The Fuse

Upstream Investment in Mexico Rises Ahead of Key Presidential Election

by Nick Cunningham | February 28, 2018

At the end of January, Royal Dutch Shell purchased nine of the 19 blocks offered in Mexico’s deepwater auction, a vote of confidence in the country’s offshore sector. The auction was billed as one of the most important offerings in the nearly four years since Mexico’s energy sector was opened for private investment, ending decades of a state-run monopoly. Earlier rounds were met with disappointment, but the latest sale showed strong interest from some of the largest oil and gas companies in the world.

While Mexico seems to finally have momentum in its effort to revive struggling oil production, the country is also faced with political uncertainty ahead of this year’s presidential elections.

Mexican oil investment picking up

In the most recent auction, 19 out of 29 bids were awarded, sharply higher than the seven expected by the government. Successful bids were submitted by Shell, Malaysian state-owned firm Petronas, and Qatar Petroleum, and Mexican officials estimate that the awarded blocks could eventually attract upward of $93 billion in investment. That money has not yet been committed, and Mexico has a long way before it reaches the estimated $640 billion needed through 2040 to bring oil production back to its peak levels of about 3.5 million barrels per day (Mbd), last reached in the early 2000s. Mexico currently produces approximately 1.9 Mbd.

IOCs are interested in Mexico’s deepwater, particularly because the acreage is geologically similar to the prolific fields located just across the maritime border in U.S. waters.

Yet, the auction builds on the country’s effort to halt sliding oil production. Many international oil firms are interested in Mexico’s deepwater, particularly because the acreage is geologically similar to the prolific fields located just across the maritime border in U.S. waters. Moreover, existing infrastructure in the U.S. Gulf of Mexico could aid in development of Mexican fields. “It’s only natural for Shell to pursue opportunities in Mexico,” Lysle Brinker, analyst at consultancy IHS Markit, told Reuters in late January. “It’s near an area where Shell is already producing.”

Political risk looms

Despite the success, the historic energy reform legislation passed at the beginning of President Enrique Pena Nieto’s term still faces some political headwinds. The liberalization of the energy sector was highly controversial to begin with, and the benefits of the historic opening have yet to be fully felt by the Mexican people. The Mexican government insists that the reform measures cannot be rolled back, and just days before the successful January auction, Mexican regulators announced another round is scheduled for July, an offering that will cover 37 onshore oil and gas areas. That will come after a previously scheduled shallow water auction set to take place in March. The multiple auctions in such a short period of time could be interpreted as an effort to accelerate sales ahead of a a change in presidential administrations that could see the political environment swing back in the other direction.

The July onshore auction will be a test for the next administration.

The July onshore auction will be a test for the next administration. On the one hand, as Bloomberg notes, the offering will include onshore oil and gas fields that include some existing infrastructure and already-drilled wells, meaning that some of the projects could come online in a short period of time. That will likely appeal to prospective bidders in the industry. However, since it will be the first auction after the presidential election, it could shape up to be a barometer for how the oil industry will respond to the incoming administration.

“The rounds transcend the electoral cycles,” Mexico’s Energy Minister Pedro Joaquin Coldwell said in January when announcing upcoming oil auctions, according to Bloomberg. He stressed that the offerings were irreversible, arguing that they “exclusively comply with the energy policy that Mexico demands and will continue to demand in the future.”

The frontrunner for the July election is Andres Manuel Lopez Obrador, who has, at best, expressed skepticism toward upstream energy reform.

The frontrunner for the July election is Andres Manuel Lopez Obrador, often referred to as AMLO, who has, at best, expressed skepticism toward the energy reform. AMLO was originally opposed to the energy liberalization, and he has at times suggested he may revisit the contracts awarded by the Pena Nieto administration if elected president. More recently, in an interview with the Wall Street Journal, Rocio Nahle, an AMLO ally and possible energy minister, tried to reassure voters and investors that while Lopez Obrador will not try to invalidate those contracts, he could halt the auctioning process until the country sees some “success” from areas already awarded to international companies. The comments appear to be an attempt to alleviate fears that AMLO will try to re-nationalize oil assets. “Investors can be calm, we’ll respect the law,” Nahle said.

A focus on refined products

Nahle also said that a Lopez Obrador administration would try to curtail crude oil exports and instead favor the processing and export of refined products as a way of capturing more value for the country. That would likely lead to heavy investment in oil refineries. “We must abandon this lazy mentality that says that we can’t produce here,” Nahle told the WSJ.

A Lopez Obrador administration would try to curtail crude oil exports and instead favor the processing and export of refined products as a way of capturing more value for the country.

Mexico’s aging and crumbling refineries have been operating at low utilization, making the country increasingly dependent on imports of refined products. The six refineries have a capacity to process 1.7 Mbd, but only averaged 770,000 barrels per day (b/d) of output last year.

State-owned Pemex has already tried to stop the declines. In 2014, Pemex announced a $4.6 billion expansion of its Tula refinery, with the goal of doubling gasoline production capacity from 140,000 b/d to 300,000 b/d. The project will not be completed until the early 2020s. The unit processed 219,000 b/d through the first 11 months of 2017, according to Reuters.

Beyond that, Pemex has had trouble finding investors for its aging refineries. While international companies are interested in upstream production, they do not appear eager to help Mexico’s struggling downstream sector. Reuters estimates that Pemex has seen $5 billion in operating losses from its six refineries over the past few years. Moreover, many of the older refineries are equipped to handle lighter forms of oil, rather than the heavy Maya blend Mexico currently produces. As a result, refineries tend to operate below capacity while Mexico is forced to import upward of 60 percent of the country’s gasoline and diesel needs.

Lopez Obrador wants to turn around the downstream situation. Nahle, his possible energy minister, told Reuters that AMLO would want to upgrade the country’s six oil refineries, while also building one or two new facilities that could boost capacity by 300,000 b/d to 600,000 b/d. “In a three-year period, at the latest, we need to try to consume our own fuels and not depend on foreign gasoline,” Nahle told Reuters in an interview. There are question marks about how viable such projects are, including the high price tag, but if Lopez Obrador were to succeed, it would erase some business for U.S. refiners, which exported an average of 800,000 b/d of gasoline and diesel to Mexico last year. Moreover, heavy oil refiners on the Gulf Coast of the U.S. would lose out on some feedstock, although the oil flows from Mexico to the U.S. have already been declining due to the drop off in Mexican production. The U.S. imported an average of only 600,000 b/d of crude from Mexico in 2017, down sharply from the 1.1 Mbd in 2011.

Upstream to proceed, downstream unclear

The oil industry does not appear to be worried about the prospect of a shift in administrations.

For now, if the January auction is a guide, the oil industry does not appear to be worried about the upcoming change in administrations. Mexico’s aging oil fields continue to see declines, a trend that will only be reversed by significant upstream investment from international companies. Meanwhile, the presumed frontrunner for president wants to increase refined fuel production, but that will likely require a substantial public investment as private companies have shied away from Mexico’s downstream sector.

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