Managing risk key to unlocking Mexico's energy riches
Foreign investors are eager to enter the country's newly liberalised energy sector - but they should be wary of red tape, holes in the supply chain for unconventional extraction and short-term shortages in skilled staff
Mexico's forthcoming licensing round presents private investors with the most attractive upstream opportunity in a generation. But acreage winners will damage returns and destroy value if they fail to address manageable above-ground risks - ensuring they have adequate human resources, a robust supply chain and the ability to navigate Mexico's regulatory and legal environments.
Interest in Mexico is justifiably high. No comparable opportunity for private-sector investment in conventional oil and gas exists elsewhere. The country's conventional oil reserves rank 19th in the world and undiscovered conventional resources may amount to as much as 50 billion barrels of oil equivalent (boe).
The outlook for unconventional oil and gas production is promising too. The International Energy Agency (IEA) estimates Mexico's unconventional resources - split evenly between oil and gas - could amount to as much as 120bn boe, which would make them the sixth largest in the world. Moreover, most of the countries that rank higher than Mexico in reserves and prospective resources restrict private investment.
In addition, private investors are likely to view Mexico's licensing terms as favourable (see box below) and its local-content requirements as relatively modest. They will also be reassured by its track record in developing other industries, including the automotive, pharmaceuticals and aerospace sectors, as well as its legal stability. Mexico's 20-year membership of the North American Free Trade Agreement also makes the country highly attractive to investors, as does its participation in more than 40 free-trade agreements with other countries.
Yet Mexico is not risk free. While promising, the regulatory system for oil and gas development remains to be fully defined. Aspects of the supply chain also need to be made more robust, especially in emerging areas such as unconventional oil and gas.
Meanwhile, all indications are that competition for acreage will be intense. International operators are opening offices in Mexico, signing memoranda of understanding with state-run Pemex and setting up local subsidiaries. Successful bids are likely to be won on tight terms. On top of this, with a variety of financial institutions indicating support for the Mexican opening, capital will be freely available. Companies caught up in the euphoria of the opening - especially firms with little or no experience of the oil sector - risk imperilling their own profits with imprudent or ill-considered investments.
Within a highly competitive environment, awareness of manageable risks and the ability to control them will mark the difference between success and failure. The three biggest above-ground risks are: Securing sufficient numbers of staff with appropriate experience and skills to excel in Mexico's unique and complex upstream environment; understanding and navigating local regulations; and ensuring a robust, reliable supply chain is in place. In the immediate term, the most effective solution to all three problems is to seek out mutually beneficial partnerships with a variety of other companies.
Unlike capital, oil and gas talent in Mexico is not a commodity and will be an important factor in defining success. Over the next decade, as upstream activity in Mexico ramps up, thousands of new petrotechnical professionals (PTPs) - skilled workers such as geoscientists and petroleum engineers - will be needed (see Figure 1). Those workers will be required in a variety of areas of the business: there are at least five generic asset types, all of which have been included in Round 1 (see Table 1). Mexico's diverse range of upstream asset classes provides a broad range of opportunities for operators, but a concomitant range of technical challenges.
The long-term outlook for the supply of PTPs is reasonably healthy because Mexico has an abundance of raw local talent. It is a large country with a mature education system and several related industries that could supply PTPs to the oil sector. With government support, universities and technical schools have a unique opportunity to scale up training of new graduates, and to convert experienced professionals from other industries into oil-industry specialists. Companies too must accelerate training and development programmes, and avoid the harmful, zero-sum game of poaching from each other.
Nonetheless, measures such as these are only likely to start to generate a steady, reliable supply of PTPs in three to five years' time, leaving operators exposed to the risk of skilled staff shortages in the early stages of Mexico's energy sector liberalisation. The government can help mitigate this problem by taking measures to facilitate the influx of foreign PTPs - such as adapting immigration and labour laws.
However, importing talent is likely to prove an incomplete solution. Simply transferring engineers to Mexico from other countries will be ineffective if those engineers do not have a deep understanding of Mexico's unique geology and lack the capabilities required to exploit it.
Shallow-water acreage in the Gulf of Mexico, for example, features naturally fractured carbonate, an unusual reservoir type requiring specialist knowledge and skills that not all companies possess. This skills base is particularly critical in mature fields which require unique improved oil recovery or enhanced oil recovery designs which take into account the complexity of the fractured carbonates.
Forming partnerships may be the quickest and simplest solution to the short-term PTP deficit. Potential partners include oilfield services companies, many of which have been working with Pemex for decades, and have formed a deep understanding of Mexico's upstream sector.
Pemex itself, however, is the most compelling upstream partner and the 11-12 joint-venture projects for operating large fields in partnership with the former state monopoly are surely the pick of the opportunities in Round 1. As the national oil company and the only Mexican firm with operating experience, Pemex has unrivalled in-house knowledge that - initially at least - private investors may lack.
Foreign investors will also benefit significantly from partnerships with local firms when it comes to navigating Mexico's legal and regulatory environment. Indeed, in Mexico's case, geological diversity is reflected by complexity at the surface. Fields are located on- and offshore, and in the conventional and unconventional domains.
