The nationalized energy industry of Texas’ southern neighbor and top trading partner is undergoing a sea change. Reversing 76 years of government policy, Pemex (Petróleos Mexicanos), Mexico’s state-run oil and gas monopoly, is opening itself to partnerships – and its fields to exploration and production (E&P) – by private firms. Many Texas-based O&G service companies already subcontract in Mexico, but allowing foreign E&P is a whole new ballgame.
“I didn’t think I’d ever see it in my lifetime,” observed Eric Potter, associate director of the Bureau of Economic Geology at the University of Texas at Austin. He and his colleagues have conducted extensive research on various O&G formations for Pemex.
While Mexico is already one of the world’s oil-producing giants, economists believe its E&P growth potential is quite strong, given the country’s vast amounts of untapped deposits. The two big unanswered questions now are how attractive Mexico’s business terms will be and how much oil and gas it can supply reliably and profitably.
In December 2013, Mexico’s state legislatures ratified a constitutional amendment that ended decades of public control over both the nation’s electricity and oil and gas industries. Though advanced by an effective coalition, it was still a hard sell given the government’s longstanding, deep-seated dependency on Pemex. Mexico derives 35 percent of its federal budget from oil and gas revenue, according to Alejandra León, associate director of Latin America – Downstream Oil for global economic analysis firm IHS/CERA. Pemex sends the government 65 percent of its income, according to Potter, limiting what’s available for reinvestment. Indeed, energy stagnation due to a lack of development resources bolstered the argument that Mexico would prosper if it brought in private and foreign investors.
Not surprisingly, some critics continue to suggest that Mexico will be shortchanged in the bargain. As Potter notes, the devil is always in the details. The Mexican congress is slowly modifying numerous laws and enacting new ones to implement the transition. The government also is determining how much of its resources Pemex will retain and what will be up for grabs. The outcomes will determine just how much investing there will be in Mexico’s brave new energy world.
Pemex will become one of many players, Potter said, but it will have more flexibility to sell greater interests in what it retains. This will, in turn, generate more operating capital. Given its historical dependence on oil, the Mexican government may still take a sizable cut of E&P revenue, León said, regardless of who is generating it. Nevertheless, both Potter and León think the initial impact of the new law could benefit firms across the entire E&P spectrum, from independent producers to the major global oil companies, perhaps including some Mexican entrepreneurs as well. Potter added that some investors might even negotiate deals and transfer them to others.
“The overall pie should grow, even though Pemex’s share will decrease,” he predicted.
What’s In It For Me?
While not outright privatization, the new agreements are expected to be more lucrative than the current performance-based service contracts first allowed in 2008, according to analysts at PFC Energy, a subsidiary of IHS.
They expect Mexico to offer three types of contractual arrangements:
- Licenses (permits similar to concessions) and contracts for sharing production and profits. Licensees are paid in oil and gas produced.
- Production contracts, which earn holders a percentage of what’s produced and to which they hold title. Both licenses and production contracts allow booking of reserves. Being more lucrative, production contracts are more likely to be applied to higher-risk operations.
- Profit-sharing contracts. Contract holders are paid in cash based on a percentage of earned profits. They own none of the resources but can book their shares of the revenue.
Potter suggested that the business terms – royalties, taxes, and contractual obligations – that emerge will be key. He said potential investors also will need to consider where the opportunities are located and their types.
The opportunities won’t be immediate, says León, and Mexico’s E&P likely won’t be competitive in the near term. “Pemex must decide what it will keep,” she explained.
To date, in what has been dubbed “Round Zero,” Pemex is opting to relinquish its northern Mexico shale plays and some of its deepwater offshore holdings. Both are expensive enterprises requiring extensive, and very different, expertise.
Potter believes it is too early to predict how attractive Mexico’s shale oil and gas plays will be in areas where the geology is complex and largely untested. Pemex has drilled only a half dozen wells in its portion of the Eagle Ford shale compared to more than 8,000 in Texas, he pointed out. Security also is a concern, given that portions of the formation extend southward beneath areas subject to control by Mexican drug cartels. However, there are other similar shale plays in Mexico that may also lure enhanced recovery firms.
Pemex’s deepwater presence in the Gulf of Mexico is currently next to nothing, so it, too, is ripe for development. But only the more financially sound, technically sophisticated players need apply.
Hurry Up and Wait
Mexico’s energy ministry has until mid-September to decide if Pemex has the capacity to manage and develop the resources it wants to retain or open any of them up to competitive bidding. Then, over the next few years, it must prove itself capable of doing so. Short term, León said, there will be two concurrent systems: one for existing projects and a parallel regulatory framework for newly developed areas. The transition won’t be complete until 2016. Regardless of what the new regulations are, Potter said, they must be administered fairly and ethically in order to work.
The impact on global markets and prices is uncertain. But Potter is confident that the ripple effects in Texas will be positive and pervasive.
While a bit of a mixed metaphor, Potter’s observation is economically true nonetheless: “A drilled well is just the tip of the iceberg.”