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Life with Amlo

Mexico's upstream has boomed in recent years, and a bullish new president wants to drive growth

Mexico's presidential election this July saw leftist candidate Andrés Manuel López Obrador, popularly known as Amlo, sweep to victory. While long expected, his decisive winning margin has given the oil industry pause as it digests the implications for Mexico's five-year-old Energy Reform program. That market-friendly program is widely judged to have been a success from upstream to retail. The industry is now waiting to see whether Amlo will put on the brakes or let it take its course as his vow to raise oil output by 600,000 barrels a day within two years suggest he might.

Analysts and oil industry officials believe that the months until the new president's inauguration on 1 December will clarify his intentions. In August, he laid out intentions to dedicate $9.4bn in new investment to Mexico's energy sector, including downstream projects. That would be a major boon to an industry brimming with potential.

Since the Energy Reform's launch in 2013, prospects for Mexico's upstream industry have been transformed. Through a series of nine licensing rounds, oil exploration and production—once a monopoly of state oil company Pemex—has boomed. Since the first onshore and shallow-water Gulf of Mexico blocks went to auction in 2015, the country has awarded over 80 blocks to 70 companies. Estimated spending should projects reach commercial production is over $100bn.

But since peaking in 2004 at just over 3.8m b/d, Mexican oil output has declined steadily, to average just under 1.9m b/d this year, according to Pemex. Discoveries made since the first Energy Reform Licensing Round appear to promise to reverse this trend, if perhaps not as quickly as the president-elect wishes. These include Talos Energy's Zama-1 discovery estimated to contain over 1bn barrels of recoverable oil, and Eni's Campeche Bay discoveries, which the Italian multinational believes hold 2.1bn barrels of oil in place "in world class reservoirs".

Eni has implemented fast-track development processes and expects output from its find to reach 90,000 b/d by 2021. Pemex has had its own post-Energy Reform success in a joint agreement with BHP Billiton to develop the deep-water Trion field, discovered in 2012, with an estimated 485m barrels of proved and probable reserves, with first oil expected by 2025. Additional finds are expected from this year's deep-water auction—Shell bid aggressively to win nine blocks.

Transparency required

Analysts wonder whether oil exploration companies' enthusiasm for Mexico will endure following the results of Amlo's promised review of contracts awarded to date. Reportedly he plans to ensure they are free of any corruption. They point out that large sections of Brazil's prolific offshore pre-salt acreage have also come to market. Mexico "is less of a known quantity regarding the terms and how good the reservoirs are going to be", says one upstream analyst. Press reports suggest the pace of offerings may slow—the next deep offshore auction has already been postponed until February 2019—but that Pemex will likely continue to offer what one analyst terms "Discovered Resource Opportunities" in joint ventures similar to its Trion agreement with BHP Billiton. The consensus appears to be that upstream the Energy Reform process may slow, but won't stop.

Downstream difficulties

While the upstream sector ponders its future under the new administration, the president-elect has also given the downstream much to think about. Downstream reforms administered by the regulatory trio of the Energy Ministry (Sener), the National Hydrocarbons Commission (CNH), and the Energy Regulatory Commission (CRE) have aimed at liberalising oil product retail prices and encouraging third-party access to existing oil and gas logistical structures, although the ailing oil refining industry hasn't been directly addressed.

The country's six refineries' nameplate capacity of approximately 1.5m b/d doesn't match Mexico's 1.9m b/d of oil consumption and capacity utilisation has been falling steadily since 2013, to its current 50%. That balance suggests Mexico is importing nearly 1.2m b/d of oil products, many of which originate in the US. Amlo is promising a new grassroots refinery in his home state of Tabasco, which many see as an expensive makework project for his electoral base.

The country's existing refineries also need comprehensive technical upgrades. Pemex figures show that refinery system fuel oil yield is currently over 30%, compared with a fuel oil yield of less than 4% for the US refinery system, according to US Energy Information Administration. Amlo has promised to have all of Mexico's refineries operating at full capacity within two years and to build his projected new refinery within three years. But such ambitions are difficult to square with the economics, actual development times for a new plant, and with labour opposition to inevitable new working requirements, oil industry officials say. Earlier discussion of involving private-sector investors in the refining sector seems to have been shelved.

Downstream logistics is another sector needing rapid development as oil demand grows and new entrants begin to enter the retail market. Mexico's existing downstream oil terminals reportedly run on less than a week's forward consumption capacity, while the fragmented pipeline system is operating near full capacity. New entrants into the market, which was fully liberalised at the retail price level this January, are building additional storage capacity in order to support their activities. Such storage is often contracted to independent Mexican retail distributors, in a model often developed by oil trading companies in emerging markets.

At the sharp end of the retail sector, major international companies including ExxonMobil, BP, and Spain's Repsol are all actively building retail networks. Mexico is seen as ripe for retail expansion. As the Energy Reform was launched, the national retail network—entirely owned or franchised by Pemex—totalled only 12,000 stations, roughly as many as far smaller and less populous Spain. Many in the market expect initial throughput to be high as new stations take up growing demand, and new brands entice customers from legacy Pemex distributors.

In the natural gas sector, where Mexico's electricity commission, the CFE, has promoted gas-fired power generation, domestic gas production of about 41bn cubic metres annually meets less than half of domestic demand of about 88bn cubic metres a year. This makes Mexico a large and growing customer of US gas, both by pipeline and via liquefied natural gas imports. Mexican imports of US gas have more than quintupled since 2010, to about 45bn cm/y, according to the EIA.

Amlo has said he will aim to improve electricity generation in Mexico in part by growing hydropower facilities. Electricity industry officials think recent enthusiasm for renewable power generation in Mexico has nearly reached its price limits for both wind and solar photovoltaic generation. Some successful developers have already taken profit on their investment. InterGen Services sold its 2.2-gigawatt Mexican gas and wind generation portfolio to private equity firm Actis Capital in December.

Reversal of fortunes: Eni and Talos Energy have made big discoveries in the Gulf of Mexico Source: Petroleum Economist
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