Round One: Is Success or Potential Disappointment on the Horizon?

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    Jeremy Martin

    With its Round Zero submission in March to the Ministry of Energy (SENER), Pemex launched the first act of the implementation of the historic energy reform measures passed in December 2013.

    In Mid-August, not long after the Mexican Congress approved the secondary legislation associated with energy reform, SENER announced the assignments awarded to Pemex to complete Round Zero.

    Pemex received 100% of its 2P reserves (probable and possible) request which is effectively 83% of the entire nation of Mexico’s 2P reserves. SENER’s allocation of reserves to Pemex totals an estimated 20.6 billion barrels of oil equivalent (BOE) and roughly 90,000 square kilometers of territory. Or as one news report headline noted: Pemex keeps prime acreage.

    For those arguing that the reform measures and the Round Zero process were intended to gut the national oil company and place it on a path to irrelevance, these numbers offer a strong counterargument. Indeed, the reserves assigned to Pemex as part of the Round Zero process place the company fifth in the world among non-OPEC producers, behind only ExxonMobil, Petrochina, Shell, and Petrobras.

    With the culmination of Round Zero, the next phase for Mexico’s new oil and gas reality began with the hugely anticipated bidding termed Round One.

    Mexico’s Round One oil and gas bid round tender has been set for the first half of 2015. There are 169 blocks offered and contract terms are being developed by the government. The Mexican government has argued that Round One is a balanced and diversified portfolio of blocks that range from deepwater to mature fields to unconventional and shale resources. In announcing the outline for Round One, the government has established investment targets of $8.5 billion of annual investment.

    Beyond the large amounts of investment expected, the government has made a strong commitment to recovering oil production. Indeed, the energy reform measures spell out production of 3 million barrels per day (bpd) by the end of the Pena Nieto sexenio in 2018. That is roughly a 500,000 bpd increase in just over 3 years.

    Many argue that it is for that exact reason that there are several production blocks included and mature fields and unconventional resources such as Chicontepec that have long hamstrung Pemex in its efforts to ramp up production and make up for the sharp decline at its Cantarell field.

    The jury is out, however, whether the acreage, blocks and nature of fields being offered will provide the oil production gains that are spelled out and hoped for by the Pena Nieto administration.
    One argument is that since Mexico has been so severely underexplored for so many years, the size and square area of the blocks on offer is insufficient to make a serious dent in the country’s exploration arrears in the near term.

    Are the opportunities offered in Round One sufficient to attract the level of investment set forth by the Mexican government? Will the blocks allow for oil and gas production gains for Mexico in the near and medium term? What are the possible obstacles for the investment figures touted? Or will Round One be everything policy makers in Mexico hope for in terms of investment and recovery of oil and gas production?

    Christian Gomez

    The opportunities offered in Round One are ample despite the apparent focus on Pemex’s allocation. There is significant area available both onshore and offshore – the latter being more compelling due to the need for foreign capital and investment. While production gains will likely not be seen in the near term, in the next ten years there is expected increase in production, estimated by Pemex to be 3 million barrels per day by 2025. Obstacles for private investment include project deadlines, the speed at which capital is mobilized, and procurement issues, especially with regards to equipment. Opportunities do exist which will see results, just not likely in the short term.

    Pamela Starr

    Pascual del Rio of Excelsior TV interview Mexico’s Hydrocarbons Energy Assistant Secretary, Lourdes Melgar, about the Round One process. You can watch the 20 August 2014 interview here.

    Jed Bailey

    To build on Christian’s comment, I think the answer to the question depends on the horizon that you are considering. Long term, Mexico has enormous potential and should be attractive to a wide range of companies. Even so, I agree that reaching 3 million barrels per day by 2018 is a tall order. Bear in mind that doing so requires not just a 500,000 or so bpd increase from today’s production level, but also additional new production to offset the continued decline of Cantarell and other mature fields during the time period.

    The success of Round One will depend on details that are still unknown – especially the contract particulars and overall level of government take. Even a highly successful round – one that attracts many bidders who bring the capital, technology, and know-how to quickly boost Mexico’s oil output – may still be unable to meet the 2018 target. With that in mind, I think it’s important to remember that Round One is just that – the first of what should be many rounds that will steadily increase the level of activity in Mexico’s upstream. Maintaining focus on this long term trajectory can help temper any short term disappointments when the sector experiences the inevitable growing pains along the way.

    Isidro Morales

    Apart the uncertainties surrounding the particulars of contracts and government takes highlighted by Jed Bailey, there are two other uncertainties that could hamper the attractiveness of Round One.

