Latin America Advisor

Energy Advisor

A Publication of The Dialogue

Was Mexico’s First-Ever Deep-Water Tender a Success?

Mexico held its first-ever deep-water oil auction since ending the monopoly held by state oil company Pemex, which is headed by José Antonio González Anaya.

Mexico on Dec. 5 held its first-ever deep-water oil auction, attracting bids from foreign oil companies. Was the auction successful? What is the outlook for Mexico’s oil sector as the country opens its deep-water reserves to international oil companies? What challenges will Mexico’s oil sector face as these new projects move ahead? What lessons can be learned from Mexico’s deep-water tender?

Eduardo Canales, associate, and Steven P. Otillar, partner, for Global Energy Transactions at Akin Gump Strauss Hauer & Feld: “Ever since Mexico’s energy reform was enacted in December 2013, the first deep-water oil tender was marked on everyone’s calendar, because it would serve as a true gauge of Mexico’s integration into the international energy stage. Round 1.4 only became more relevant in recent months as (i) Mexico’s oil reserves and production rates continue to decline, (ii) the energy industry experienced uncertainty caused by oversupply and price volatility and (iii) oil companies had to reconfigure their value-creation strategies to weather the down cycle. Despite industry trepidations and an unclear market outlook, international oil companies as well as national oil companies with international portfolios converged in Mexico to beat even the most positive forecasts. Ultimately, eight out of 10 deep-water licenses were awarded to prominent companies like ExxonMobil, Pemex and Chevron, which are expected to have an associated investment effect of almost $35 billion over the next 35 years. In addition to Round 1.4, the first ‘farm-out’ contract was awarded to BHP Billiton, who will partner with Pemex to explore and develop the Trion deep-water field, one of Pemex’s most promising assets. Dec. 5 was a boon for Mexico: on one hand, the Mexican energy industry will benefit from the competition, innovation, diversification, employment, talent development and capital infusion required for these highly complex offshore projects, while on the other hand, the energy industry broke recent market trends and acquired long-term assets expected to have a concrete impact on their reserve-replacement ratios. Looking ahead, it is critical for Mexico to use this success as a stepping stone to address key challenges that could fundamentally jeopardize the evolution of its energy industry and its conclusive integration into the international energy stage. Now that Mexico seems to have developed a good rapport with the energy industry based on the transparency, impartiality, receptivity and responsiveness that characterized every Round 1 auction, the focus will need to turn more granular—focusing on the other governmental agencies and industry regulations and standards—to further incentivize investment and facilitate the sustainable development of natural resources, while balancing the need for health, safety and environmental protection.”

Jeremy M. Martin, member of the Energy Advisor board and vice president for energy and sustainability at the Institute of the Americas: “Mexico’s deep-water auction was a soaring success. Eight of the 10 blocks on auction and the farm-out and partnership with Pemex were awarded, exceeding both the government’s expectations and the estimates of many across the industry. Indeed, the key outcome from the auction was the boost it gave to the government as the nation’s monumental energy reform process surges forward. The deep-water auction had long been said to be the key to attracting the globe’s largest upstream oil and gas firms, and it delivered on that score with the likes of BP, ExxonMobil, Chevron, Total, Statoil, CNOOC and Petronas all emerging as winners. Moreover, with the eyes of the energy world focused on Mexico City, the government again conducted a transparent auction and one that counted a highly rigorous qualification and adjudication process. Despite oil price headwinds and capital constraints, Mexico proved that large projects can still be successfully tendered when resource materiality and fiscal terms line up. The Trion farm-out highlighted that Mexico’s national oil company, though struggling financially and operationally, remains relevant as the new industry dynamics unfold. But beyond the importance of the level of blocks tendered and relative competition, there was some debate over the formula used to compute winning bids, that is, the calculation of additional royalties and biddable wells per block. Arguably, the formula undervalued additional work and wells vis-à-vis additional royalties. This could prove to be a critical lesson and an issue to draw upon in advance of future bidding, but particularly in large-scale deep-water projects. Lastly, translating the investment commitments to exploration, employment, and particularly new production, will require time.”

Arturo Sarukhan, board member of the Inter-American Dialogue and former Mexican ambassador to the United States: “The auction of 10 deep-water blocks is the most significant step yet in Mexico’s effort to reclaim its spot as a global crude-producing powerhouse, and without sufficient liquidity and investment, Pemex would have continued to shrink. Unsurprisingly, the high-fives in Mexico City are proof that the auction played out competitively and drew big results. These were widely viewed as a validation of the Mexican government’s efforts to revitalize the country’s oil and gas industry, and of the tack and efforts taken in previous months and rounds to inject flexibility and pragmatism to the bidding rules. The capital investment commitments for all 10 blocks amount to approximately $4 billion, with most of it going into exploration wells. More than three-fourths of prospective oil resources are located offshore in deep waters of the Gulf of Mexico, which is why—by the way—the landmark 2011 negotiation between the previous Mexican government and the United States for the joint exploitation of trans-boundary reservoirs in the so-called Western Gap in the Gulf is a key piece of the puzzle. Nonetheless, the real metrics and analysis to determine success are effectively further down the road. Beyond the inherent challenges to exploration and extraction, and the contracts being turned into productive oil and gas wells, Mexican authorities—and the political parties that supported the groundbreaking energy reform in Congress—need to ensure that they continue to win the punditry battle as well as the battle on the street. Even though reversing the opening of the sector would require a constitutional reform and therefore entail a huge uphill battle, with presidential contenders teeing-up next year ahead of the 2018 general elections, the hearts and minds of Mexicans will be key in politically bulletproofing this critically important reform. And the direction of the Mexico-U.S. relationship in the Trump era could have a profound impact both on public opinion and political maneuverability and appetite in Mexico regarding an expanded U.S. energy footprint.”

John Padilla, managing director at IPD Latin America: “Mexico’s Round 1.4 auction was a resounding success, particularly given the commitments it required, and the current oil price environment. Twelve new companies will now enter Mexico’s deep-water arena to begin delineating one of the world’s last under-explored offshore areas. The implications are vast; it will be fascinating to watch this ecosystem evolve. The biggest shift will likely occur within Pemex. It must digest and start to work in its new role as partner on the E&P side with BHP Billiton in Trion (the farm-down) and with Chevron and INPEX in Perdido’s Block 3. The billions of dollars in investment, which will not turn into production for several years, come as Pemex struggles with falling production—to the tune of some 375,000 bpd since the 2013 energy reform was passed. The government will have to double down on its efforts to turn that tide, whether that be through more blocks that can rapidly bring production online, more farm-downs and/or finally pushing through the long-delayed CIEPs and COPFs. The Mexican government’s ability to listen and receive feedback was key to making this bidding round a success. But competition from Brazil and the United States in particular looms. Mexico will still have to fine-tune its contract and mechanisms, to ensure it can build off this historic bid round’s success.”

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