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Growing pains ahead for Mexico's reforms

Regulators have won high praise from the industry for progress to date, but the oil opening is still in its early days and fresh obstacles lie ahead

After a rocky start, Mexico's oil reforms have gathered pace, with a series of successful bid rounds capped off by a major shallow-water discovery this summer by Houston-based Talos Energy.

The find vindicated much of what the reformers had argued all along. Talos and its partners not only brought fresh capital into Mexico, it also brought fresh ideas. Armed with the same geological data Pemex has been sitting on for years, Talos looked afresh at the area off Tabasco State and spotted the Zama prospect, which initial drilling has shown could hold as much as 2bn barrels of crude, one of the industry's largest finds this decade.

But the discovery comes with a hitch—one that points to the next wave of challenges which will face Mexico's energy reformers as they have to fill out the rulebook that will govern the transformed oil industry. The Zama field spans Talos-operated Block 7 and a neighbouring license held by Pemex. That means the field will require a so-called unitisation agreement between the license holders, which will allow both to share in the spoils of the discovery.

However, while this is standard practice in much of the oil world, it is uncharted territory for Mexico's regulators. International investors will be watching closely to see how the Energy Ministry and the National Hydrocarbons Commission, the chief regulator, deal with establishing a new rule which will determine how big a slice of the find Pemex gets.

Suspicions are already up that Pemex's home-field advantage remains stronger than the government cares to admit, and serving the state oil company's interests could come at the expense of international investors. In late August, the Energy Ministry gave cash-strapped Pemex a two-year extension at more than 100 blocks where the company had failed to meet minimum investment requirements, including at the license sitting atop part of the Zama discovery.

Time, too, is of the essence. Talos and its partners, Premier Oil from Britain and homegrown Sierra Oil & Gas, want to press ahead with an appraisal drilling programme in 2018, with an eye on starting production by 2020. But the companies aren't going to funnel cash into the project until they have a clearer understanding of the unitisation terms. At a Petroleum Economist-hosted conference in Mexico City in early October, Claudio de la Cerda, the head of exploration and production at the Energy Ministry, said a ruling would come before the end of the year and likely "within weeks". Loren Long, the head of Talos' Mexican business, said he was confident a fair agreement would be reached, and that he had been impressed with the regulators' capacity to respond to industry concerns in the past. The rest of the industry will be watching the Energy Ministry's decision closely, not just for clues on Pemex's clout but also how any future unitisation would work for them.

It won't be the only fresh difficulty that arises for regulators. As companies move past the auction process into more intensive exploration operations, and eventually production, issues that are commonplace elsewhere in the world will need to be ironed out in Mexico's regulatory framework. For instance, it is routine for small companies to move early into frontier areas like Mexico, strike a big discovery, and then sell out of the field to a larger, better financed, operator before production starts. That, however, is not a situation that has come up in Mexico yet, and there remains a great deal of uncertainty over how that process would be managed under the country's new oil rules.

Adding to the uncertainty is that no one knows who will be overseeing the writing of these new rules following next year's election. If a broadly pro-investor administration succeeds President Enrique Peña Nieto, who spearheaded the reforms, then investor minds will be eased. However, if an opponent of the reform like leftist candidate Andrés Manuel López Obrador, who has led in early polls, takes office these sorts of decisions could provide an avenue for the new government to administratively undermine the reforms by making the terms unattractive or just gumming up the works.

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