Mexico's reformation leader
In October, Petroleum Economist met with Mexico's Secretary of Energy, Pedro Joaquín Coldwell, during our strategy forum in Mexico City. In the following weeks, we carried out an interview over email with the minister. The questions and answers follow
PE: Mexico's Energy Reform is one of the most important legislative changes in the global energy sector in decades. Are you satisfied with its progress?
PJC: Very satisfied. Mexico undertook the deepest and most comprehensive Energy Reform in the last 80 years, in a context of volatility in international energy markets and in which technological changes have radically transformed the industry at the global level. Mexico is performing a true energy revolution . The relevance of this transformation lies in the fact that practically all activities in the hydrocarbon and electricity value chain - except for nuclear energy - were opened to private investment.
President Enrique Peña Nieto promoted a new legal framework that places Mexico in a modern and competitive order, along with what was happening in other parts of the world. A little more than two years after its approval, Mexico has a new institutional arrangement and a robust regulatory framework in full operation.
In this new paradigm, private and public companies coexist in a diversified industrial system open to investment all along the hydrocarbons and electric-power value chains. The Mexican Constitution and its legislation established a system of checks and balances for decision-making, which provide certainty to investors under the highest standards of transparency and sustainability.
In the next upstream rounds, what is the desired profile of the companies that will invest in Mexico?
The Mexican tenders have been designed to attract a diversified portfolio of companies, from the largest and most globalised, to smaller and specialised ones that can start strengthening their operations in the country.
We completed four tenders on Round One. The first three included areas in shallow waters and onshore mature fields. As a result, 38 new participating companies from eight countries entered the market, with different features and sizes, and where they complement and coexist with Pemex. Twenty-six of these new companies are Mexican.
The fourth tender of Round One concluded on 5 December, and it successfully awarded eight out of 10 areas in deep and ultra-deep waters from the Gulf of Mexico , within the Perdido Fold Belt and the Salina basin. Each block has an average surface of 2,384 square kms, and a depth ranging from 500 to 3,600 meters.
Alongside this tender, the first strategic alliance in Pemex's history was performed by the Trion farm-out, where its partner for this deep-water field in the Gulf of Mexico was selected. Our national oil company will be associated with BHP Billiton, one of the most important international companies for exploration and extraction of oil, and with an investment estimated at more than $7bn.
Sixteen companies participated, grouped in 10 bidders, and as a result of the process, eight contracts were awarded to six bidders (12 companies). Attracting new companies of great capacities and international prestige strengthen and make a more competitive hydrocarbons sector for the country.
Among the winning companies you can find world major oil companies such as BP, Total, ExxonMobil, Statoil, Chevron, China Offshore Oil Corporation [part of Cnooc], and Petronas, and of course Pemex, our national oil company. Also Inpex and Ophir were winning companies as financial associates in consortia with some of the abovementioned oil companies.
As you can see, there was a diverse group of North American, European and Asian participants, and nearly $41bn dollars of investment are expected throughout the life of the contracts.
In addition, for the three Round Two tenders recently announced and currently underway, we are seeking to allocate 15 shallow-water production-sharing contracts, as well as 26 license agreements for onshore areas. A diverse profile and size of the companies is expected to participate, considering the features of each block.
What would be a realistic production goal for Mexico's upstream? In the midstream, what is the target for infrastructure and pipeline capacity? For the downstream, what is the target for refining capacity?
The previous regulatory framework limited Pemex's ability to associate with other companies, as only our national oil company could perform exploration and extraction activities for hydrocarbons. With financial and technological limitations, Pemex focused its work on fields with less technical and operational complexity, and which declined over time. These factors brought a downward trend in domestic hydrocarbon production.
The Energy Reform opened the oil and gas industry up to private investment, attracting companies with technical, financial and execution capacity to extract hydrocarbons in deep waters or non-conventional fields, where 76% of our resources are located. With the 30 contracts signed so far, we expect to obtain a maximum production of 191,000 barrels of oil equivalent a day.
Once the four ongoing bids are completed more will be added to the following figures:
• The fourth tender of Round One includes deep-water fields with prospective resources of 10.89bn boe. The Trion block has reserves for 485m boe. Of the first eight fields awarded within the next nine to 10 years, adding what Trion may produce in the next six years, we estimate an approximate additional production of 0.9m b/d compared with current output.
• The three ongoing tenders from Round Two include prospective resources for 1.59bn boe for the first tender in shallow waters, 0.64m boe for the second tender for onshore areas and 251m boe for the third, also for onshore areas.
In the case of oil products, the lack of investments led, for example, to insufficient transportation and storage infrastructure. With the opening of oil-products import permits, the liberalisation of the gasoline and diesel retail market is underway. This will send a signal to the private sector to invest in pipelines and storage terminals, increasing our energy security.
