First bidding round showed Mexico reform challenges, House panel told

An apparently disappointing first round of bids for oil and gas exploration rights revealed problems that require attention if Mexico’s dramatic energy policy reforms are to succeed, witnesses told a US House Foreign Affairs Committee subcommittee (OGJ Online, July 16, 2015).

“Mexico saw the impact of the difficult business climate in global oil production with the disappointing interest in Round One,” IHS Inc. Senior Vice-Pres. Carlos Pascual, a former US Ambassador to Mexico, said during the Western Hemisphere Subcommittee’s July 23 hearing.

“Thirty-nine companies paid for data to investigate the blocks which were offered, 34 companies prequalified to compete, but on July 15 there were only 9 bidders, with 4 of the bids coming from consortiums,” he testified. “Only 2 out of 14 blocks were awarded.”

Pascual, who also was formerly Energy Affairs Coordinator at the US Department of State, said interest in the shallow-water tracts from outside the country possibly was tepid because:

• Field offerings were small, and possibly not of much interest to larger multinational companies.

• Contracts were offered for 4 years with a 2-year extension, but some potential bidders may have wanted longer contract terms to explore more extensively and determine whether there might be complex presalt formations that could be exploited at deeper levels.

• Government minimum bids may have been influenced by historic Petroleos Mexicanos (Pemex) production costs, which may be lower than costs potential investors estimated.

• Fiscal terms may not have met investor requirements to mobilize capital, given increased pressure from low global crude oil prices to cut costs and capital expenditures.

“The important point is that all of these issues can be addressed, Pascual said. “Mexico took a historic first step, demonstrating the potential for an important combination of international oil partners, American capital, and a start-up Mexican private industry.”

Mexico’s government will need to address other issues, including the capacity of its service sector, whether other companies in the country can secure international partners, Pemex’s role in future bidding rounds, and pipeline and storage capacity, Pascual said.

“However, with the sector now open for investment, these potential issues can be turned into business opportunities,” Pascual said. “If the Mexican government and outside investors take that perspective, these difficult first moments could help consolidate the profound need for sensitivity to international markets and competitiveness that Mexico needs to demonstrate to fulfill its aspirations.”

But a second witness told the subcommittee that Mexico’s oil and gas reforms have possibly severe inherent problems because the government still is not ready to relinquish control over Pemex despite changing some aspects of the national oil company.

“In the March 2015 Round Zero oil auction, Pemex was the only bidder and received over 80% of the oil and gas plays it wished to keep,” said Tony Payan, Mexico Center director at Rice University’s Baker Institute for Public Policy. “What Pemex did not want or could not keep was then fair game for others in subsequent bidding rounds.”

Terms and conditions of contracts that were offered to foreign and private investors also originally capped revenue, ensuring maximum flows to the federal government, Payan said. Companies pushed back, and some of the profit caps were made more flexible, he said.

Troubling contract terms

“The government also has legislated that any contract can be rescinded at any point, even due to purely administrative violations—an undefined term—which will give federal bureaucrats enormous discretionary power over continuing, modifying, or ending contracts,” Payan said.

Finally, the government intended to prohibit contract clauses that allow investors to bring disputes to international arbitration bodies, preferring to resolve them in Mexico’s own courts, which are notoriously deficient and susceptible to corruption, Payan testified. “The courts’ ability to fairly consider the interests of both investors and the Mexican government is questionable, to say the least,” he said. “It is not clear yet whether Mexico’s government has backed down on this point.”

This suggests that Mexico’s government would have preferred to keep its energy sector under tight control, but was forced by circumstances to make reforms, Payan told the subcommittee. “In my estimation, Mexico’s energy reform is more restrictive than that of other countries, and continues to give the government excessive power,” he said. “This should be kept closely in mind as Mexico’s open energy market becomes an integral part of the North American energy landscape.”

A third witness said that the July 15 bidding round featured marginal shallow-water blocks, with prices arbitrarily set by the government, and that future auctions will feature more attractive deepwater and onshore unconventional shale oil and gas tracts.

“Lessons learned from the first auction on pricing and other matters will also be applied to later rounds,” said Eric Farnsworth, vice-president of the Council of the Americas and Americas Society. “As well, on a comparative basis globally, additional investment blocks are larger, and potentially more significant, than those available elsewhere in the world.”

Investor interest in Gulf of Mexico deepwater reservoirs and unconventional oil and gas in the Eagle Ford shale in the Burgos basin is high, Farnsworth said.

Cross-border shale deposits

“Mexico’s shale reserves are the sixth largest in the world, according to the US Energy Information Administration, overlapping with shale resources in southern Texas,” Farnsworth said. “Just as the shale revolution increased US oil production by more than 55%, the application of new technology, capital, and best management practices could catalyze a similar jump in oil and gas production in Mexico.”

But the fourth witness said that while the experience with Texas’ Eagle Ford shale can be a useful reference point for Mexico’s shale opportunities, there are important differences.

“Although there have been infrastructure challenges in South Texas, most were overcome relatively quickly. In Mexico, the infrastructure challenges will be much more significant,” said Thomas Tunstall, research director at the University of Texas at San Antonio’s Institute for Economic Development.

Tunstall recommended that the US expedite a swap of its light, sweet crude with Mexico for its heavier grade which can be processed in US Gulf Coast refineries; streamline processes for transferring knowledge and technology into Mexico; work with Mexico to improve its roads, housing, workforce, medical facilities, railroads, telecommunications, and pipelines to better support oil and gas activity; and remove restrictions on exporting US-produced crude.

Farnsworth said the two countries—“and let’s bring Canada into this too”—should work together on common issues such as joint recognition of licenses. “These things aren’t necessarily highly political, but they’re important,” he said.

Pascual said, “There is no other country in the world offering new hydrocarbon that has so many positive attributes. There are challenges, but I think the foundation is there for Mexico to build on. It’s also in our interest.”

Contact Nick Snow at nicks@pennwell.com.

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