Insolvency Aspects of E&P Contracts

Intro

The opening of Mexico's energy industry to private investment in 2013 marked a significant shift in the country's approach to oil and gas exploration and production, until it was curtailed in 2018. Since 2018 the government has stifled the E&P market by reversing course on the opening of new E&P areas.

During this period, the Federal Government entered into a limited number of Exploration and Production (E&P) contracts with private sector entities. These contracts offered new opportunities, but also introduced complex legal considerations, particularly in the realm of insolvency law.

Treatment of Contracts: Continuity

E&P contracts, as generally all other executory contracts, remain in effect despite an operator's insolvency declaration. However, the bankruptcy trustee has the authority to assume or reject the contract based on the best interests of the estate. This decision could carry significant implications for both the operator, its counterparts, and regulators, potentially affecting the continuity of exploration and production activities.

Treatment of Assets

Asset treatment in insolvency scenarios presents another layer of complexity. While hydrocarbons in the subsoil remain the property of Mexico and are thus excluded from the bankruptcy estate, other assets such as the E&P contract itself, materials, machinery, and equipment are subject to specific rules. The transfer of these assets often requires regulators’ consent, adding an additional regulatory hurdle in potential insolvency liquidation scenarios.

Abandonment

One of the most challenging insolvency aspects of E&P contracts is the treatment of abandonment obligations. These obligations, which include demobilization and environmental remediation, are crucial for responsible resource management. However, an operator's insolvency can jeopardize the fulfillment of these commitments. To mitigate this risk, operators are required to establish a trust fund to cover abandonment costs. This mechanism ensures that funds for abandonment remain separate from the operator's general assets and protected from creditors' claims in the event of insolvency. Whether these trust funds are beyond the reach of the bankruptcy estate is an issue that has not been finally settled by bankruptcy courts.

Conclusions

While the opening of Mexico's energy sector created opportunities for its few participants, it also introduced complex legal challenges, particularly in the realm of insolvency. The treatment of E&P contracts, assets, and obligations during financial distress requires a nuanced understanding of both energy and insolvency law. As the sector matures, it is likely that these legal frameworks will continue to evolve, shaped by practical experiences and the need to balance the interests of operators, regulators, and other stakeholders in the Mexican energy landscape.

The complete 2015 version of this article can be found here