Each is unique in terms of access, infrastructure, the local environment, affected communities and the maturity of the supply chain. Many reputable Mexican companies in other industries, such as cement, petrochemicals, mining and steel, have expressed an interest in diversifying into the oil sector. These companies also have a deep understanding and knowledge of local markets, and can provide an invaluable interface with the government, local authorities and communities. In exchange, international companies offer expertise, project-management skills and technology - opening the way to greater productivity and increased recovery factors.
However, the supply chain represents another bottleneck in getting that expertise, equipment and technology to the right places, and assuring continuity and growth for the industry as a whole. With a century-long history of oil production, oilfield services are well established in some parts of the Mexican oil business.
A mixture of local and international players supply drilling and pipeline services, and facilities engineering and construction services to the conventional onshore and shallow-water industry, for example. But, under Round 1, which is expected to see the licensing of numerous small-to-medium-sized fields, the supply chain will become stretched, even in conventional developments. As a result, identifying new suppliers will be vital.
The supply-chain problem is more acute in new unconventional oil and gas ventures, and deep-water projects. To date, Mexico has drilled only a small number of unconventional wells and there is limited capacity to supply core services such as fracturing. A supply chain for unconventional projects must be developed locally and the economics of doing so must be taken into account when planning bids for upstream acreage. Similarly, deep-water exploration and production is an emerging business in Mexico, although much of the supply chain can be imported from the US. Indeed, Mexico's opening presents US players with an opportunity to grow directly or through partnerships.
Security must also be taken into consideration when weighing up opportunities in Mexico. Although the country is not free of security problems, the issue needs to be assessed on a project-by-project basis, as insecurity (or the risk of it) tends to be localised in specific areas. Local and international companies have operated successfully in the country with reasonable security measures - both in oil and gas, and in other industries.
Encouragingly, none of the risks facing potential investors in Mexico's upstream sector is insurmountable. And there are plenty of reasons for optimism. Latin American countries have, in recent years, established an admirable track record in attracting investment both locally and internationally. Despite having relatively limited underground resources, Colombia, for example, doubled national production within a decade of reform, multiplying income for the state.
Its success came from growth by the national oil company and from private companies. Mexico is different, but by sticking to the ambitious timetable it laid out following constitutional reform at the end of last year, the government has demonstrated its commitment to responsible, sustainable evolution of the energy sector.
Mexico's decision to establish a licensing regime that is amenable to private capital indicates a firm desire to attract the world's leading oil companies to its patch. And, with careful planning, companies can avoid easily identifiable pitfalls and capitalise on what may be the last great licensing opportunity - creating a thriving upstream industry in which both the state and private investors are winners.
Further clarity is vital
Mexico's new regulatory framework appears attractive, but the government and regulator must reassure investors on lingering areas of uncertainty.Designed on the basis of best practices from countries with successful regulatory regimes, the reforms create a strong independent regulator for resource management. The aim appears to have been to create terms and conditions that are familiar and attractive to the industry - and create conditions conducive to high profitability.
However, some aspects of the mechanics of Round 1 have not been fully defined, such as how data on blocks will be made available and how assets will be transferred to winning bidders.The most important elements of the new model are:
- The state plays the true role of resource administrator. The energy ministry defines upstream policy and strategy for the bid rounds. The National Hydrocarbon Commission manages technical information and executes the rounds and contracting phases. Pemex becomes one operator among many, albeit a large one;
- Three new types of contracts - profit oil, production-sharing, and licences - will be used in addition to existing service contracts, which will continue to operate. Winning contracts will be those that offer the most favourable terms to the state in open, competitive bids, following technical pre-qualification. As a result, the state take will be market driven, although royalties on oil production will be capped 12.5%;
- Local content requirements, capped at 35% in the long term, seem reasonable. Production in Mexico has not dropped below 2.5 million barrels a day in the past three decades, indicating the country has the nucleus of a robust local supply chain and talent pool; and But uncertainties persist. There is a degree of doubt over the quality of the technical information that will be made available in Round 1. To conform with international standards, access must be timely, and data must be transparent and of clear value to bidders. To reassure investors that the process will be managed effectively, the regulator must demonstrate that it will provide open access to data to all players and explain its protocols for information transfer. It must also define rules and procedures for the transfer of assets from the state to winning bidders. This includes establishing production accounting and cost accountancy rules. Transparency in these areas is vital as they dictate profitability both for the state and the investor.
Achieving a task of this complexity will be no small feat, as Round 1 is to include 169 blocks of different types. However, encouragingly, the authorities have - so far - met the principal milestones of the opening process within weeks of their original target or even earlier, in what has generally been considered an ambitious timeline for implementation. Complying with the timeline sends positive messages to the industry in terms of commitment, political efficiency and collaboration.
Following constitutional reform in December 2013, Round Zero results were announced in August, clearly defining the role of Pemex and the scope of Round 1, which will be held in 2015. In September, the Congress approved the secondary laws.
Dr Raul Camba, Mexico office manager, SBC. SBC is the business consulting arm of Schlumberger