Risks, Record keeping and reporting obligations & Sanctions, related to local content on Energy Infrastructure Projects. 1

Why is local content important for Mexico regarding Energy Infrastructure projects? Mexicans continue to express skepticism about the government’s ability to ensure that local benefits from the oil and gas industry are realized through the opening of the industry. There has to be a balance of local content specially now with the opening of the industry to international oil companies (IOCs). To take leverage in the opening of the industry, the energy reform included strict local content provisions

Risks associated with the need to meet strict local content provisions. 1.- Satisfying Regulatory Requirements. Some regulatory requirements are new and still under development, creating uncertainty and room for discretion. When rules are less clear, there is more room for companies to fail compliance.

Risks associated with the need to meet strict local content provisions. 2.-Use of Third Parties/Vendors. To do their work, operators need to rely on a host of third parties and vendors. Local content requirements, which will increase to 35% by 2025, put further pressure on the use of local entities. Companies might choose to manage all third party relationships themselves, to save money. While this approach is more cost effective, it requires more heavy lifting on compliance to ensure that the company is protected.

Risks associated with the need to meet strict local content provisions. 3.- Cost Recovery Efforts. Companies operating blocks are required to submit detailed cost accounting reports to Mexican regulators as part of a cost recovery regime. Companies should understand that, despite this regulatory oversight, they still need to have robust internal controls in place calibrated to detect any deviations when local content is involved.

Risks associated with the need to meet strict local content provisions. 4.- JV Partner Risks. A common model for performing E&P contracts in Mexico is through joint operating agreements involving multiple parties. Non-operators can be liable for the out of compliance activities of operators. Operators themselves can also be liable for the out of compliance declarations regarding local content In this way, both operators and non-operators should take steps to ensure that their partners have compliance programs in place, and that written venture agreements have adequate compliance commitments and mechanisms.

Record keeping and reporting obligations Still pending for the Ministry of Economy to publish the Decree regarding local content information that should be provided from the related parties. What should we expect? Recordkeeping: Keep all documents related to local content determination (I.e.: Invoices, certificates of origin, analysis of local content, manufacturers affidavits, etc.) for 5 YEARS. Reporting obligations: Operators and Contractors: Report local content information on an annual basis (APRIL). Non –operator licensee: Reporting local content every five years.

Sanctions and fines In accordance with the transitory article nine of the Hydrocarbons Law, the Mexican National Hydrocarbons Commission (CNH) is the Regulatory Agency in charge of imposing fines to the companies that do not meet local content requirements Penalties are equivalent to a percentage of the value of the concepts outlined in the methodology   In the case of the Round 1, clause 19.3 states the following penalties: The company that does not meet local content requirements must pay a % of the value of the project in accordance with the following chart: Period Percentage Exploration period 15% 1st operating year 20% 2nd operating year 40% 3rd operating year 60% 4th operating year 80% 5th operating year 100%

Contacto Q & A Sergio Barajas esq. Partner, International Trade & Customs Basham barajas@basham.com.mx