Energy Alert


Main Procurement Requirements in the Contracts for Exploration and Extraction of Hydrocarbons in Mexico

Mexico City, May 30th, 2018

In accordance with the procedures established in the Contracts for Exploration and Extraction of Hydrocarbons in Mexico (the “Contracts”), the Operators of said Contracts shall observe the rules and guidelines for the activities to be carried out according to each of the Contracts awarded in the different Bidding Rounds derived from the Energy Reform in Mexico.


In this sense, as the Bidding Rounds carried out by the Mexican National Hydrocarbons Commission (“CNH” per its acronym in Spanish) have progressed it has prevailed that all the activities related to the procurement of goods and services related to the Contracts have been subject to principles of transparency, economy and efficiency. In particular, the following general principles in term

· Give preference to contracting with local companies, when they offer competitive conditions compared to those in the international market in terms of quality, availability and price, provided that the latter is determined based on Market Rules or, in the case of transactions with related parties, based on the Transfer Pricing Guidelines for Multinational Enterprises and the Tax Administrations approved by the Council of the Organization for Economic Cooperation and Development ("TP Guidelines");

· Give preference to purchasing materials, equipment, machinery and other consumer goods produced locally, when these are offered in equivalent conditions to those materials, equipment, machinery and other consumer goods available in the international market, in terms of quantity, quality, delivery dates and price, provided that the latter is also determined by Market Rules or, in the case of transactions with related parties, based on the TP Guidelines;

· When contracting with suppliers, the companies that offer the best terms for quality, price, logistics and guarantees as to the volumes of goods and services required throughout the project shall be considered;

· The goods or services that are linked to joint processes shall be agreed upon on an integrated basis, if this represents a greater guarantee of supply and greater associated economic benefit; and

· In any event, the contest or bidding processes shall be carried out under principles of transparency, maximum publicity, equality, competitiveness and simplicity.

Although the general terms mentioned above are consistent in the procurement of goods and services regardless of the type of Contract awarded, whether it is a Production Sharing Contract ("PSC") or a License Contract, there are certain differences in the requirements related to the suppliers of goods and services contracting depending on each type of Contract. In this way, it is relevant to highlight the main terms in these procurement procedures per type of Contract in order to identify both the differences and similarities shared in their obligations. The following charts summarize the main terms related to the suppliers contracting depending each type of Contract, in which, it is worth noting the importance to comply with the Transfer Pricing obligations in the case of contracts or acquisitions with related parties:

Procurement Requirements

PSC Contracts

• For contracts or acquisitions with a value up to $1,000,000 USD, there are not specific requirements to determine the procedures and methods to choose an appropriate supplier. There is a requirement to keep information, documentation and/or evidence in order to support that transactions with both third parties and related parties were carried out in accordance with market references.


• For contracts or acquisitions with a value between higher than 1,000,000 USD and lower or equal to $20,000,000 USD there is an obligation to obtain at least three quotations for the goods or services awarded. If the supplier selected is a related party, there is a requirement to provide the agreement for that transaction and the Transfer Pricing Report to the CNH and the Ministry of Finance and Public Credit (“SHCP” per its acronym in Spanish) through the electronic systems made available by the Mexican Petroleum Fund (“FMP” per its acronym in Spanish).


• For contracts or acquisitions with a value greater than $20,000,000 USD a requirement for an international public contest or bidding process is included, in which the same treatment shall be granted to all participants and chose the supplier that offers the best economic conditions. Furthermore, a clause emphasizing that the Operator shall not unnecessarily divide the procurement or contracting processes in order to avoid the established thresholds is included.


• The aforementioned thresholds are $957,351.30 USD and $19,147,026 USD, respectively, in Round’s 3.1 Contract, and every year in the month of January these thresholds will be based on the changes in the United States Producer Price Index. Moreover, the Operator shall not unnecessarily divide the procurement or contracting processes in order to avoid the established thresholds and procedures.


• The Operator may directly assign the contract or acquisition to a related party or a third party, without the need for a contest or bidding process, as long as it is first demonstrated that the bid submitted by the related party or third party offers a price or consideration that is not higher than the benchmarks or market prices, amounts of consideration or profit margins found in reasonable markets, in accordance with the interquartile method procedure. For these purposes, the Operator shall prepare the documentation that supports said assignment.


• The analyses or Reports (such as the Transfer Pricing Report) to support transactions with third parties and/or related parties must be accompanied by all the information to permit replication of the results obtained, as well as the criteria followed in its preparation. If the information provided is insufficient to replicate results, the difference above the median according to the interquartile range method will not be considered as Recoverable Cost.

• For acquisitions greater than $5,000,000 USD, the Contractor shall provide the required documentation in order to demonstrate that the contracting of such goods and/or services was agreed upon Market Rules in case of transactions with third parties or, in case of transactions with related parties, in accordance with the TP Guidelines.

• The Operator may directly assign the contract or acquisition, as long as in operations greater than $5,000,000 USD the Operator submits to the FMP´s system the documentation with respect to the Costs derived from such contract or acquisition, in which it is demonstrated that such Costs were determined based on Market Rules or, in the case of transactions with related parties, according to the TP Guidelines, and in this case, that the amounts of consideration or profit margins are reasonable.

Procurement Requirements

License Contracts

Based on the above, the consistent use of the terms "market references" and/or "market prices", as well as the explicit references to the requirement to comply with the TP Guidelines, resemble the importance to unequivocally comply with all the Transfer Pricing obligations in the procurement of goods and services with related parties, including an array of requirements not only in terms of the preparation, but also with the submission of the Transfer Pricing Report, as well as the preparation and filing of the supporting documentation in accordance with the guidelines established in each of the Contracts

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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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


Enrique González

Houston Office – Transfer Pricing Leader

enrique.cruz@ey.com


Ricardo Barbieri

Mexico City Office – Transfer Pricing

ricardo.barbieri@mx.ey.com


Marco Molina

Monterrey Office – Transfer Pricing

marco.molina@mx.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


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


Rodrigo Mondragón

Houston Office – Tax Modelling

rodrigo.mondragon@ey.com


Salvador Meljem

Mexico City Office – Tax Modelling

salvador.meljem@mx.ey.com


José Carbajal

Chicago Office – Transfer Pricing

jose.carbajal@ey.com