Mexico's government this year will introduce petroleum tax reforms that will transform how its state owned petroleum company approaches capital spending.
Effective Jan. 1, 1994, the Mexican government began to implement a revamped tax regime designed to accompany the breakup of Petroleos Mexicanos into four new operating subsidiaries. Each of the four new companies Pemex Exploration & Production, Pemex Refining, Pemex Natural Gas & Basic Petrochemicals, and Pemex Secondary Petrochemicals will be responsible for paying a new income tax.
Levies on E&P will be tied to a ringfence mechanism tailored after the scheme employed by the U.K. and Norwegian governments in the North Sea.
INVESTMENT RATIONALE AFFECTED
While the new structure is unlikely to increase investment resources available to Pemex in the short term the company will continue to turn over about 60% of its gross income to the Mexican treasury new fiscal variables will be introduced into investment decisions immediately.
And over the medium term, Pemex officials expect the tax collectors to slowly transfer the gains or losses associated with changing world oil prices from the government to the company, thus giving Pemex a new incentive to operate with an eye toward profitability.
Ernesto Marcos Giacoman, Pemex chief financial officer, said, "Before this change we were subject to a very harsh tax regime, a tax on gross income. Imagine, with that kind of thing you can't even calculate results. You don't know if you have won or lost."
The situation had become so onerous for Pemex finances and bleak for those considering lending money to the company that there were some years in which Pemex was left with as little as $6 million in the bank (Table).
NORTH SEA RING-FENCE MODEL
The biggest change will be felt by Pemex E&P. It will begin to pay an oil extraction duty of about 75% of its net cash flow. But it is expected that by second half 1994, individual production areas will be taxed at different rates. Like the ring fence scheme in the North Sea, the more productive areas will be taxes at higher rates, while depreciation charges a relatively new concept at Pemex and applicable immediately upon investment will also vary according to production rates, ease of development, and the useful life of a particular well or field. In practice, this new scheme will tax certain highly productive regions such as Cantarell in Campeche Sound at rates of as much as 90%, while other regions, whose production has dither fallen or whose promise is more long term, could be subject to duties as low as 30 40%.
"Right now we make an investment decision based on technical considerations," said Marcos Gaicoman. "We say we can invest X amount of millions of dollars for some equipment, and it's going to give us X amount of crude. "
"Now we are going to have to turn that calculation on its head. We are going to have to ask how convenient is it to invest in this field compared with what another field could require based on the expected flow of each of these fields with the instant depreciation of new investment already factored in.
"We are going to be forced into establishing a fiscal strategy."
OTHER TAX CHANGES
Under the oil extraction duty, Pemex E&P also will be forced to include the international market price of flared natural gas in its sales figures. That will make it financially advantageous for the company to continue to invest in natural gas recovery infrastructure.
A second new tax, called IEPS, win be levied on retail sales of refined products, notably gasoline, diesel, and aviation and marine fuel. This tax will be a variable rate tax equal to the difference between what's called the Houston Producer Price (HPP) for these fuels and the Mexican government's controlled retail prices. A drop in gasoline prices will automatically increase the tax received by the government at the pump. Because a higher percentage of the government's target tax bill for Pemex will be covered by consumers, a drop in the HPP also will lower the oil extraction duty charged to Pemex E&P.
A third new duty will a straight 34% tax on net income, a tax similar to that paid by any private company in Mexico, and which Pemex may decide to pay on behalf of its four subsidiaries collectively or individually. Key to the establishment of this tax was the decree that Pemex workers were not entitled to a 10% share in the company's profits, as is mandated for private companies under Mexican law. The Mexican government was able to come up with this decree after jailing union leader Joaquin "La Quina" Galacia Hernandez on corruption and arms smuggling charges in early 1989 (see related story, p. 36).
Despite this new way of figuring Pemex's tax bill, the government will continue for at least the next couple years to set its petroleum tax target via its old formula approximately 60% of projected gross income.
The oil extraction duty will be the most dynamic of the three new taxes, with its rate being altered either monthly or quarterly, based on fluctuations in world oil prices. Pemex will continue to provide 20 30% of all revenue collected by the Mexican government (Fig. 1).
SHIFTING THE BURDEN
Nevertheless, Marcos Giacoman and other Pemex officials believe that this new tax regime is the first step towards a shift in who bears the burden for fluctuations in international oil prices.
Currently, it is the Mexican government which takes the risk, and Mexico's central bank must buy risk coverage contracts against a decline in crude prices. But the next Mexican administration, scheduled to take office in December 1994, could decide to set a target amount of taxes that Pemex must cover and let Pemex assume the risk of fluctuating prices.
In that case, a good year for Pemex and the petroleum industry in general could increase Pemex's capital budget for the following year.
"The hope is that in the future, Pemex will take on the management of market volatility," said Marcos Giacoman. "Our new tax rates will become stable. And with that stability, if some years we do well, then that money is for us. We are going to be able to spend it in more investments for the company. We know it is going to take a while, but that is the objective of this whole change."
Copyright 1994 Oil & Gas Journal. All Rights Reserved.
