Financing Mexico's oil opening
Reserve-based lending could help bring cash into the country's oil patch—if regulators can get the rules right
Mexico's energy reforms have put the country on the map for international oil companies. For the first time in more than 70 years, private firms can take part in its upstream oil and business alongside state-run Pemex. A big question for these private companies, especially smaller exploration and production players, is how they are going to finance their new Mexican business.
To open up the country's upstream, new types of contracts are being offered which, while used elsewhere, haven't been implemented in Mexico before. Specifically, Mexico is now awarding private investors production-sharing contracts (PSCs), which allow a percentage of the output as payment, as well as licence agreements that allow the transfer of hydrocarbons through a cash payment once extracted.
Private parties may now also report on those upstream contractual agreements, and the expected benefits, as long as it is clearly stipulated that all resources found in the subsoil remain the property of Mexico.
The National Hydrocarbons Commission (CNH) has held a steady stream of auctions, and dozens of companies have won contracts for a diverse portfolio of blocks across Mexico. The financial and economic viability of these tenders and exploration and production agreements is crucial to the industry and the country's economic future.
Many E&P companies will need to obtain debt financing to fund their capital spending and operating costs. Meeting these needs will be a challenge in Mexico's newly opened market. But it is an attractive opportunity for banks, investment firms, lawyers and other consultants who are familiar with its regulatory framework and possess the ability to structure such complex transactions.
The challenge is to identify what is possible under Mexican law to properly secure, enforce and/or dispose of the oilfields awarded, by CNH and at the same time, make sure the loan and the collateral will not be subordinated—debt which is subordinated is riskier because it will only be paid after all other corporate debts are paid, should a borrower default or go into bankruptcy. For these projects, adjustments to the current regulatory regime will need to be made to provide certainty and clear rules to both lenders and borrowers.
Globally, upstream companies use many structures to finance their E&P businesses. Typically, independent, non-integrated E&P companies seek financing through Reserve Based Lending (RBL), a revolving line of credit collateralised by lower-risk proven reserves, helping to determine how much can be borrowed.
Although RBL structures may vary from one jurisdiction to another, RBL is a solid and long-established product in the banking industry. The US is one of the few markets where it is possible to obtain a mortgage over an underlying oil-or-gasfield, because an oil company is able to own the underlying reserves. In Mexico, and many other countries, however, the reserves are state property so different forms of RBL have been created.
The domestic regulatory framework in Mexico is not completely developed, nor is it fully aligned with the legal concepts and banking practices seen in developed countries. RBL requires a degree of certainty with respect to the size and commerciality of hydrocarbon reserves, as well as to the oil company's rights to such unproduced reserves.
More flexibility should be provided under the current regulation to grant and foreclose on security interests in favor of those lenders financing oil companies in Mexico. One viable option for Mexico to consider is allowing and regulating a "non-possessory pledge" to be used as collateral for this type of loan. A non-possessory pledge is a form of security interest granted over movable or intangible assets, to secure the payment of a debt or their performance.
As opposed to a typical commercial pledge that requires physical, virtual or legal delivery of pledged assets, a non-possessory pledge does not require the delivery of any rights, account receivables or assets. These pledged assets can instead be described either specifically or in a general manner. It is relatively easy to create a non-possessory pledge over the borrower's rights under an E&P contract.
Mexico saw great interest in a recent block auction - Source: Petroleum Economist
However, there are certain difficulties to secure CNH's consent under the current rules, as it could take several months for an assignment to be approved and the assignee and/or transferee shall comply with particular technical and economical capabilities, which a bank or lender may not be able to comply (particularly when the borrower is the operator). For instance, the lender's designated third party's qualifications could be pre-approved by the CNH, without further and burdensome consents needed, even without the participation of the borrower to make effective the assignment of its participating interest under the granting instrument.
Other securities may be also granted in favor of the lender providing a RBL-style loan to affect other related assets and rights, but for the specific collateral required to get access to the benefits derived from the E&P contracts (i.e. the oil and gas reserves), a non-possessory pledge may be the ideal security vehicle.
When granting RBL in Mexico, the risk associated with a termination or revocation of the agreement needs to be considered, since it is the only source of any possible collateral. To mitigate this risk, temporary step-in rights in favour of lenders should be introduced. In the case the contractor defaults, this would allow the lender to ensure operations continue while it looks for a replacement contractor.
The challenges and imperfections to implementing a RBL scheme in Mexico are not necessarily prohibitive to structuring sophisticated lending structures for the Mexican oil and gas industry. The typical RBL structure used in the US is legally friendlier from a securities standpoint and may not be possible in Mexico, but just as in any other emerging market, the necessary adjustments can be made to implement similar schemes.
Support and participation from the authorities and regulators, mainly CNH, will be needed to successfully implement RBL-type loans in Mexico. The good news is that banks have historically been able to learn and develop expertise to overcome these challenges, adapting the RBL model to different jurisdictions. Getting the financing part of the oil opening right is essential to the success of Mexico’s energy reforms.
Benjamín Torres-Barrón is a partner at Baker McKenzie in Mexico. Hector Medina-Perez is an associate at Baker McKenzie in Mexico. Both advise on the acquisition and development of oil & gas, power and infrastructure projects in Mexico.