On Dec. 6, 2016, Mexico conducted the fourth and final call of Round One, the first upstream bidding process opened to private companies in almost eight decades. This was made possible by the country’s historical liberalization of its energy industry in 2013, which effectively abolished the monopolies of state-owned companies Pemex (oil and gas) and CFE (electricity). On the oil front, the most powerful incentive for reform was the urgent need to address Mexico’s shrinking crude and liquids production. Production and proven reserves fell by 31% and 38%, respectively, over the past decade (2005-2015). Crude exports, the bulk of which is directed to the U.S., fell by 40% between 2005 and 2015. Meanwhile, refining capacity has remained largely stagnant and unable to match demand, leading to a surge in refined product imports, notably gasoline and primarily from the U.S.

Upstream themes

The upstream market opening revolves around three broad themes:

  1. Five licensing rounds are to be held up to 2020: one to award Pemex exclusive acreage or “entitlements,” and four opened to private companies;
  2. Pemex is to seek partners for selected promising areas; and
  3. Twenty-two legacy “enhanced” service contracts between Pemex and private companies are to migrate to one of the new types of contracts specified in the new contractual framework (production and profit-sharing contracts, licenses and service agreements). Eventually, all of these elements are expected to gradually expand the country’s resource base, moderate its production decline and, ultimately, result in higher production—the groundwork for a vibrant domestic industry.

Round One began in 2015, with the first call offering 14 shallow-water blocks for exploration taking place in July; followed by five shallow-water blocks for development in September; 25 onshore blocks for development in December; and 10 deepwater blocks for exploration, plus the first Pemex farm-out a year thereafter. Retrospectively, Round One can be considered a success: 38 out of 54 blocks were auctioned, an award rate of 70%, with 68 companies (of which 21 are single and the rest are grouped in 18 consortia) making an astounding total of 256 offers. Overall, upstream investment might surpass $50 billion over the next decade, although flows are likely to vary greatly in specific years given the distinct nature of the blocks awarded.

Beating the odds

Yet when Round One began, the odds were not good, despite the fact that Mexico is arguably unique in that it offers all types of assets to would-be upstream players. Indeed, when Round One was announced in late 2014, oil prices already had plummeted, and they would hit record lows over the following two years. There was much concern over whether Mexican fiscal terms would be attractive enough to overcome both low oil prices and competition from other countries. In addition, the government itself was undergoing its own learning process with regard to best practices since the energy industry had been closed for so long.

This lack of experience was evident in the first call (shallow-water exploration). Since the government had insisted on keeping secret the minimum values for acceptable offers, the call attracted only six bids, with two blocks awarded (a paltry 15% success rate), thus casting a shadow on the rest of Round One. Moreover, the fields on offer were considered relatively small, and some were geared to less appealing natural gas. Despite the disappointing result, the first process was historic in many ways. For the first time in more than 75 years blocks were awarded to private companies, including one Mexican company, thus symbolizing the emergence of a new industry. The whole procedure was transparent, and the bids for the winning blocks were highly lucrative for the state.

Subsequent Round One processes, however, proved much more successful in terms of awards after the government amended its strategy. In particular, it began publishing minimum values ahead of each bidding process and showed greater eagerness to listen to industry concerns, modifying fiscal terms several times and addressing other pressing issues such as corporate guarantees and arbitration. As a result, the second call (shallow-water development) achieved a success rate of 60%. Collectively, there were 15 bids, and three blocks were awarded. More strikingly, the third call (onshore development) awarded 100% of the blocks on offer.

Round One can be considered a success, with 38 out of 54 blocks auctioned. (Source: EY)

 

Local industry

Admittedly, it was intended to attract mostly independent Mexican companies and set the stage for the emergence of a domestic E&P industry. As such, the blocks were relatively easier to operate, with abundant seismic data and some degree of infrastructure in place. Moreover, the financial and operating requirements were more relaxed than in the first two processes.

Finally, the fourth auction (deepwater exploration) was geared toward international majors endowed with the technical, financial and managerial resources necessary to develop such complex tasks. The potential resource base in the Gulf of Mexico, one of the world’s most prolific basins, would conceivably justify long-term deepwater projects despite a short-term fall in oil prices. That proved to be the case.

The four blocks on offer in the northern Perdido Fold Belt were awarded (the Belt is close enough to the U.S. maritime border to be conceivably connected to existing U.S. subsea infrastructure, which would lower development costs). More surprising, perhaps, four out of six in the southern part of the Gulf (the so-called presalt basin, where infrastructure is virtually nonexistent) also found suitors and achieved a success rate of 80%. During the same bidding process, Pemex’s first-ever farm-out—the Trion Block in the Perdido Fold Belt—was awarded. Unsurprisingly, the world’s heavyweights in deepwater exploration were all present, typically in consortia, although all did not bid or win. The two interesting developments were the aggressive participation of the Chinese, marking their first important foray in North American deepwater acreage, and the bid by several independents, albeit backed by a large national oil company. The results were clearly a vote of confidence for Mexico’s opening.

New bid rounds

Round One was just the beginning in a series of regular auctions to be carried out in the future. In October 2015 the Energy Ministry released details for three new bidding rounds due to take place over the following five years. Including Round One, 338 blocks are to be auctioned, with total reserves of 107 Bboe spread over 236,000 sq km (91,120 sq miles). In broad terms the blocks to be auctioned in the next three rounds will be much larger and hold higher reserves on average than in Round One.

About 78% of the blocks on offer in the four rounds are located in development areas, which suggests greater urgency to reverse the current production decline. Round One concentrated on most of the proved, probable and possible (3P) reserves (61 out of 67 Bboe for the four rounds), which by definition are much more uncertain. By contrast, rounds 2 through 4 hold the bulk of “prospective” resources (29 out of 40 Bboe), which includes proved and probable (2P) reserves as well as yet-to-find resources that the government believes are abundant. Development blocks will still be mostly located in onshore areas (70% of all blocks) since mature fields could be turned around and start/ increase production much more quickly than deep water. Rounds 2 through 4 will account for 144 out of the 169 onshore blocks on offer. Exploration blocks are spread across more evenly, notably over rounds 2 through 4.

Round One ultimately represented the first stone in the construction of Mexico’s upstream industry over the long term, with domestic players focusing on less risky, more mature resources and international companies delving into more complex and challenging endeavors. In this sense, the country’s first five-year plan, which is likely to evolve, indicates a clear direction: an effort to improve the overall attractiveness of future rounds and a focus on known albeit underdeveloped resources.


Read the other two regional reports from the April E&P issue:

Unlocking A Mexican Prize

Mexico’s Emergent E&P Sector Will Continue To Grow