Mexico’s new era

David Shields provides a glance at Mexico’s energy reform and Round One.

Pemex’s Ku-S platform at the Ku Maloob Zaap oil field in the Bay of Campeche. Image from Return To Scene.

Round One, the cornerstone of Mexico’s historic energy reform, was set in motion on December 11, 2014, with a call to the global oil industry to explore for oil for the first time since oil nationalization in 1938.

“For the first time, Mexico has announced an open public tender for domestic and international companies to explore and produce our fossil resources in shallow water under a production sharing contract,” says Pedro Joaquin Coldwell, Mexico´s energy minister.

“Mexico is offering a very attractive Round One bidding process, as it has quite a variety of fields and I think we are going to be competitive and that we will be able to attract investments and technology that our country badly needs,” he says.

The first call for bids in Round One has been called almost exactly one year after the Mexican Congress passed a constitutional reform on energy. This reform which was passed on December 20, 2013, modified Articles 25, 27 and 28 of the constitution, opening up all areas of the Mexican energy industry to direct private investment and to competition. This is the first constitutional amendment on energy that has been passed in Mexico in over 50 years. Moreover, more than 20 regulatory statutes were published towards the end of 2014 to set out the rules for private-sector participation in the diverse activities of Mexico’s energy industry.

Pedro Joaquín Coldwell acknowledges that this first bidding round is being carried out at a time of extreme volatility for oil prices in international markets and that this could reduce the interest of some companies in participating. However, “this circumstance will highlight the competitive strengths of Mexico’s Round One, which offers a diversified portfolio of oilfields and areas for exploring and producing hydrocarbons, as well as clear and stable rules for companies to invest,” he says.

Even so, it is likely that certain prospects originally foreseen in Round One – given that a round is to be held each year – will be postponed until future rounds. These prospects include unconventional oil (shale), as it is now thought that they may not be profitable at current levels of oil prices, according to Finance Minister, Luis Videgaray. The same criteria will most likely be applied to deepwater prospects.

A map of the 14 contract areas offered during Mexico’s Round One. Each are in shallow water, ranging in size from 116-501sq km.

A wide-ranging energy reform

Areas (blocks) to be tendered.

The constitutional reform in energy puts an end to the legal monopoly long enjoyed by the state-run companies Petroleos Mexicanos (Pemex) and Federal Electricity Commission (CFE), which are now to become “productive state enterprises,” which means that they will have greater administrative, operational and budgetary autonomy from other government institutions, allowing them greater freedom and flexibility in decision-making, even though they will continue to fully belong to the Mexican State.

The elimination of restrictions on private and foreign investment throughout the energy industry is intended to greatly increase investments in projects and infrastructure. In particular, the reform highlights openings to private capital through licenses, production-sharing and profit-sharing contracts. In this way, Mexico expects to adopt the best practices and standards of the global energy industry, both upstream and downstream, creating conditions for an open and competitive energy market.

Round One sets out the aim of awarding contracts in all of the countries oil-bearing regions to private-sector operators through licensing rounds. New players will be able to take part in bidding as partners of Pemex, or in other consortia, or independently from this first bidding round on.

Another aspect of the reform is the strengthening of the regulatory bodies: the National Hydrocarbons Commission (CNH), which oversees oil and gas production, and the Energy Regulatory Commission (CRE), which will look after all midstream and downstream activities in both oil and gas and in electricity. The National Agency for Industrial Security and Environmental Protection in the Oil Industry, known as ASEA or ANSIPA, is also created.

Upstream reform: Round One.

The reform cancels the exclusive tenure of Pemex in oil and gas exploration and production. On August 13, 2014, the results of Round Zero were announced, giving Pemex the areas in which it has worked and invested for decades. These are areas in which Pemex already has commercial production. Pemex was awarded exactly what it requested from the government, which was 83% of the country’s 2P (proven and probable) reserves. These entitlements should be sufficient for Pemex to maintain its oil production close to the current level of 2.4MMb/d in coming years, meaning that any future increase in crude oil output would correspond to new operators in areas to be awarded in Round One and in other future rounds and which can be developed without Pemex’s participation.

In Round One, 169 areas (or blocks), covering 28,500sq km of onshore and offshore territories, with prospective resources estimated at 14,606 MMbbl of crude oil equivalent, are envisioned to be put up for auction in bidding rounds. These areas are to be awarded through production-sharing or profit sharing contracts and/or licenses through bidding rounds to be held by the CNH. The consecutive auctions would cover five different groups of fields: shallow water fields, offshore extra-heavy oilfields, onshore mature fields, non-conventionals (shale) and deepwater.

In the first auction, announced on December 11, 2014, a first group of 14 areas in shallow water of the Gulf of Mexico was put up for bids, with production sharing contracts to be awarded.

Lourdes Melgar, Mexico’s Undersecretary for Hydrocarbons, explains that “under production sharing, the contractor carries out exploration at his own risk and begins to receive payments once the field comes into production. Contracts will have a lifespan of 25 years, which can be extended through two additional five-year periods. The exploration phase will be between 3-5 years.”

A period of up to three years is established for carrying out exploration. “What we are seeking with this proposal is that at the end of the first 36 months we can get an additional 26 exploratory wells in this area,” Melgar says.

In January, the data rooms were opened up to interested parties. These companies now enter into a prequalification phase, with the result to be announced on April 27, 2015. Then, from April 28 to June 25, the CNH will give responses to companies’ questions on the projects and the contracts. The bidders will put forward their bids (one for each area on offer) and the corresponding award announcements will be made on July 17. A similar procedure will take place for the rest of the fields in Round One, which is to be concluded at the end of 2015.

A chart presenting the new agencies created after the energy reform.   Source: Secretaría de Energía.

