By Manuel Cervantes, Managing Director at MCM Abogados
For the first time since the enactment of the Energy Reform, CNH authorized today the creation of collateral regarding the contractors’ working interest under three different hydrocarbons exploration and production contracts (two in onshore contractual areas of Round 1.3, and one in a deepwater project of Round 1.4, respectively); specifically, the security allowed by CNH consists of a “Floating Pledge Agreement” over the working interest under the relevant exploration and production contract. Consent from CNH was needed for such purposes in terms of the contract and the applicable law.
It caught my attention that it took around two months for CNH to resolve the authorization after the filing of the application, in the case of the two onshore contracts of Round 1.3. And in the case of the deepwater contract from Round 1.4, it was a little bit more than one month to get the resolution.
The relevance of this determination, in my opinion, is that it provides an indication of the mechanics, steps, conditions, limitations and timing to put in place a legal, valid and effective security agreement over operators’ contractual rights. For instance, it was explained during CNH’s 16th extraordinary session that the collateral should be limited to a portion of the total working interest of the operator, without affecting other rights and obligations under the granting instrument. Likewise, CNH explained that it evaluated the consistency of the draft of the Floating Pledge Agreement submitted by the interested parties with the applicable regulation, as a requirement to give its consent.
CNH’s approval of the creation of the Floating Pledge Agreement was subject to certain basic conditions, such as perfecting the pledge and notifying CNH within 30 days following the notification of the resolution, and the submission of an affidavit from the pledgee indicating that the lien will not affect or put at risk the continuance of the oil and gas activities under the exploration and production contract (this means that the creation of the security cannot interfere with the performance of the project’s operations). Likewise, the submission of a statement from both pledgor and pledgee, which could enforce the guarantee, will be subject to CNH’s authorization.
While the allowed charge does not entail an assignment of the contract, and it does not give to the pledgee the nature of contractor, with this type of collateral in place it would be possible for JV partners, under Joint Operating Agreements, to create a guarantee in case of breach of payment obligations among the partners (due to a failure to comply with cash calls, for instance). Similarly, this tool will allow lenders to protect their interest in case of a default under the facility instrument. This is a paramount tool in the context of project financing.
We understand this could be the first step or preamble to a series of different actions through which CNH would seek to establish the foundation for the implementation of reserve-base lending in Mexico. We would expect that this effort would be further developed in the first administrative regulation regarding this topic.
While this is a fundamental step to bolster project financing in the Mexican oil and gas industry, there are other aspects of collateral that are not yet doable in Mexico, such as the creation of liens over the tangible assets dedicated to oil and gas activities, which are those either built, acquired, leased or subcontracted by the operator to carry out the activities under the project, such as wells and lines. We assume, subject to reviewing a potential draft of administrative regulation by CNH (which, we understand, should come shortly), that the regulator is still not ready to develop and agree on a mechanism to establish a lien over fixed/tangible assets associated with an E&P project, precisely because of the interest of the Mexican state to avoid disrupting the operation. We should recall that title to the project assets will shift to the Mexican state at the termination of the contract.
On the other hand, change of operatorship, if needed as part of the enforcement of the collateral, is still a matter subject to compliance with CNH’s guidelines, including the need to propose a qualified operator that may satisfy prequalification requirements similar to those on which the project was originally awarded.
In conclusion, we can say that the determination of CNH today is a fundamental first step and should be welcomed by the international financing community and industry players. Hopefully, this will evolve to progressively allow the financing of these kinds of projects.