La Jolla Conference: Mexican energy reform a ‘telenovela,’ panelist says

Energy reform in Mexico is a telenovela wherein stories of intrigue and suspense will arise, but in the end, everything will turn out okay, opined Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center for Scholars, during a May 21 panel discussion at the XXIV La Jolla Energy Conference in La Jolla, Calif.

Drawing parallels to a genre he evidently enjoys, Wood even pointed out that the nation’s First Lady Angelica Rivera is a real-life soap star. He explained that observers of reform were having an intense love affair with the Mexican government until things were fully disrobed and those observers realized that contract terms for exploration blocks weren’t competitive.

Those terms were revised in February, but the reaction was still one of disappointment. Final terms are scheduled for release by May 29, but Wood wonders if they’ll be revised enough to garner substantive bids from interested companies that are thinking, “Will we land a contract, invest billions, but then lose it?”

Wood also questioned whether regulators have too many functions as they cover everything from the wellhead to the pump. Wood believes that Mexico should ask companies, “What can we do to help you drill more wells?” While this approach might make some people uncomfortable, it would be beneficial to both outside investors and the country as a whole, he said. Friendliness to outside investors is essential because neither side—the investors and the government—are familiar with each other at the moment.

Environmental monitoring

One part of the monumental reform undertaken by Mexico entails the organization of a new federal regulatory structure for oil and gas. The Agencia de Seguridad Energia y Ambiente (ASEA) was formed under the new Secretaria del Medio Ambiente y Recursos Naturales (SEMARNAT), and is tasked with regulating and supervising environmental competencies through the entire energy value chain.

Carlos de Regules Ruiz-Funes, executive director of ASEA, hopes by 2016 to implement “cutting edge” regulatory and permitting policy, which includes everything from offshore and shale development to downstream operations. ASEA, which he said “is all about managing risk,” features a multilevel inspection platform that “aligns incentives of regulator and regulated entities, the reinsurance sector, and verification units.”

The agency began operations in March and has since prequalified 25 companies participating in Round One bidding for safety competency. The agency currently has more than 8,000 issues—such as permits, licenses, acts, and resolutions—needing attention and he’s trying to ensure none are missed.

De Regules noted that local authorities, meanwhile, are responsible for urban land use changes and emergency response, the latter of which is coordinated with state and federal authorities, therefore constant communication between the different entities is key, he said. Petroleos Mexicanos (Pemex) informs ASEA multiple times per day on safety issues or incidents that the company has observed.

Resource management challenge

Mexico’s National Hydrocarbons Commission (CNH), a resource management entity, has been considerably strengthened during the reform, tasked with performing the bidding process, signing contracts, managing overseas contracts, authorizing drilling, approving and overseeing exploration and development plans, authorizing seismic studies, and managing the National Information Center, according to a presentation by Edgar Rangel, the agency’s commissioner.

The country’s first two bid rounds, Round Zero and Round One, were announced in August 2014 and Pemex has since taken 83% of 2P reserves including 98% of shallow-water assets. However, Rangel noted that the company's 1P reserves are on par with Petroleo Brasilierio SA’s, and it took just 21% of prospective resources.

Rangel boasted that Round One’s first call for shallow-water exploration, launched on Dec. 11, 2014, has received interest from 49 companies, of which 39 have access to data rooms and 34 are registered to the bidding process. Notable participants have been Total SA, Eni SPA, BP PLC, Statoil ASA, Royal Dutch Shell PLC, BG Group PLC, ExxonMobil Corp., Chevron Corp., OAO Lukoil, Petrobras, CNOOC Ltd., and Sinopec.

CNH just gave approval for 19 companies, including ExxonMobil and Chevron, to bid on the 14 shallow-water exploration blocks. Shell and Petrobras ultimately decided not to participate.

Second call for shallow-water extraction, launched on Feb. 27, has received interest from 28 companies, of which 21 have access to data rooms and 11 are registered to the bidding process. Notable participants are Shell, BG, Total, Chevron, Lukoil, CNOOC, and Sinopec.

Just launched May 12, third call for onshore conventional extraction has received interest from four companies—Shell, Fieldwood Energy LLC, Torenco Energy Inc., and Perforadora Central SA de CV. Wood Mackenzie recently said that the third call “could be very attractive for smaller players but it will not lift Mexico’s oil production significantly.”

Pablo Medina, WoodMac research analyst, explained, “If the objective is to allow Mexican companies to be part of the new energy landscape by offering small fields and flexible prequalification criteria, then it could be a success. If the objective is to attract a diversity of larger international companies with expertise in mature fields, then the round could fall short of expectations due to the small number of high-potential fields on offer.”

He noted that the third call is unique from the previous two in that it will use a license contract with bidding variables including additional royalty and work commitment. “The regime has the potential to be very attractive, although it will ultimately depend on the minimum acceptable bid level that will be announced at a future date,” Medina said.

Bidding for the blocks ends on July 15. Winning bids will be announced before July 17 and contracts must be signed before Aug. 21.

Farmouts enticing

Pemex is particularly excited about the prospect of farmouts, which will be announced this year, as they promise short-term production returns. Wood noted, “Pemex actually has something that people want and that is a very good thing.” Rangel describes farmouts as the “silver bullet” for Mexico.

He said more than 100 companies from all over the world are speaking with Pemex regarding farmout deals. Extraction blocks, which he describes as the “marshmallows” of the bunch with high quantities of light oil, will be completed by September.

Rangel noted that Mexico has valued transparency, making all info relating to its bid rounds public including specific bids, contracts, and costs. “Those checks and balances are important to minimize the risk of pollution and corruption,” he said.

Regarding low oil prices and their impact on international interest in Mexico, Rangel remained unfazed, explaining that 85% of historic prices are below the current level. “We just got used to high prices,” he said, reaffirming that all assets up for bid offer profitability.

The best metrics to measure the success of reform are investment, work volume such as the number of exploration wells, and climbing volumes of reserves and production, Rangel stated.

Social concerns

On the social side, the panelists cautioned that Mexican citizens are still leery of reform and a possible invasion by international entities, and will remain so until the perceived benefits unfold. Therefore companies must understand the social climate of the areas where they plan to operate.

Alberto de la Fuente, country chairman at Shell Mexico, emphasized the importance of collaboration between industry, government, and academia, the latter of which is tasked with creating talent that will take Mexico's energy sector into the next century.

During a separate panel discussion on above ground risks in the Americas, Read B. Taylor, upstream executive director of Mexico City-based independent startup Sierra Oil & Gas, said that universities are the best source when researching cultural and social issues in Mexico. Sierra, backed financially by energy-focused private equity firms Riverstone Holdings LLC and EnCap Investments, participated in the first two calls for bid.

He said that as with Brazil, the situation domestically will get more complicated and difficult as reform advances. He said this is the “beginning of many, many challenges” relating to the social, environmental, and economic outcomes, and it’s “foolish to forecast where this will go.”

Wood predicts the Mexican public will truly warm up to—maybe not necessarily fall in love with—energy reform when they can purchase higher quality fuels due to the proliferation of retail gasoline competition. Consumers in Mexico and elsewhere see oil contracts as abstract and often don’t understand their greater value.

De la Fuente added, “I hope that the people [of Mexico] are patient and realize these things don't happen overnight.”

Contact Matt Zborowski at matthewz@ogjonline.com.

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