Requirements for participation in Round One

In the first published bidding guidelines, the CNH has set out the requirements that companies need to meet if they are to take part. Companies must prove their knowledge and experience in working in shallow waters by demonstrating their participation in at least three exploration and production projects, or alternatively in one or in two large-scale projects, which together involve capital investments of US$1 billion.

They must provide to the CNH the curriculum of the specialists that will be in charge of their operations and who must have 10 years of experience in key positions in this kind of projects. Each company or consortium must also prove its experience in applying systems of industrial safety and environmental protection in line with best international standards and practices.

A company that aspires to be the operator of a project must prove equity of $1 billion and assets of $10 billion. If the company decides to team up in a group of companies –which must not have more than three members– it must prove equity of at least $600 million, or alternatively it can prove that it has an investment grade rating. When companies form a consortium, their joint equity must amount to at least $2 billion. In a consortium, the operating company must be a member with at least a third of the equity.

According to Juan Carlos Zepeda, President of the CNH, “Operators can participate on their own or in consortia, though operators that take charge of activities in the field must own at least a third of the project and none of the consortia members can have a higher stake. Moreover, no company can participate in two consortia at the same time. Also, companies which are defined as large-scale operators –as they have global production of over 1.6 MMb/d– will not be allowed to team up together, at least in the first group of shallow water fields.

Major operators are interested in the first group of 14 shallow water areas. As many as 30 companies have paid the fee to get access to the data room and see the technical information on the fields. These companies include ExxonMobil, Chevron, Ecopetrol, BG Group, Shell, Hunt Overseas Oil and BHP Billiton, according to Zepeda.

Oil companies will be allowed to participate through joint ventures, though none will be allowed to form part of more than one consortium. Companies or consortia will be able to make bids for a maximum of five of the 14 areas that are up for offer in shallow water. “We want to have a competitive bidding process and not for the biggest companies to group up together,” Zepeda says.

This restriction might not be applicable in other groups of fields to be tendered in Round One, Zepeda says, “Since other projects might require joint ventures among the biggest companies.” Pemex may participate in the Round One auctions in joint ventures with partners of its choosing, if it so desires.

Bidding processes can be followed online, allowing interested parties to have access to details of each one as they move forward. “Companies that are found taking part in acts of corruption will have no further opportunities to make bids in Mexico,” says Juan Carlos Zepeda.

Another aspect of Round One is that Pemex will be able to “migrate” its Zero Round entitlements into contracts in which it can have private-sector partners for developing these assignments. Pemex has given indications that it is interested in having private companies as partners in at least 10 such “migrations.” The decision on who will be Pemex’s partners in migrations will be made through bidding processes to be carried out by the CNH, taking into account basic criteria for such ventures which are to be defined by Pemex.

However, the collapse in oil prices has modified the outlook of both the federal government and companies with regard to the bidding processes ahead. The government’s optimism has turned into caution. “Due to the drop in oil prices, we could have a lower number of companies participating than we would have had several months ago,” acknowledges Miguel Messmacher, Undersecretary for Revenues at the Federal Finance Ministry.

Reform in the downstream

The Centenario platform explores the deepwater Gulf of Mexico. Image from Pemex.

In natural gas, liquid fuels and electricity, energy reform opens up wide-ranging opportunities to international investors in the whole chain of activities through the issuance of permits by the CRE. Also, such investments may well be less sensitive to volatile oil prices.

A new institution, known as the National Control Center for Natural Gas (CENAGAS) will operate the country’s natural gas trunk pipelines and gas storage units. Pemex will have to transfer its assets and natural gas contracts so that CENAGAS can acquire and administer the country’s natural gas infrastructure.

Under the new rules, companies holding permits to move natural gas through pipelines will not be allowed to sell gas. Reserved capacity, which is not used will be opened up to the market through an open season. Pemex and CFE will be users, together with other companies, of the country’s integrated system of natural gas pipelines.

The idea is to create an open gas market, as well as a wholesale electricity market. In five years, no company –including Pemex and CFE– will be allowed to own more than half of the country’s natural gas infrastructure and, in 10 years, no company, whether publicly or privately owned, will be able to own more than 20%

In five years, no company will be allowed to sell more than 50% of all natural gas or electricity sold in Mexico. In ten years, no company will be able to sell more than 20%. Within 5 years, no company will be allowed to own more than 50% of the pipeline capacity that crosses the U.S.-Mexico border and within 10 years no company will own more than 20%.

In short…

The rules of the game in Mexico’s energy industry are changing and the new legislation has basically been defined. The first bidding auctions in Round One are defining the new rules for taking part in exploration and production in Mexico.

According to official estimates, the energy reform will add 1 percentage point to Mexico’s Gross Domestic Product and will attract a great deal of foreign investment into the country. The Mexican government has forecast that annual investment just in oil and gas exploration and production will increase from $24 billion in 2014 to $37 billion in 2024 (while maximum potential is estimated at $62 billion annually). However, such expectations are now seriously in doubt as a result of the recent fall in oil prices, which is already, which will hit both public revenues and the income new players are expecting to receive from the new oil and gas projects in which they will participate.

The Mexican government faces the challenge of offering the oil industry projects that are economically and fiscally attractive in the new price environment. This is in addition to challenges related to transparency and fairness –a level playing field in the bidding processes– and well as the full, good-quality geoscientific data that companies will require in order to take part.

Mexico offers investors one of the most attractive oil-bearing basins in a privileged geopolitical location in the Gulf of Mexico. It is an opening that has long been awaited by the global oil industry. It has generated great interest among companies from all over the world. However, it is occurring at a tough, challenging time because of the surprising collapse in global oil prices that could force many companies to reassess their investments and consider shrinking their global activities, instead of expanding towards new countries, including Mexico.