Address Underinvestment to Foster Competitiveness

Bridging the transition between the old monopoly and the new, open market created by the Energy Reform will bring a number of challenges and years of underinvestment will need to be addressed to foster a new, competitive market, says Eduardo López, EY Mexico’s Executive Director Oil and Gas.

One stage of the solution, he says, will be the construction of all the necessary infrastructure to support increased activity in the industry, especially in the distribution of refined products. “The majority of distribution and transportation of refined products is done by truck in Mexico, which is the least efficient way,” López says, adding that the construction of pipelines is complex due to the country’s difficult topography. Despite CENAGAS’ and PEMEX Logística’s open seasons providing the opportunity for private firms to use the country’s existing infrastructure, third-party storage and distribution infrastructure will be required in the future.

EY, López says, is there to help its clients as they take their first steps into the Mexican oil and gas industry. “Mexico is fiscally complex, so EY uses its knowledge of local conditions to guide our clients.”

The country’s oil and gas industry is a critical component in EY’s global portfolio and the sector’s emergence from its previously monopolistic structure presents a great opportunity. EY’s focus is now on helping clients cross the challenging gap between the monopolistic model and the emerging market-oriented version to take full advantage of all the opportunities stemming from the Energy Reform.

Mexico’s infrastructure problems, López adds, are not limited to storage and distribution but stretch into the lack of investment in PEMEX’s six refineries. The Cadereyta, Madero, Minatitlán, Salamanca, Salina Cruz and Tula refineries have fallen into disrepair and will remain in a “sorry state” unless PEMEX tackles head on their many operational problems and upgrades their configuration, López says. The refineries’ crude oil processing output has dropped nearly 24 percent since 2013 to 933,062b/d by the end of 2016. It has also fallen over 28 percent since a maximum of 1.3 million b/d in this century, registered in 2004.

One instrument that could assist cash-strapped PEMEX in creating new revenue streams is the Fibra E, a financial instrument designed to allow companies to monetize productive assets, similar to the Master Limited Partnerships (MLPs) of the US. Although Mexico’s NOC could find it an uphill challenge to put a value on aging and depreciated infrastructure, several Fibra Es are expected to be launched.

López is cautiously optimistic about Mexico’s emerging deepwater industry cemented by the successful licensing round in December 2016. “The Gulf of Mexico is one of the last frontiers for deepwater explorers,” he says, “and the success of Round 1.4 validates the fact that big players believe that.”

But it is not just about the success of the licensing rounds. Cementing a longer-term view of the industry remains a challenge because the authorities chose to prioritize royalty rates over investment for the deepwater round. “The fact that companies won based on royalty rates shows that the government is trying to maximize revenues. But revenues from the venture will only start to flow once the fields have been fully developed, which will be in 10 years or more.”

According to the oil and gas expert, if CNH had demanded higher investment amounts, companies would have been forced to develop the fields more quickly to speed up their ROI. After all, the government could conceivably renegotiate royalty rates later, following the lead of countries such as the UK.

One clear step forward for the Energy Reform was the Trion farm-out, López says. BHP Billiton is making a significant bet as it partners with PEMEX, a company still haunted by financial constraints and efficiency concerns. “It was a huge relief for PEMEX and for Mexico as a country,” he says, adding that Mexico can look forward to a more buoyant energy sector and economy despite the roadblocks still ahead.