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Mexico's reforms start to bear fruit

Mexico's energy overhaul is notching up successes after a slow start

Mexico's first international oil auction in July 2015, a landmark moment in the country's energy reforms, was widely panned as a failure. Just two of the 14 blocks put up for bidding garnered winning bids. The world's major international oil companies (IOCs), whose know-how and cash Mexico was desperately seeking, largely gave the round a pass. Even the most ardent reform supporters had to admit it was an inauspicious start.

The critics were too hasty. Two years on, their dim judgement needs revising. The first exploration well to come out of that round was completed in July and it was a blockbuster. Talos Energy, a private-equity backed Gulf of Mexico explorer, said its Zama-1 well, drilled in the Sureste Basin's shallow waters about 60km off the coast of Tabasco state, hit between 1.4bn and 2bn barrels of light oil in place, likely making it one of the five largest discoveries in the world over the past five years. For Mexico's oil reformers, the news that the first exploration well drilled by a foreign firm in eighty years was such a success was sweet vindication.

After an unsteady start, the early exploration triumph and a string of recent successful licensing rounds have provided fresh momentum to Mexico's oil opening.

Talos, and its partners Premier Oil and Sierra Oil and Gas, are still in the early stages of exploration, but the Zama prospect looks very promising for the companies and Mexico. Appraisal work won't start until next year, but commercial development looks all but certain. Premier, in a presentation following the find, said it envisions a fixed offshore platform pumping more than 100,000 barrels a day from the field to an onshore processing facility at the nearby port of Dos Bocas, in Tabasco state, within five years. That is equivalent to roughly 5% of Mexico's current output and would generate billions of dollars in investment.

The find puts Mexico's shallow waters in the spotlight. It was widely assumed that the biggest discoveries would be made in the nation's deep waters. But the Zama find indicates that Pemex missed some giant near-shore opportunities during its long exploration monopoly. Billion-barrel shallow-water opportunities will be particularly prized in today's austere environment. The Zama-1 well cost $61.5m, a relative bargain considering the price tag for deep-water wells in Mexico will likely top $100m. A fixed platform development with pipelines going to shore will also be far cheaper and quicker than developing a similar-sized discovery further offshore, which would require technically complex and costly subsea systems.

Pemex owns the rights to three other neighbouring areas, which it retained through the so-called Round 0 process in 2014, when the company was allowed to choose blocks from its existing portfolio it wished to keep. Last year, the cash-strapped national oil company won a judgement from regulators to reduce the minimum work requirement on two of the blocks, but is still required to carry out significant 3-D surveying on the blocks and to drill one well on each of them this year. If it can't meet those commitments, the company could be forced by regulators to give up the blocks or to put up a share of the licences to be farmed out. That decision may have been reached as Petroleum Economist went to press, and the fate of the potentially lucrative blocks will be closely watched.

Licensing ramp-up

The exploration success should help Mexico continue its run of successful licensing rounds. Last December's deep-water round largely lived up to the hype, with international supermajors showing up in force. ExxonMobil, BP, Total, Chevron, Statoil and China's Cnooc were among the winners pledging hundreds of millions of dollars in exploration spending, which the government hopes will lead to billions of dollars of investment in new production. That was followed by June's round, which exceeded expectations in seeing 10 of 15 blocks awarded. Eni was the auction's big winner, snapping up three blocks and accelerating its push into Mexico's shallow waters, while Repsol, Lukoil, Petronas and Germany's DEA also won new acreage. Even July's lower-profile auction of onshore gas-rich acreage saw seven of 10 blocks snapped up.

In total, 54 new upstream companies of all sizes from around the world have entered Mexico's oil patch through the licensing rounds, a remarkable change in the landscape just three years after the auctions started.

International companies will get their next crack at Mexico's deep waters in January 2018. The second deep-water round will put 30 licenses up for bidding, three times as many as the first round. The most hotly contested area will be the Perdido Basin, which spans the US-Mexico maritime border. In the first deep-water auction, Cnooc won two blocks in the basin, while consortia led by Total and Chevron won two more. The Perdido Basin's geology is better understood because of the drilling activity on the US side of the border, and any discoveries could be developed by linking fields in Mexican waters to existing infrastructure across the border. The first round also saw strong interest in the Salinas Basin's unexplored deep waters, with a Statoil, BP, Total joint venture winning two blocks there and Petronas and Murphy Oil led consortia also snapping up acreage. The round will, for the first time, test interest in the largely gas-prospective Cordilleras deep-water basin, with 10 blocks up for bidding.

While the reform agenda is starting to gather successes, it is far from smooth sailing. Oil output continues to languish and there won't be a quick turnaround. Production has averaged 2.018m barrels a day this year, down 0.5m b/d from 2013 and 1m b/d less than a decade ago. Falling output has been driven by the spectacular decline of the Cantarell field. In 2005, its output topped 2m b/d—similar to what the much-hyped Permian oilfield is pumping today. Today the field is producing just 186,000 b/d and is dropping at a double-digit rate every year.

Pemex says that it is stabilising output, and there is some evidence in the data that production has hit a plateau. However, drilling activity remains at historic lows as Pemex slashes investment and most new foreign projects are in the pre-drilling phases. Just 29 wells were drilled across the country through the first five months of 2017. In 2013, the same period saw 328 wells drilled and 2012 brought 520.

The wave of new exploration being generated by the oil opening should eventually start lifting output, though the timing and scale of any new production will depend on the exploration results. It will be the early 2020s at the earliest before a significant number of new barrels from reform-era projects hit the market.

Given the long project timelines between the start of exploration and first production there has always been a risk that the public, sceptical of the reforms from the start, could turn against the oil opening before it really bears fruit. Andrés Manuel López Obrador, the leftwing populist candidate that has ridden a wave of anti-Donald Trump sentiment to the top of the polls for 2018's presidential election, has promised a referendum on the reforms if he wins the office. He likely would not be able to completely overturn the oil opening, but his victory would inject uncertainty into the sector and may see companies pull back.

For now, however, the reformers look ascendant. "What went wrong?", Juan Carlos Zepeda, the head of Mexico's oil regulator, asked ruefully after that first disappointing round, "we'll have to reflect on this". The reformers have righted the ship since then and have wind at their back.

Source: Petroleum Economist
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