The Fuse

Mexico’s Energy Reform Finally Yields Results

by Nick Cunningham | May 30, 2017

Mexico’s historic 2013-2014 energy reform opened up the country’s oil sector to private investment, allowing international companies to access Mexico’s energy reserves for the first time in over seven decades. The impetus for such a dramatic policy overhaul was the sharp and ongoing decline in oil production from state-owned Pemex. The company has relied on a handful of giant oil fields that are far past their prime. Mexico’s oil production peaked in 2004 at 3.85 million barrels per day (mbd) and dropped to as low as 2.5 mbd in 2016. The Mexican government of President Enrique Pena Nieto broke up Pemex’s monopoly and opened up the energy sector for foreign investment in order to reverse that decline.

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The reform has been met with mixed results. Staged offerings from the Mexican government, which initially auctioned off shallow water and onshore blocks, attracted scant interest. The collapse of oil prices beginning in 2014 did not help matters, which led to delays for subsequent rounds of auctions.

However, interest has picked up more recently. Last December, Mexico took its largest leap forward with a deepwater auction, the most prized offering to date. There is still a long way to go before production can grow in a meaningful way, but several years on since the landmark liberalization of Mexico’s energy sector, the situation is finally moving in the right direction.

December auction moves the needle

Several auctions since 2015 have been only  modestly successful. But the December 2016 deepwater auction was the biggest test so far for Mexico’s energy reform. The auction included more attractive assets than the previous shallow water rounds, and it was deemed a success with eight of 10 blocks awarded.

ExxonMobil and Total won the rights to a section in the Perdido Fold Belt, one of the most sought after sections of Mexico’s deepwater because it is located along the maritime border with the U.S.

Notably, the auction succeeded in attracting several oil majors. ExxonMobil and Total won the rights to a section in the Perdido Fold Belt, one of the most sought after sections of Mexico’s deepwater because it is located along the maritime border with the U.S. International companies have extensive experience drilling across the border in American waters, where Royal Dutch Shell, Chevron and BP are already producing. The companies hope that Mexico’s Perdido Fold Belt will be as lucrative and prolific as the U.S. Gulf of Mexico has been for the majors. China’s state-owned CNOOC, meanwhile, also won two blocks in the Perdido.

However, drilling will be complex. Exxon’s block is located in water depths of 9,000 feet. “The block is primarily outside of salt,” Lorna Campbell, exploration manager in Mexico for ExxonMobil, told S&P Global Platts in early May. “It’s ultra-frontier deepwater—but certainly within the realm of current technology. We’re working towards planning our first wells already.” Other companies are a little more cautious. One Chevron official told S&P Global Platts that its block in the Perdido Fold Belt could take years of seismic analysis “on very large computers to tease” out a section to drill.

One particularly exciting prospect is the Trion field, which holds an estimated 485 million barrels and is located just across the U.S. maritime border. BHP Billiton beat out BP to win the rights to the Trion and will be required to invest $1.2 billion initially in a joint venture with Pemex. Fully developing the field will require $11 billion. BP won the rights to some parcels in the Saline Basin, located south of the Perdido. Much less is known about the Saline, but Mexican regulators have hyped it as a high-risk, high-reward investment.

The winners of the December 2016 auction have until September of this year to submit their exploration plans, and the government will have four months after that to review submissions. The first deepwater well is not expected to be drilled until late 2018 at the earliest. The Mexican government estimated that developing all 10 of the blocks it offered in last year’s auction would lead to investment of $34 billion over 15 years. Actual investment won’t reach that level since only eight of the blocks were awarded. But the figure demonstrates why the government of Nieto has pushed so hard for energy reform.

Shallow water and onshore also hold promise

Although the deepwater offerings have been the most closely watched, there is still potential in conventional areas. Italian oil giant Eni drilled a successful well in March in shallow water in the Campeche Bay, the first well drilled by an oil major since Mexico passed its energy reform. The success was not a surprise—Eni obtained the drilling rights from a 2015 auction in which tracts with known discoveries were on offer. However, Eni says it found oil at greater depths than anticipated, making the discovery “very promising,” according to Eni CEO Claudio Descalzi. “We want to go fast…it’s reasonable to think that in a couple of years, three years, we could start production,” Descalzi said in March, according to the FT.

Although the deepwater offerings have been the most closely watched, there is still potential in conventional areas.

Mexico is set to hold another auction in the next few weeks for shallow water blocks. Unlike past rounds, interest has never been higher, coming on the heels of a successful deepwater offering and the positive news from Eni’s shallow water project. Going forward, Mexican regulators have laid out plans to hold two auctions per year—shallow water and onshore conventional offerings at mid-year, followed by deepwater and other unconventional assets in December. Mexican regulators are offering reams of data to participating companies in order to spark interest, while the companies themselves will be allowed to nominate blocks.

Hurdles ahead

Mexico has not succeeded just yet in sparking a drilling bonanza. Some oil executives are pressing the government to take a more aggressive approach if it wants to reverse the country’s falling oil production. “To turn that ship around, you need a substantial number of large projects,” Chris Sladen, BP’s country manager for Mexico, told Reuters in mid-May. “I would encourage Mexico to offer substantial numbers of large projects because that’s what it takes.” BP has already drilled in some shallow water prospects, and the initial results have been better than expected. In December’s auction, BP won the rights to two deepwater prospects in conjunction with Statoil and Total SA. They will submit their exploration plans by September.

With more than a couple oil majors now heavily investing in Mexico’s energy sector, the country is further along than at any point in the last few years in realizing its goals of halting its decline in oil production.

Still, the deepwater fields will take years to develop even in the most optimistic scenario. The highly touted Trion field, for example, could take up to a decade before the first barrels of oil are produced. In the meantime, the 2018 Presidential election could complicate matters. One of the leading candidates is Andrés Manuel López Obrador, who was opposed to the energy reform legislation years ago. Obrador has said he would put the energy reforms up for a public referendum, which, needless to say, would inject a lot of uncertainty into the operating environment for oil companies coming into Mexico.

Despite these potential stumbling blocks, Mexico’s progress is notable. With more than a couple oil majors now heavily investing in Mexico’s energy sector, the country is further along than at any point in the last few years in realizing its goals of halting its decline in oil production.

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