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Mexico's oil reforms stumble amid lower prices

The reformers have presented poor options to investors which has made conditions more fragile

It's hard not to feel some sympathy for the architects of Mexico's energy reforms. They spent years designing a much-needed overhaul of the country's oil sector and pushing it through a resistant political system, only to see a global oil price crash threaten the entire project. Faced with this new landscape, however, the reformers haven't been doing themselves any favours. 

With oil prices declining, potential bidders were looking for more favourable terms for the country's first oil auction, which will focus on shallow-water projects, but were caught off guard by a series of restrictive bidding conditions that could diminish interest in the round.  

Bidders, for instance, that produce more than 1.6 million barrels of oil equivalent a day cannot team up to put forward joint bids, which effectively rules out consortia made up of more than one international major. Companies are also not allowed to join multiple consortia for the bidding, a common strategy in licensing rounds. Moreover, companies can only bid on a maximum of five of the auction's 14 blocks. 

Mexican officials have argued that these restrictions will foster more competitive bidding in the first round. When oil prices were $100 a barrel (b), potential bidders would likely have brushed off these restrictions. But with prevailing oil prices already squeezing the economics of even the relatively low-cost shallow-water projects, it is raising concerns. 

The concern is particularly acute among smaller Mexican and international operators, which should worry policymakers. Their participation in the early stages of the oil auctions is crucial to the reform's success because they are seen as the most suited to the smaller shallow-water projects on offer in the first stage of bidding. But they are also being hit hardest by the price decline. 

For instance, Pacific Rubiales, Colombia's largest private producer, has shown a keen interest in Mexico's oil opening and is the sort of entrepreneurial mid-sized company that the country is hoping to woo. But the company is now being forced to cut spending to the bone as it faces an uncertain financial future. If the combination of low oil prices and restrictive bid terms mean companies like Pacific Rubiales shy away from bidding, it could see Mexico's energy reforms stumble out of the gate.

When Mexican reform was launched amid a sustained period of high oil prices, it was a no-brainer for international oil companies. The country holds a lot of potential pitfalls for investors - from the security concerns associated with the country's criminal cartels, which are increasingly targeting the oil industry, to the risks associated with a bloated and often corrupt bureaucracy. But the opening up of the country's huge untapped oil reserves is also a unique opportunity for an industry that is often locked out of the most promising oil provinces. 

Mexico


However, now that oil prices are roughly half their year-ago level, the calculus isn't so straightforward. Some of the smaller, lower risk shallow-water and mature onshore projects on offer may still be profitable with oil prices around $50/b, but the deep-water and unconventional fields that the industry was so excited about look far less appealing than they did a few months ago.

Mexican officials have pledged to push ahead with the first stage of bidding as scheduled, despite the price decline.

Round 1 will see a total of 169 blocks covering shallow water, deep water, as well as onshore conventional and unconventional fields auctioned off over the course of this year. But the bidding is being broken up into a number of different stages that will cover different sorts of projects. 

The first stage, launched in December with winners expected to be announced in July, includes 14 production sharing agreements for relatively low-risk, well-explored shallow water licences in the Gulf of Mexico. These projects lack the huge reserve potential of deep water and shale projects, but they will be lower cost.

Although seen as more appealing for smaller international and Mexican players, majors ExxonMobil, Shell and Chevron as well as BG Group and Colombia's Ecopetrol are among the companies that have paid to access the data room for the acreage, regulators said in January. Around 30 companies in total have shown an interest in the round. Still, the true test will come when companies bid for the acreage later this year.

Beyond the first stage of bidding, questions surround the viability of the country's planned deep-water and shale auctions. Regulators have already said that bidding for some of the unconventional licences have been put on hold. And unless oil prices bounce back in the coming months, they may be forced to do the same for deep-water projects.

"The Mexican oil reform has been put on a standstill," analysts at Bank of America Merrill Lynch wrote in a recent note. "Mexico could end up being a big medium-term loser out of the global collapse in oil prices."

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