As Mexico’s energy industry slowly opens up to outside investment, the country’s industry is assured to look very different in the future from today. GlobalData’s Adrian Lara and Will Scargill examine the details.
Pemex has had a monopoly over the Mexican upstream oil and gas industry since 1938, but the government is now opening up the sector to outside investment in an effort to combat production declines.
Following the passage of constitutional amendments required for energy reform in December 2013, secondary legislation was passed in August 2014 outlining the structures of possible contracts and the details of royalties and taxes. While the only outside investment in the sector was previously through limited service contracts granted by Pemex, the government will now be able to sign royalty and tax licenses, production sharing contracts (PSCs), profit-sharing contracts, and service contracts with investors.
Additionally, Pemex is subject to a new fiscal regime for assignments (the areas that it was granted by Comisión Nacional de Hidrocarburos (CNH) in Round Zero). Price-based royalties and exploration rental fees are payable under all contracts and assignments except service contracts, and all exploration and production companies, including Pemex, must pay both a hydrocarbon activity tax based on the contract area and ISR (Impuesto sobre la Renta) at 30%.
In line with the schedule offered by mid-2014, the first bidding round has now begun, with the first call for bids offering shallow-water exploration blocks in the Gulf of Mexico (GOM). The final value of the biddable parameter determining the state’s initial share of profit oil will be a significant determinant of the attractiveness of Mexico’s PSC regime. The government has not yet published any guidance on the expected value, although a minimum value will be set when the final bidding terms are published. Full details of the other contract models are yet to be released, and the recent oil price decline may spur the government to put bidding for some areas on hold.
The Round 1
The first bid round was split into five main phases and, after shallow-water, the following areas will be offered: extra-heavy oil, Chicontepec and unconventional, onshore, and deepwater. The government had previously released an ambitious timeline for the bid round that would have seen the bidding for shallow water areas opened in the first half of November 2014 and the bidding for the four other areas opened in each of the first halves of the following four months.
However, with the international crude oil price having dropped from nearly US$110/bbl in the first half of the year to its current price of below $50/bbl, the government has been forced to rethink its plans. The energy minister, Joaquín Coldwell, has indicated that the offering of unconventional areas and the Chicontepec play will be delayed due to the high costs of such projects.
The same rationale may mean that the discovered extra-heavy oil fields set for bidding could be put on hold due to the significant price discounts associated with their low-quality crude. Despite this, the government is still expected to open bidding on additional areas, including deepwater blocks, in the first half of 2015. It is also likely that further calls for bids will be made for shallow-water areas, offering discovered fields and farm-outs.
Even for those areas that opened for bidding, the delays caused by adjustments to the round to account for low oil prices, combined with the complexities associated with CNH organizing its first ever bid round, could affect the timeline for the award of contracts. All are contracts to be awarded by October 2015 under the original schedule; this may push the award of contracts for those areas opened later towards the start of 2016.
Despite the impact of lower oil prices, bidding on the shallow water exploration blocks that have already been opened for bidding is expected to be competitive. The shallow-water blocks are located near existing infrastructure and are expected to have a production cost below $20/boe with potential production of light crude oil.
A comparison of the regime with that applicable to shallow water areas in the US GOM suggests that bids offering the government an initial 20% share of profit oil may be competitive. However, while the regime appears relatively responsive low oil prices, remaining profitable at $50/bbl up to a bid of 30%, at $40/bbl the profitability of a PSA contract might be challenged.
Following the bidding on the exploration blocks, shallow water fields are also expected to be offered, which is likely to result in a higher government take due to the lack of exploration risk in these fields. Moreover, for deepwater areas, it is expected that the government will offer royalty and tax licenses, reflecting the high costs and risks associated with this type of exploration and development.
Although the full details of this contract model have not yet been disclosed, it is expected to use a similar adjustment mechanism for the biddable additional royalty to that in the PSC. Additionally, the head of CNH has disclosed that the provisions in the first call for bids that limit companies to bidding on five blocks and prevent multiple ‘large-scale oil companies’ (those with 2014 production of 1.6 MMboe/d or more) from participating in the same consortium will not apply for deepwater areas.
Is Pemex at risk?
In the medium to long term, any changes to the upstream fiscal and regulatory regime in Mexico are likely to depend on how attractive the contracts in Round 1 prove to be, and on the results of exploration blocks that are awarded in the round. If bidding is competitive in Round 1 and significant discoveries are made, the government may offer tougher fiscal terms in future rounds. In contrast, poor exploration results and lackluster participation in the bid round would likely spur the government to offer more attractive terms.
Furthermore, the path of the oil price is likely to play a significant role in what terms will prove attractive to investors, and if prices remain at the current level of around $50/bbl through the medium term, the government may have to rethink its strategy on fiscal terms in high-cost areas, such as unconventionals and extra-heavy oil. In any case, any future adjustments are likely to be made initially through the specific contract terms and minimum bidding parameters, rather than the royalty rates or income tax, which are set in statute.
Despite the delays to Round 1, Mexico’s energy reform process means that the country’s upstream oil and gas industry will look very different in 2016 than today. The government may not be able to award contracts for high-cost areas, such as extra-heavy oil fields or unconventional plays, if oil prices remain low. However, the level of industry interest in the opening of Round 1 and the new fiscal regimes suggest competition to participate will be significant.
From an upstream perspective, Pemex’s immediate challenge in the context of the first bidding round is successfully forming a joint venture for the assets listed to be farmed-out (14 in total, of which three are in deepwater). A positive round of extra-heavy crude oil or the deepwater farm-outs in the form of joint ventures could incentivize Pemex to migrate other assets into this arrangement.
In the medium to long term, given Pemex’s underperformance in downstream and petrochemical divisions and in the context of growing imports of oil products and natural gas, the need for additional capacity in pipelines, car tanks and storage presents investment opportunities for private parties.
In this respect, the company will have few options but to get ready for the gradual opening of the products market, starting with the competition from gas stations other than Pemex brand in 2016, liberalized imports by 2017, and the full price liberalization by 2018.
Adrian Lara directs the upstream team in charge of conducting quantitative and qualitative research relating to oil and gas activities in Latin American countries. Lara has several years of experience as an oil and gas industry analyst, having held different positions within the trading arm of Mexican state-owned company Pemex, where he focused on analysis of oil and gas fundamentals in the context of upstream exporting strategies and international trading. Lara has an MSc in Mineral and Energy Economics from the Colorado School of Mines, with a specialization in oil and gas from the Institut Français du Pétrole. He has a Bachelor of Arts in Economics and Political Science from the Instituto Tecnológico Autónomo de México (ITAM).
Will Scargill analyzes the fiscal and regulatory environment facing the upstream oil and gas industry across global markets. At GlobalData, Scargill has analyzed the fiscal attractiveness of new upstream investment opportunities, such as offshore Lebanon and the Brazilian Pre-Salt, as well as scrutinizing the impact of changes to the fiscal regimes of established areas, such as UK, Norway and Algeria. Scargill has a BA (Hons) in Philosophy, Politics and Economics from Oxford University.
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