Low oil prices and tightened budgets could work to the advantage of investors considering entry to Mexico’s oil and gas sector, as market conditions may force the country to become more flexible and tweak regulations governing its historic bid round.
But the situation could also give Mexico a reason to slow down its fast-paced moves to grow production and state revenue in order to get feedback and make changes, according to panelists at Mayer Brown’s latest Mexico energy reform forum.
Starting with shallow-water assets in its Round One tender, Mexico is opening its E&P sector to the world as oil prices hover around $45/bbl and companies cut back spending, laying off workers worldwide. Data rooms open today, and whether companies show up and respond positively will determine the success of the bidding round, said Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center for Scholars.
“The terrible thing now is that Mexico is really in the worst of both worlds because it has declined production, less than 2.5 million barrels per day, and you have a low oil price. That is obviously going to hit not just the government; it’s going to hit Pemex as well,” Wood said.
But no one would blame the Mexican government for pushing back some of its deadlines. Doing so would allow more time to get feedback from the industry,which has already voiced concerns about parts of the regulations. “The good news is that SENER [Secretaría de Energía de México] has been very receptive to feedback, and they have been willing to modify their terms along the way.”
The country is taking a staggered approach to the Round One tender, which will make available 169 blocks covering about 28,500 sq km (11,004 sq miles) with more than 18 Bboe in prospective resources and proven and probable reserves. Currently, of the 169 blocks being proposed, 109 are exploratory assets, while 60 blocks are extraction blocks with 2P reserves.
The first phase features 14 shallow-water areas, ranging in size from 116 sq km to 501 sq km (45 sq miles to 193 sq miles), explained Pablo Ferrante, a partner with Mayer Brown’s Global Energy Group.
Any Mexican, foreign or state productive company may participate in the bidding round either individually or in consortium. But there are restrictions.
- No company may take part in more than one joint bidding group for the same contract area;
- A joint venture of two companies having production of more than 1.6 MMbbl/d of oil, excluding deepwater, is prohibited; and
- Companies or consortia may only bid on up to five contractual areas during the bidding process.
To qualify as an operator, a company must have served from 2010 to 2014 as operator for at least three E&P projects or have total aggregate capital E&P investments of at least $1 billion. Plus, the company must show experience as an operator in at least one offshore E&P project or as a partner in at least two such projects and must show experience in industrial safety and environmental protection within the last five years. And, the proposed personnel for key managerial positions must have at least 10 years offshore E&P managerial and operational experience.
Regulations include additional financial requirements—operators for a consortium, for example, must have a net worth of at least $600 million, and there are fees, including a $350,000 fee for data room access, an $18,600 registration fee and a $2.5 million standby letter of credit.
Proposals for each contract area must specify the share of operating profits offered to the state and any additional investment, which will be factored into the formula used to determine the winning bid, Ferrante said. Cash payment and coin flip will break ties.
Some of the bidding terms, rules governing procurement and the production-sharing contract model have generated some concerns from the industry, panelists said.
- Procurement. A procurement process is not required for goods and services valued at less than $1 million. If the amount is greater than $1 million, contractors must get at least 10 bids, including from three national companies. If the amount is greater than $20 million, contractors must conduct an international procurement process. “In any event, these are onerous requirements and something that we might see some feedback from companies requesting changes and we might see some changes,” said Gabriel Salinas, an associate with Mayer Brown.
- Production-sharing contract model. The duration is 25 years with an option for two additional five-year periods, said Jose Valera, a partner with Mayer Brown, adding that the term may or may not be sufficient to properly and fully develop a discovery. The initial exploration period is three years with options to extend. All contract areas require seismic work. Two of the 14 contract areas require at least one exploration well to be drilled, while the others require at least two explorations wells be drilled.
- Annual work programs. The programs must be submitted annually to the National Hydrocarbons Commission for approval, and quarterly progress reports, among other requirements, are among the conditions.
Other areas of concern include extensive reporting and monitoring requirements, “tough” work commitments, the limited number of areas on which a contractor is allowed to bid and the absence of a royalty cap, panelists said. Different hydrocarbons will be the subject of different royalty rates. In addition, certain parts of the regulations need clarification. These include rules on processing and transportation expenses.
“Why is there so much control? Why is there so much reporting? Why are they making things way more complicated than they have to be?” asked one audience member. “It’s almost like you guys [Mexican government officials] are setting up for this round to fail.”
Speaking for himself and not his employer, the man—who didn’t give his name while commenting—cited for example the $350,000 fee to access the data room, noting that the same fee will apply for the next data room. “The cost to get in before we are even allowed to prequalify is painful.”
He also expressed concerns about the work program requirement that mandates a well be drilled. If seismic data show nothing, then why should a company be forced to drill a well, he asked. “That’s just a technological decision that doesn’t make any sense to me.” He encouraged Mexico to make its terms more attractive. “We’re looking for the big bang.”
Investors are being more careful about their investment decisions so attractive contract terms are a must for Mexico.
“You better make sure that Mexico looks like a good bet versus not just other parts of the world like West Africa but versus the United States, the U.S. side of the Gulf of Mexico, Texas, the Bakken, whatever,” Wood said, noting there is little capital to spread. “And for that reason, I think, we are likely to see some shifting on the contract terms in the months ahead. The Mexican government will recognize that in order to make a success of this first batch of contracts then they are going to have to be a little bit more flexible. We can look at a number of different issues.”
However, politics still play a role.
Although public opinion toward energy reform has softened over time, “the government does not want to make it look as though they are selling the family silver,” Wood said.
Extra heavy oil has already been taken off the agenda. “Chicontepec and unconventionals don’t make a lot of sense in this oil price environment either,” he added. “Maybe we will see that being shelved. Maybe we will see a focus on shallow-water exploration and extraction and then deepwater. That will allow you to focus on some of the most important areas that are around there.”
Mexico has committed itself 100% to this progress and it will stay the course, Wood continued, but the contract terms are worrying for a lot of firms.
“If Round One is not a success, it creates a bad precedence. It damages the image of the government but it doesn’t actually change the fundamental fact that … there is a lot of oil,” he said. “That’s why everybody is interested in [Mexico]. That low oil price that we are experiencing now may damage the short-term investment, but in the long-term companies are going to go for it.”
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