Several companies have shown interest in building new infrastructure. The first open-season for the development of the first privately owned pipeline, which will transport gasoline from Corpus Christi, Texas to the metropolitan area of Monterrey, Nuevo León, has already been carried out. Some companies are looking to bring fuels through the pipeline, from ports in the Gulf of Mexico to the centre of the country, while others are considering importing fuel by rail.
Mexico's six refineries face several challenges. The first is to finish the reconfiguration process for heavy-crude processing in three of them, since they were configured for light-crude processing and our current production is predominantly of heavy oils. The second challenge is to improve their efficiency and the urgency to reduce operating losses by welcoming private-sector partners. The reforms have opened up this opportunity to become partners of Pemex.
How much investment is needed in Mexico's energy sector to meet your needs and in what time frame? How much of this will come from the private sector?
One of the objectives of undertaking a reform of the energy sector was to attract capital and state-of-the-art technology to access resources that we were not able to develop. According to the Special Report on Mexico in the International Energy Agency's World Energy Outlook 2016 , potential investments, under a scenario of full instrumentation of all its projects until now, is estimated between 2015 and 2040 to be around $240bn in electricity; $0.64 trillion in hydrocarbon exploration and production, and $130bn in energy efficiency, coming mainly from the private sector.
What is the government's final vision for Pemex? Is there any model among national oil companies elsewhere that points to the kind of company it will be, or the role it will play?
Pemex was transformed and strengthened with the reform in order to compete on equal terms with other companies in the private sector. It now has more effective corporate governance, and recently issued its new 2017-21 business plan. Within it, they will prioritise partnerships and alliances with private companies along the value chain, as a transversal strategy that sets the basis for a modernised, competitive and strong Pemex, within the framework of the Energy Reform.
The Mexican government has supported the company, through the Ministry of Finance and Public Credit, with resources that have allowed Pemex to receive capital to pay almost 100% of its debts to suppliers; tax deductions have been authorised for a greater percentage of the investments made in its assigned fields, reducing its need for external financing; and the government has given support for Pemex's pension liabilities within the framework of the renegotiation of its collective labour contract.
Do you think there will be further deregulation or privatisation in Mexico, in addition to that already announced? Could Cenegas be privatised?
It is important to highlight the Reform was very careful to protect the nation's original ownership of subsoil hydrocarbons. The announced opening allows private participation, always under state stewardship. The Energy Reform created Cenegas as a public body to administrate, as an independent system operator, the natural gas pipeline network.
Our challenge for next year is to create a base for the establishment of a natural gas market in Mexico, according to a system of prices determined according to the supply and demand of each region. A first step has been that Pemex transferred almost 9,000 kms of gas pipelines to Cenegas and, last October, began the first open-season to reserve capacity in these pipelines. In this process, both Pemex and CFE [the state utility] will have 40% of the transport capacity, for its industrial transformation and power-generation processes, respectively.
The remaining percentage will be distributed among the applicants, respecting the previously signed transport contracts, as well as its acquired rights. The rest will be openly offered to all marketers and end-users in transparent and competitive bidding.
At our Mexico conference, several investors expressed reservations about the licensing process and re also concerned that Pemex remains too dominant. Are these criticisms justified? If so, how will the government act in this regard?
The Energy Reform has been implemented in record time, compared with other countries that have made similar reforms and shifted from a state-owned-company model to one encouraging competitive energy markets. The development of these markets in Mexico is an unprecedented event, for which we did not have reference or previous experience.
Having begun the implementation phase of the Energy Reform, it is normal that new challenges are emerging, and that adjustments must be made along the way, both to encourage greater competition and incentivise investment. These markets are at a maturing stage and are attracting a greater number of participants in order to increase competition.
For oil and gas exploration and extraction tenders, we have been making adjustments to bidding rules, contract models, block sizes, and national-content percentages. This is to make the process more competitive.
The Hydrocarbons Law helps to lessen Pemex' dominance by establishing the existence of an asymmetric regulation from CRE [the energy regulator] until an effective level of competition is reached. This allows the regulator to establish rules that facilitate the entry of new players to the market. For example, the obligation to yield 70% of natural gas contracts, and the inclusion of no-penalty exit clauses in retail contracts for petroleum products.
The entry of new competitors into natural gas and oil-products markets will materialise with the ongoing open-season processes being performed by Cenegas on one side, and the ones CRE is about to approve for oil products, on the other.
Has the weaker oil price been an obstacle to efforts to attract investors, especially in the upstream?
While oil price volatility has been a major factor in defining the strategy for our upstream auction rounds, on average export prices for Mexican oil benchmark blends have remained at around $35 dollars a barrel, while the average cost of extraction in national territory is nearly $16/b, which remains attractive to investors.
Investor appetite has also been verified through the results of our bidding rounds. In our fourth bidding in Round One, eight contracts were awarded for exploration and extraction of hydrocarbons in deep-water fields in the Gulf of Mexico. The State will be receiving, on average, between 59.8% and 66.1% of the income from the eight contracts awarded.
