016 would be at least 30 percent of PEMEX’s earnings after taxes, but will be reduced to 15 percent in 2021 to zero beginning in 2026. PEMEX could then reinvest remaining revenues into the company’s operations.

Through the profit-sharing regime and a surface fee on non-producing areas, PEMEX would be economically incentivized to produce more. Under the newly proposed regime, new areas granted to PEMEX for exploration would be granted under a profit-sharing contract, in which PEMEX and the government share the profits of a particular field or zone. The surface fee concept is very similar to delay rentals in the United States, in which a company purchases an oil and gas lease and pay a signing bonus based on the number of acres and annual rentals until commercial production begins, Parker noted.

The surface fee would make it so that allowing leased land to sit untouched forever is not an economic option, Parker noted.

“I believe this is the analogy of the economic concept that Mexico is trying to introduce to PEMEX. And, certainly, if at the same time, there is competition in Mexico, and PEMEX knows that if it does not produce hydrocarbons from the specific property, then that property may be subject to being leased to someone other than PEMEX.”

The proposed tax reform would also grant Mexico’s energy minister the power to adjust fiscal terms on a contract-by-contract basis in order to attract the needed investment and technology for a particular contract area.

The tax reform provision governing PEMEX seeks to boost Mexico’s oil production, while the broader energy reforms seek to spur the Mexican economy by introducing competition into the sector, and by bringing in significant capital and expertise to develop and monetize Mexico’s vast natural resources.

This particular tax legislation applies only to PEMEX.  

“I think the goal is that by allowing PEMEX to retain some profits when producing more challenging fields, that the government is saying, we want you (PEMEX) to be more efficient, to take some risks and be able to keep some of the rewards of your risks,” Parker told Rigzone.

The reduction in PEMEX’s tax burden cannot happen overnight due to Mexico’s economic dependence on oil profits. Currently, oil profits comprise nearly one-third of Mexico’s federal budget, meaning the Mexican government will need to find other revenue sources. However, the proposed hydrocarbon revenues law provides a roadmap for decreasing this dependence and granting financial and operational freedom to PEMEX so it may act more like an independent company.

PEMEX would then be able to more adequately contract with third parties to embark on higher risk/higher reward programs and more challenging projects such as deepwater, ultra-deepwater and shale gas development activities, Mayer Brown noted in the legal update.

The new Hydrocarbon Revenue Law would take effect  Jan. 1, 2015, if enacted by Mexico’s Congress, according to Mayer Brown’s legal brief.

The 2014 tax reform package seeks to boost overall government revenue and growth by raising corporate and individual income tax rates, establishing stock exchange capital gains and dividend taxes and eliminating permitted deductions and exemptions.

The tax reform package, which includes a broad range of tax and budgeting proposals that will affect the entire Mexico economy, fell short of expectations of sweeping reform.

“In general, the expectation was that the reform would seek to increase productivity and at the same time increase government revenue to meet the current administration’s spending plans,” said Gabriel Salinas, Houston-based associate at Mayer Brown’s global energy practice, in a statement to Rigzone.



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