The Fuse

Mexico’s Initial Auction a Bust, But Region’s Pivot From Resource Nationalism a Positive

by Matt Piotrowski | July 17, 2015

The opening up of Mexico’s oil sector to international oil companies was supposed to herald in a new era, but initial results from this week’s bid round in Mexico City show how much difficult work is ahead in order for the country to meet its long-term goals. Nonetheless, the historic opening auction, one of more to come, is a positive reflection of how major producing countries in Latin America are moving away from resource nationalism—for now, at least—as they struggle in the current low oil price environment that shows no sign of turning around.

The historic bid round, one of more to come, is a positive reflection of how major producing countries in Latin America are moving away from resource nationalism—for now, at least—as they struggle in the current low oil price environment that shows no sign of turning around.

The changes in Mexico, the world’s tenth largest producer, come at a time the country’s oil industry is coping with low oil prices and structural declines in output. In 2014, Mexico’s production for petroleum and other liquids averaged 2.812 mbd, a far cry from the peak of 3.6 mbd in 2003-4. The auction is the result of Mexico amending its energy laws to allow private and foreign companies access to its energy reserves. Before, the country’s petroleum business was dominated by state-run Pemex for almost eight decades.

In the first phase of round one, only two out of the 14 exploration blocks were awarded, just 14 percent of the total and well below the government’s expectations of 30 to 50 percent. The blocks on offer in this phase were never seen as the main focus for international oil companies in Mexico, as they include exploration in shallow water and not the more excitable prospects onshore and in deepwater.

The winning bidder for blocks 2 and 8 was a consortium of Sierra Oil & Gas, Talos Energy and Premier Oil. The first block covers an area of about 75 square miles off the coast of Veracruz state and is expected to produce light oil and dry gas, while the second area the group won, after outbidding Statoil and three others, will produce light crude oil. The tender is the first of five for the first round—but the subsequent auctions are bigger prizes as they include onshore reserves, deepwater reserves and shale.

A big flop, for now

There is no doubt the first round has so far been a huge disappointment. Experts believe that the current fiscal terms Mexico is offering are unfavorable, with oil prices at current levels.

“The terms would have been much better a year ago,” said Lisa Viscidi, Director of the Energy, Climate Change and Extractive Industries at the Washington-based Inter-American Dialogue, who noted that the government’s take was considered too high with prices in the $50 area. Last year at this time, Brent crude was trading at $105, while U.S. West Texas Intermediate was slightly lower at $100.

With the current low oil price environment and the disappointment from the opening phase of round one, does that mean Mexico will not be able to successfully turn output around and reach its goal of 3 mbd by 2020?

“The oil sector will change, but it will take longer than what the government originally expected,” said Viscidi.

The oil sector will change, but it will take longer than what the government originally expected.

The Energy Information Administration (EIA) significantly revised its long-term outlook for Mexico last year as a result of the new terms, projecting output for total liquids to reach 3.7 mbd by 2040, versus expectations of just 2.1 mbd before the country amended its laws.

One major uncertainty for the rest of round one and upcoming bid rounds—there will be five in total—will of course be the oil price. With prices so low, and the possibility they will fall further, investment in Mexico and anywhere else for that matter is highly uncertain and risky.

For Mexico, another major concern is how other countries alter their terms to entice investors in the low price environment. If international oil companies continue to find Mexico’s terms unfavorable while those in Latin America and other regions offer sweeter deals, the entire liberalization of the country’s oil sector could come under threat. There are, however, a number of fields that will be heavily sought after by foreign companies. Deepwater is the top prize for Western investors, but there is high exploration risk, similar to shale. Many analysts say Mexico offers fields that are essentially an extension of the Eagle Ford shale play in the Southwest U.S., which has seen output rise to well above 1 mbd from under 0.1 mbd since the end of 2010. But there are numerous above-ground risks for shale in Mexico including infrastructure constraints, limited water, and land rights issues that may scare away potential investors.

Push away from resource nationalism

Growing resource nationalism in Latin America has had significant negative repercussions for oil-producing countries, but governments are trying to adapt to recent trends of declining output and falling oil prices. Mexico’s new plans to open its oil sector to outsiders reflect this move away from resource nationalism. But a main concern is that if and when prices rebound, governments may revert to old habits and push away investors.

Growing resource nationalism in Latin America has had significant negative repercussions for oil-producing countries, but governments are trying to adapt to recent trends of declining output and falling oil prices.

Brazil, whose national oil company Petrobras has been mired in scandal, now has legislation moving through the Senate that would open Brazil’s massive pre-salt reserves to international oil companies. Colombia, meanwhile, is changing its terms for investment and has taken measures to prop up its main producers Ecopetrol and Pacific Rubiales, while even Venezuela—where the curse of resource nationalism has arguably been the most acute—is trying to adjust in response to stagnant production, lower prices and the country’s economic turmoil. Argentina, which nationalized YPF in 2012 from Spain’s Repsol, is tapping its vast shale resources in the Vaca Muerta formation with foreign investors such U.S. Chevron, as it needs roughly $200 billion for the play to reach its potential

Mexico’s importance for U.S.

The success for Mexico has broad implications for the U.S. oil market. Mexico currently exports some 0.8 mbd to the U.S., making it the U.S.’ fourth largest supplier. In fact, crude imported from Mexico is critical for Gulf Coast refiners as they are geared toward taking in heavy grades from Mexico that typically trade at a wide discount to WTI, helping boost downstream margins.

With the growth in domestic production combined with exports from Canada (3.8 mbd) and Mexico, the U.S. now gets some 85 percent of its crude from sources in North America. If Mexico can boost its own resources, U.S. dependence on suppliers from overseas would likely lessen some more, making U.S. consumers—even more slightly—less vulnerable to supply volatility.

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