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Mexico’s Deepwater Oil Auction: A New Beginning

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Mexico’s national oil regulator CNH carried out a highly successful auction for oil and gas acreage in the deepwater Gulf of Mexico on December 5, giving a boost to President Enrique Peña Nieto’s plans to lift production and investment in Mexico’s failing oil sector. The auction saw international oil companies snap up eight of 10 exploration blocks on offer, as well as a majority stake in the Trión deepwater oil field discovered in 2012 by state producer Pemex. The results mark a watershed moment for Peña Nieto’s still-controversial energy reform, which ended Pemex’s 76-year monopoly and opened Mexico’s oil sector to private investment. The outcome will likely encourage the government to accelerate plans to auction off more fields to private investors, though it will take years before the increased investment leads to a reversal of the country’s decline in oil production.

The auction drew a broad range of participants, with many of the world’s largest oil companies investing in Mexico for the first time, including state-owned China National Offshore Oil Corp. (CNOOC). Other big names in the oil sector also scored a foothold, such as France’s Total, Norway’s Statoil, UK-based BP, and US-based companies Chevron and Exxon Mobil. Pemex only took a stake in one block while Sierra Oil & Gas, a Mexican independent, took stakes in two blocks.

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In the biggest surprise of the bidding, Australia’s BHP Billiton beat out BP for a 60% stake and operating rights to Trión. From a geological standpoint, that block –located in the Perdido Fold Belt near the border with the US side of the Gulf – looked extremely attractive, as Pemex’s discovery had removed much of the exploratory risk facing investors. Yet, up until the auction, many industry observers had worried that companies would shy away from bidding on Trión. One concern was that Pemex, which had grown accustomed to running Mexico’s oil sector on its own terms, would prove unwilling to accept a secondary role in the project.

Indeed, the government did nothing to assuage those concerns with the first draft of the CNH’s joint operating agreement (JOA) for Trión, which raised objections from bidders over provisions that gave Pemex unusually broad powers for a junior partner. One issue that particularly rankled private companies was language giving Pemex the de facto ability to unilaterally remove the operator under certain conditions. However, the government ultimately addressed company concerns, and the final version saw that provision removed. Other changes in the final JOA further reduced Pemex’s role – notably, the state firm’s stake in the project was reduced from 45% to 40%, while the share of staff it could appoint was cut from 20% to 10%. Many other countries have similarly made adjustments to contract terms in an effort to attract investment amid lower oil prices.

In the end, however, those concerns were not enough to dissuade BHP Billiton and BP from making strong offers for Trión. In an effort to bring immediate cash to the treasury, the finance ministry set the bidding variable – the promise of additional royalties above the statutory minimum – in a narrow 3%-4% range, with a cash signing bonus serving as a tie-breaker. Both bidders promised the maximum 4% in additional royalties, but BHP’s $624 million signing bonus beat out BP’s $606 million offer.

For Peña Nieto, the auction came as a vindication. Since the president garnered a two-thirds majority in congress in December 2013 to approve the energy reform, the leftist opposition has criticized it as an effort to privatize Pemex that would not solve the sector’s problem of falling production. His government has faced intense criticism over a series of scandals and political missteps including corruption allegations and the hugely unpopular decision to receive then-US presidential candidate Donald Trump at Los Pinos. Although the auction will not attract enough public attention to reverse his weak public approval ratings, it will likely bolster his credibility among the business community.

In a press conference after the bidding, Mexican officials – clearly pleased – described the auction results as a game-changer for the oil sector. Energy Minister Pedro Joaquín Coldwell said the nine contracts awarded could bring some $41 billion in new investment to Mexico’s oil sector. Juan Carlos Zepeda, the CNH’s presiding commissioner, predicted that full development of the areas awarded this week could eventually add some 900,000 barrels per day (b/d) to Mexico’s oil production, although the first incremental output – from Trión – would likely not come until 2023. New production from the exploration blocks, Zepeda suggested, would take a full nine to 10 years to come online.

That means Mexico’s long decline as an oil producer will continue, at least for a while, as Pemex continues to struggle with the natural decline of major fields and heavy financial losses. The state firm’s output has fallen from a peak of almost 3.4 million b/d in 2004 to barely 2.1 million b/d currently, and last month management predicted production would average just 1.944 million b/d in 2017. Those declines have accompanied a string of quarterly losses – currently 16, and counting – which have led the government to demand steep cuts to Pemex’s investment budget; those cuts, in turn, have exacerbated the output fall. While the company’s latest business plan, released last month, predicts a gradual production increase beginning as soon as 2019, the likelihood of a sustained rebound anytime soon seems slim.

Despite those obstacles, this week’s auction clearly marks the beginning of a new Mexican oil sector. The nine deepwater contracts, which the CNH expects to sign early next year, add to the total of 30 that emerged last year from three earlier auctions of smaller, less material oil and gas blocks. Most of that acreage went to smaller firms, including many recently created Mexican upstream outfits such as Sierra, and so far the energy liberalization has had no discernible impact on production. The arrival of big-name oil producers is a sign that Peña Nieto’s reform has been successful in its core objective of increasing energy investment, and that could boost public support for the policy.

The latest auction’s success will likely bolster the government’s confidence and encourage officials to accelerate plans for future bid rounds. Indeed, during the post-bidding press conference Joaquín Coldwell laid out an ambitious plan for several additional auctions before the president’s term expires in December 2018. In recent months, the government had authorized three small-scale auctions – one for shallow-water blocks, to be awarded in March, and two for onshore fields, with a July bidding date. Now, though, the energy minister says the government will plan an additional auction for next fall, with another following in early 2018 and a third coming shortly before the end of the current president’s term. The new planned auctions will likely include more deepwater blocks, Joaquín Coldwell said. He added that it is “very probable” that the upcoming auctions will also include Mexico’s first post-reform tender of unconventional acreage. Mexico has among the largest shale reserves in the Western Hemisphere but limited experience with regulations for unconventional resources. The successful auction results suggest that Mexico will indeed be able to tap new reserves and eventually return to its status as a major oil exporter.

Jason Fargo is the Latin America Team Leader at Energy Intelligence.

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