As mentioned, up to now there have been 47 companies that have won the completed tenders, and who are already operating in Mexico, while more than 60 companies have shown interest in the biddings that are in process. Also, for the next rounds that we concluded in December of 2016, and to be awarded in 2017, we have seen interest from the world's leading oil companies to participate in these processes.
There continues to be some popular opposition to liberalisation in Mexico. How does the government plan to win public support? Will prices rise for residential consumers and industrial consumers in the coming years?
One of the main challenges that the Mexican government has with the implementation of this Reform is to ensure that positive impacts are reflected in benefits for final consumers and the general population.
The Reform was about a paradigm shift, where its implementation will take some time, and its results will be seen in the medium and long term, both by the nature of investments in industry, and by the gradual opening of energy markets.
This requires a process of assimilation for the public, because this could lead to fluctuations in energy prices, which will now be determined by supply and demand. However, we must be very creative in our communication strategies, such as social media, so that we convey the rationale of economic competitiveness for the energy sector throughout the entire production chain.
How would you characterise opportunities for Mexico's deep-water investors?
The so-called "Crown Jewel", as the press has named it in our country, comprised 10 areas located in deep and ultra-deep waters of the Gulf of Mexico. This is within the areas known as the Perdido Fold Belt and the Salina basin, for which eight contract areas were awarded, plus the Trion field farm-out, where BHP Billiton won as Pemex's new partner.
From the outset, this tender generated the highest expectations, as it involves working to great flow depths. This represents a large-scale challenge and requires considerable financial, technical and operational resources that only some of the major oil companies on the planet can develop successfully.
Currently, there is volatility in the oil market, which is why the Ministry of Energy considers the awarding of more than 80% of the offered blocks an outmost success. This is the start of an era in Mexican oil industry where we will pioneer our deep waters with a diverse range of the world's major oil companies, including our own Pemex.
What is the potential for shale gas in Mexico? When will the auction of shale assets take place and what is the objective?
From the shale basin that enters our country along our northern border with Texas and continues into the Gulf of Mexico, Mexico has great potential for production of unconventional oil and gas. The Mexican Government is working to create the conditions to launch a call-to-bid for these types of hydrocarbons, such as a special regulatory framework under the highest standards of safety and protection of the environment.
Do you think Mexico's natural gas pipelines will be fully interconnected over time? What role will liquefied natural gas play?
During President Peña's government, construction of more than 10,000km of new gas pipelines has got underway. Just four years after this expansion began, we have a 78% progress on the kilometres planned for 2019. With this expansion we will have enough capacity to make our national natural gas pipeline network redundant. Natural gas supply is key for the development of competitiveness in Mexico, and one of the most important priorities for this government is to expand our gas pipeline infrastructure to encourage new industries and reconvert electric plants to replace fuel-oil and diesel for electricity generation.
During the first nine months of 2016, Mexico imported an average of 493m cubic feet a day of LNG, both for the CFE and industry consumption. This amount represents 6% of total domestic demand. In fact, with the start-up of the Ramones gas pipeline from our northern border to the centre of the country, the National Gas Pipeline System has practically stopped using LNG to balance the system.
What is your general view of oil prices? At the end of the 1990s, Mexico cooperated with Opec to restrict production, and was part of the discussions in Vienna with Opec and Russia in November 2014. Will Mexico ever again participate in supply-side management alongside Opec?
High international oil prices, which prevailed for some time, encouraged technological development and made profitable new unconventional and deep-water resources, rapidly changing the production landscape in North America.
Despite this, the diversification of the Mexican economy and the Energy Reform itself provides us with the right tools to develop our oil industry in the long-term and face the need for growth in our energy sector, according with the projected increase in demand for crude in the market.
Mexico, as a major non-Opec producer, has always been open to dialogue and exchange of information with Opec and non-Opec countries. This is because our main interest is that there are stable markets for the benefit of producers and consumers. Our priority is to have a continuous and guaranteed flow of investment for the oil industry and to strengthen global energy security.
You were praised at our conference in October for fully defending the Reform. How do you personally see your role in this process? And, personally, what do you think will constitute the success of the reform process?
I have had the honour, as Secretary of Energy, to participate in the very ambitious Energy Reform of President Enrique Peña Nieto - we came to transform the sector and it has been the most fascinating and challenging position I have had in my career.
From its legislative design and through every step of its implementation, day by day the Energy Reform demands a lot of imagination and creativity. This paradigm change implies leaving behind the old model, where only the state could invest through its two companies, Pemex and CFE. Now we're moving to a new one in a context of high competitiveness and economic complexity, rigorous parameters of transparency and sustainability.
Petroleum Economist's next Mexican energy strategy forum will take place on 5 October 2017 in Mexico City.