Considerations on relinquishment processes in Oil and Gas Contracts


Exploration and Extraction of Hydrocarbons Contracts  (“Contracts”) establish that an operator may relinquish a  percentage of its contractual area, or its entirety, at any  time (voluntary relinquishment) or may by entering into a  certain contractual stage (mandatory relinquishment),  such as at the end of the Initial Exploration Period except  for Contracts from Rounds 1.2 and 1.3 which main purpose  is development activities. However, relinquishment can be  postponed if the operator requests additional exploration  periods committing to additional drilling. Therefore, most  Contracts will soon be entering into contractual stages that  carry relinquishment activities.


REASONS FOR VOLUNTARY RELINQUISHMENT:

Lower taxes:
There are two acreage-based monthly contributions: (1) Contractual fee for exploratory phase (“CCFE”):  USD$6,980 for each 100km2 during the first 5 years and USD$16,692 per 100km2 after the 6th year; plus (2) the tax  for exploration and extraction activities (“IAEEH”): USD$9,105 per 100km2 during the exploration phase which  increases to USD$35,420 per 100km2 once a development plan is approved.

Lack of interest in operating an area :
The most obvious reason for relinquishment is when the contractual area becomes unattractive to operate. There  are some cases where bidding-round winners offered royalties that exceeded the minimum balance to operate  economically. Other, more normally expected cases, are when operators obtain poor results after drilling the first  exploration well.

Whenever a relinquishment procedure is triggered, the Final Transition Stage starts for the part of the area that is  being surrendered. Though the procedure is the same, there are some considerations that depend on whether it is  a partial or total relinquishment. Below we address the most relevant:

PARTIAL RELINQUISHMENT:

SHAPE OF THE AREA
Only Contracts from Round 1.1. establish the obligation of relinquishing areas that  are contiguous and in regular polygons. Later model contracts do not include such  provision. The sole requirement from National Hydrocarbons Commission is that  operators use the Official Grid (INEGI) for defining polygons to be relinquished  (http://www.dof.gob.mx/nota_detalle.php?codigo=5356008&fecha=12/08/2014)


STRUCTURES

Exploration and Extraction activities can only be performed in the Contractual Area, which considers the surface  and depth including any geological formation contained in the vertical projection from the surface. Thus, when  relinquishing blocks, operators shall consider that any structure left outside the Contractual Area could be subject  to a unitization process (partial structure left in the remaining area) or that they will not have the right to perform  any activity at all (total structure outside the remaining area).

PLANNED OR PROGRAMMED ACTIVITIES
Check that the relinquished areas are not included in an Exploration Plan, Appraisal Program or Development Plan  to avoid the imposition of a fee for non-compliance of the approved activities, in terms of article 85, f.II, g) of the  Hydrocarbons Law. If needed, request a modification of those documents.


TOTAL RELINQUISHMENT:

LIQUIDATED DAMAGES
In case that the Minimum Work Commitment, its Increase and/or any other additional commitments are not  fulfilled, the CNH will determine liquidated damages.

COMPLIANCE WITH OTHER AUTHORITIES
Before authorizing the relinquishment, CNH will ask SENER, the Agency for Safety, Energy and the Environment  (ASEA), the Ministry of Finance (SHCP), the Ministry of Economy, and the Mexican Petroleum Fund (FMP) if the  operator is fully compliant.




Relinquishment in numbers
Holding acreage has a considerable cost for the  Mexican Oil and Gas Industry. On a yearly basis, the  104 awarded contracts pay USD$168 million and  this number may go up to USD$554 million once  operators enter into the 6th year of exploration  and their development plans are approved


Relinquishment process in a nutshell


Relinquishment processes status