    First is the evolution of international oil prices. Since June when the Brent crude oil price hit $115 per barrel, prices have consistently dropped and now are at a level below the $90 per barrel. This could be a normal twist in a market affected by major structural and geopolitical changes, but market fundamentals seem to indicate the emergence of a glut due to increasing production coming from unconventional oil located in Canada and the US (whose production most probably will continue to increase) and the desire of traditional producers to regain market share once embargos have been lifted in Libya, Iran and Iraq. Next month we’ll see whether Saudi Arabia will be able to lead OPEC to production cuts that will prevent international prices from remaining below $90 per barrel.

    Mexico’s congress is currently budgeting oil revenues for 2015 with an estimated oil price of slightly above $80 per barrel for the Mexican export mix. At that price most of the blocs covered by Round One remain attractive. However, 91% of them include prospective resources to be developed before production starts, meaning that the investment returns for the majority of those fields remain in the long term. If prices remain weak until February 2015 when contracts will be tendered, and OPEC fails to strike a long-term commitment to defend prices, investors will be attracted to onshore fields, shale plays, and associated contracts with PEMEX rather than risking their money in Mexico’s deep water fields.

    The second uncertainty affecting the environment in which Round One has been announced is concerns about Mexico’s public safety and political stability. At the moment of writing these lines, no Mexican authority – either local or federal – have been able to give a satisfactory answer to the disappearance of 43 young rural students targeted by local policemen in the state of Guerrero, in southern Mexico. The incident has already provoked a national crisis by showing that Mexico remains an unsafe country, where citizen and human rights are still violated, and where government authorities at all levels have become infiltrated by drug barons. [Editor: Read our parallel conversation on this security challenge here]

    Guerrero is certainly not an “oil state”. But in several states where Mexican reserves are located, such as Tamaulipas and Veracruz, the political climate is not that different from what we are currently witnessing in Guerrero. How federal and local government authorities tackle this major security crisis, which threats to mobilize university students from all over the country demanding effective law enforcement and security, will remain crucial for defining the “political risk” factor for investing in Mexico.

    Lisa Viscidi

    The shortage of skilled oil workers in Mexico also poses a short and long-term risk to increasing exploration and production, as Jason Fargo argues in this blog post:  “Pemex is currently estimated to have about 150,000 employees – and the company has said that as many as half its employees will be at or near retirement age within a decade. Add in the new oil companies that are expected to enter Mexico and compete for talent, plus service providers and new and expanded government agencies, and the number of engineers needed is expected to be in the tens of thousands. The CNH, Mexico’s national oil regulator, will alone need to boost its staff from the 50-60 engineers it currently has to somewhere around 600, as it moves from supervising just Pemex to a much larger number of operators.”

    Jeremy Martin

    Continuing the conversation…
    The Mexican government has been making tremendous progress on the implementation of the historic energy reform since the Constitutional amendment last December and approval of secondary legislation in August. In late October, key pieces of implementation regulations for the reform measures were promulgated marking another milestone on the road to overhauling the nation’s energy sector.

    However, at the same time that the government has hit the fast forward button on the Round One bidding process and taken to the road to sell the opportunities, the country has been rocked by the tragic events in Iguala in the state of Guerrero. Moreover, the road show for Round One has been launched as the price of oil has dramatically dipped and is at the lowest price in several years. In our last discussion thread, Isidro Morales raised these issues as “two other uncertainties.” Picking up on that thread, what do these two issues mean for the bidding early next year? Is one more preoccupying than the other for possible investors and thus Mexico’s efforts to start the reform with a real bang?

    Pablo Medina

    Something interesting about Round One is that it addresses the two main concerns regarding the Mexican O&G sector, which are both increasing production in the short-term and securing an adequate discovered resource opportunties (DROs) pipeline for the medium-long term.

    In the short-term, production increases are most likely to be seen coming from the tail of Pemex’s portfolio, the extra-heavy oil fields and possibly from Chicontepec. Even though most of the media focuses in the potentially huge projects in the GoM, the economic impact of re-developing these mature fields could be very significant. Creating a supply-chain capable of supporting such extensive O&G development could have an important economic multiplier effect in Mexico.

    In order to focus in the future of the Mexican O&G sector, the country must start extensive exploratory work in the deep waters. Lead times of deepwater projects tend to range from 6-10 years, so there is no time to lose. Unconventionals remain a question mark given the current lack of a liquids-rich play and the access to cheap gas imports from the US.

    Ultimately, the level of attention of the industry towards Mexico will completely depend on the attractiveness of the fiscal terms on offer. Government officials seem aware of this global competition for capital and, as such, we expect government take levels to be comparable to similar markets.

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