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Reforms open Mexico’s deep waters to outside investment

The country’s oil and gas industry is set to be transformed by outside investment

Mexico's landmark energy reforms promise to open the country’s oil sector to outside players after years of state monopoly control, with the richest opportunities likely to be found in the country’s sector of the deep-water Gulf of Mexico.The US-Mexico maritime border has been a stark dividing line for the oil industry for decades.

In the US sector, a dense web of oil and natural gas pipelines crisscross the waters off the coasts of Texas, Alabama and Louisiana linking thousands of producing wells to refiners and customers onshore. Year after year, drillers go deeper into the Gulf of Mexico’s waters in search of the next big find, producing billions of dollars of investment, technological and engineering breakthroughs, boosting local economies that have come to rely on the industry. 

The line in the sand

All that activity comes to an abrupt stop at the maritime border with Mexico. Not because of geology, but because of policy. For more than 70 years, state-run Pemex has had a monopoly on the country’s oil and natural gas production.

For most of that time the company focused on its abundant and easier to produce onshore fields. Its main activity in the Gulf of Mexico was the shallow-water super-giant Cantarell field, the third largest oilfield ever when it was discovered in 1976. Together, those resources were enough to make Mexico one of the world’s largest oil producers and a major supplier to the US.

For more than 70 years, state-run Pemex has had a monopoly on the country's oil and natural gas production

For years, Cantarell was the industry’s workhorse, at peak, accounting for about two thirds of the country’s total production. But when Cantarell’s output went into free fall, starting in about 2004, Mexico’s industry plunged into crisis.

Production fell from a peak of 2.1 million barrels a day (b/d) to around 400,000 b/d last year. With no other projects able to make up for the lost production, Mexico’s total oil production fell by more than a quarter from nearly 3.5m b/d in 2004 to around 2.5m b/d in early 2014.

Pemex is the single largest contributor to the government budget by far, providing about a third of the government’s income, and the industry has accounted for around 8% of the country’s GDP over the past decade. The oil industry’s pain was felt throughout Mexico. To stem the decline, Mexico has looked across the border to the bounty that the US has discovered in its deep-water play, and sought to replicate the experience in Mexico.

Over the past decade, Pemex has invested more than $5 billion in deep-water exploration. It has carried out 3-D seismic over a 125,000 square km section of the Gulf of Mexico and drilled 25 wells, a little more than half of which have produced discoveries. 

Exploration has been concentrated near the maritime border, an ultra-deep water play proved up by discoveries on the US side of the border. The Trion-1 and Supremus-1 deep-water wells have shown that the Perdido Fold Belt oil discoveries, made in the US sector by supermajors Shell, BP and Chevron, extend into Mexican waters.

Pemex believes the portion of the Perdido area in its waters could hold as much 8bn barrels of oil equivalent. Other discoveries have shown significant natural gas potential in Mexico’s deep waters. It has been clear, though, that the scale of developing the Gulf of Mexico would be far too great for one company, especially one with limited experience. The risks, as shown by BP’s Macondo oil spill, are too great, the costs too high.

The government laid out the problem when it proposed opening the oil sector to outside investors: “It has not been easy for the US to achieve and sustain deep-water production. To achieve this, more than 100 deep-water wells are drilled each year. In 2012 alone, 137 deep-water wells were drilled. This would not have been possible without the participation of more than 70 oil companies. In contrast, Mexico, even though 2012 was a record year in terms of deep-water activity for Pemex, only drilled six wells, with purely exploratory purposes.

Opening Mexico’s deep waters to US levels of investment and activity was a major driver of Mexico’s energy reforms, and that process is now well under way. After passing the necessary constitutional reforms to allow private investment in the oil sector, Mexico’s Congress is working on crucial secondary legislation that will fill in the details of the reform. That legislation, which should to be finished in May, is being hotly debated, but to date lawmakers have come down on the side of more openness rather than less.   

The road to reform

Meanwhile, Pemex has taken its first major post-reform step. In March, it put forward requests to government regulators for the fields it wants to retain to develop itself in a process called Round Zero. The company has not provided details of its Round Zero requests, but it said it asked to keep 82% of the country’s proven and probable reserves and 31% of it prospective resources.

In the deep-water, Pemex has asked to retain some acreage where it has already drilled. “The continuation of development in fields located in the gas basins has been requested because we have already drilled some development wells in those areas. Also the oilfields discovered in the Perdido area were included in our request,” Gustavo Hernández, Pemex’s acting head of exploration and production said during a conference call on the Round Zero process.

Although Pemex has staked a claim to those areas, they may yet be opened to private investors through joint venture agreements. “Pemex requested areas where it can operate or where partners may be involved,” Hernández said. The areas are likely to be opened to outside investors through a farm out process after Pemex has officially been awarded the contracts. How exactly that farm-out process will work, though, will depend on the secondary legislation, said Maria de Lourdes Melgar, undersecretary of hydrocarbons and the Ministry of Energy. Some lawmakers would like to give Pemex the ability to negotiate directly with potential partners, as is common in other parts of the world, but others would prefer an auction process, Melgar said. The acreage not claimed by Pemex will revert to government control and will be auctioned through licensing rounds.

Regulators envision holding annual licensing rounds that include a mix of deep- and shallow-water acreage, as well as onshore heavy oil and unconventional projects. Bid rounds will start from early to mid 2015, Melgar said.  Pemex’s task, Hernández said, is to balance the need to maintain its leading role in the industry and ensure it has enough exploration assets to sustain organic growth, while ensuring there are enough opportunities for outside investors. Pemex, for instance, has not included parts of the Perdido area, which will be coveted by outside investors, on its Round Zero wish list. “We are very aware of the need to leave space open for private investors,” Hernández said.

International oil companies are optimistic at the prospects of gaining access to the Mexican sector of the Gulf of Mexico. Pemex reckons its deep waters hold around 27bn barrels of oil yet to be discovered and produced. For majors with extensive experience in the US, those reserves lay in waters they already know well. Years of drilling in the US Gulf of Mexico mean the industry already has extensive knowledge of the region’s geology and has developed technologies capable of drilling in what can be a tricky environment.

That optimism has been tempered by uncertainty surrounding the details of reform to be established by the secondary legislation being worked on by lawmakers. This legislation will nail down the specifics regarding the types of contracts that will be offered for deep-water (and other) projects and the fiscal regime. Mexico will have to offer terms that are competitive with other opportunities, including in Brazil, Colombia, West Africa and beyond, industry executives say. But if lawmakers are able to strike the right balance, there is little doubt the industry will come calling. 

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