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Mexico oil auctions stumble out of the block

Mexico’s oil reformers were poised in July to celebrate a successful outcome. But the first licensing round open to foreign investors since the 1930s drew a virtual blank

Just two of 14 blocks were awarded in the 15 July auction and most of the industry’s big names remained on the sidelines. 

The setback has prompted a round of soul searching for Mexico’s oil policymakers. “What went wrong?” the head of the National Hydrocarbons Commission (CNH), Juan Carlos Zepeda asked in the hours after the first bidding. “We will have to reflect on this.” Since, the government has talked hopefully of “lessons learned”. 

Significantly, the much-anticipated deep-water bid round, the crown jewel of Mexico’s oil opening, has been delayed. The round is now scheduled to kick off in late September, with blocks being awarded in February, though many say that timeline could again be pushed back. 

Regulators have also started responding to some of the complaints from the first phase of bidding ahead of the next auction on 30 September. The $6bn financial guarantee required in the first round was seen by many smaller companies as prohibitively large. Now, companies will be able to post guarantees that are 18 times the minimum investment requirements. That should make it easier to bid on the smaller fields. Companies had been prohibited from bidding as part of multiple consortia in the first round of bidding. Those rules have been loosened in the upcoming round to allow for companies to bid on their own and as part of different consortia. 

The measures, while a positive step and a sign of flexibility among regulators, should be the start of larger changes to come. When the oil reforms were launched, oil was at $100/barrel and the industry was banging on Mexico’s door, eager to throw investment at Mexico’s huge untapped oilfields.

Oil price impact

The oil downturn has fundamentally changed this dynamic. Austerity has gripped the boardrooms of small and large oil companies and new exploration ventures are a difficult sell to shareholders. With oil at $50/b, Mexico must now compete with countries such as Colombia and Brazil to attract investors. 

Mexico’s regulators failed to acknowledge this until the first phase of bidding, points out a partner at law firm Baker Botts, Carlos Solé. “There was a clear disconnect between the Mexican government’s view of the market and how the market responded,” said Solé. “They have to recognise that they are in a buyer’s market.”

That could make the domestic politics of the oil reforms much more difficult for president Enrique Pena Nieto’s administration. Opponents of the oil opening are already accusing the oil reformers of selling Mexico out by auctioning off oilfields for the profit of foreign companies. Regulators will now have to find a way to continue to fend off that criticism while making the terms of the contracts on offer attractive enough to pull in private investment even at today’s low oil prices.  

But it’s clear half measures won’t do. Just two of 14 blocks were awarded in the first phase of bidding, and they were both awarded to the same consortium: homegrown startup Sierra Oil & Gas, an independent explorer backed by the private equity firm Riverstone; operator Talos Energy, a Gulf of Mexico focused explorer also backed by Riverstone; and UK producer Premier Oil. The consortium won Block 2, where it edged out Hunt Oil, and Block 7, the only hotly contested area, which also attracted bids from Norwegian Statoil and Italian Eni.

Global majors Chevron, ExxonMobil and others chose to sit out the round after pre-qualifying to bid. So too did international independents Pacific Rubiales, Hess, Cnooc-owned Nexen and Marathon, which were the most likely companies to be interested in the smaller shallow-water fields on offer in the first phase of bidding. In the end, nine companies took part. Half the blocks received no bids at all. The two winning bids fell well short of the government’s own threshold for success of awarding between 30% and 50% of the blocks on offer. 

Opaque terms

There are a number of areas where the first round fell short. The finance ministry set the minimum bid terms for each block but it only announced them after the bids were in. This process revealed the gap between the market’s perception of the value of Mexico’s oilfields and the government’s own perception. Bids on four of the blocks had to be dismissed because they fell short of the minimum government take requirements. 

A joint venture between Murphy Oil and Petronas saw its two bids fall just short of the minimum and India’s Oil & Natural Gas Corporation (ONGC) also had two bids fall short.

To bring in the foreign investment that Mexico’s oil sector badly needs, industry executives argue the government must let the market decide the oilfields’ value, and drop the minimum bids. This would be in keeping with the spirit of the reforming process: the market, rather than state control, is the key to turning around the ailing oil sector. But giving up that much control to the market may still be a step too far given the lingering public doubt over foreign investment. 

Other avenues could be explored, though. Solé argues that better communication between the industry and regulators ahead of the bidding could help bridge the perception gap and the finance ministry could either release the minimum bid expectation ahead of submissions or at least putting out a range of expectations.

IHS vice president Carlos Pascual says the government might have set minimum bid requirements too high because they were using state oil company Pemex’s historic production costs, which foreign investors might consider too low. 

Regulators should also include a mechanism to review or accept bids that fall just short of the minimum bid. If the regulator in charge of the bidding could have accepted the lower bids, the results of the round would have been far different. Six of the 14 blocks could have been awarded, which would have fallen within the range of expectations the government had set for a ‘successful’ round. Instead, the Mexican government has been left lamenting a missed opportunity.

Mexico’s reformers have two consolations: the solutions to all these issues are straightforward and the process is still in the very early stages. And for the industry, there is hope that the reformers have every interest in making the reforms work. 

The first phase of bidding, although a disappointment, provides a base to build from. The process will now turn to the 30 September shallow-water auction. But the centerpiece remains the deep-water acreage to be put up for bidding in the next few months. Getting the process right by then will be crucial to turning around Mexico’s struggling oil industry.

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