Lourdes Melgar
Undersecretary of Hydrocarbons
Ministry of Energy
View from the Top

Adminstering the Future of Mexico oil and Gas Industry

Wed, 01/20/2016 - 12:59

Q: What is the short and medium-term impact of the drop in oil prices on Mexico’s energy policy and the implementation of the Energy Reform?

A: Although the drop in oil prices affects oil companies, including PEMEX, these do not come into consideration when we define the appropriate energy policies. However, this factor comes into play the moment we begin working on a specific bidding round, defining the areas, their terms of materiality, and the selection of the type of opportunity. For instance, today might not be best time to develop extra-heavy crude.

Oil and gas is a sector where we need to have the medium and long terms in mind. The drop in oil prices has severely strained both the state budget, which has undergone significant adjustments, and PEMEX. That being said, low oil prices also provide opportunities. This is the case in the electricity sector, as it was unlocked to private investment by the Energy Reform. The reform also goes deep into the midstream and downstream segments, which become even more attractive areas for investment when oil prices are low. We are taking advantage of this situation, and it is something that was already included in the reform at the constitutional and legal level. Now that we are in the phase of implementation, we hope we get the attention necessary to attract investment in these segments.

Q: Which priorities have to be met in order to measure the success of Mexican upstream oil and gas industry?

A: The idea is to mark every item on the checklist, such as increasing production, reserve replacement, value creation, and job creation, among others. Each ministry has its own priorities. While the one of the Ministry of Finance is to increase state revenue, the Ministry of Energy is seeking to increase production and reserve replacement in order to ensure energy security in the country, which includes oil and gas but also condensates and other products. Mexico cannot boost its petrochemical industry without the right production of condensates.

The decision makers want to end the country’s decline in production, which stems from clear and logical factors, such as the decline of Cantarell. This super-field once produced close to 2 million b/d and now its production stands at 230,000b/d. In addition, other fields are reaching the mature stage, such as Ku-Maloob-Zaap. We are in a period during which many projects will reach maturity or begin to decline, meaning there will be opportunities for investment in order to boost production.

While oil production is crucial, I am also concerned about natural gas production. From an energy security perspective, we need this resource. Less than 70% of the natural gas consumed in Mexico is produced in the country, highlighting the need to maintain and increase production levels both to ensure energy security and our independence from US exports. So far, the government has made a great effort in attracting investments for projects aimed at importing gas from the US, but there is a limit to the amount of infrastructure we can develop at one time.

Q: What is the extent of the challenge CENAGAS has, and when should we expect to see change within the natural gas market?

A: The first thing is to consider is infrastructure, because no natural gas market can be created without this feature, and so far we have been advancing well in this area. We have been developing the arteries of the system and CFE has implemented an extremely efficient process through the contracts. In terms of regulation, CRE is already removing a significant distortion we had in the pricing system. Pricing was set many years ago at over US$20 per billion BTU, meaning that PEMEX was effectively subsidizing the transport. This means that the production and import of natural gas is uneconomical at the current prices of US$1.7-1.8. We are now taking transportation into account, which is something that has generated complaints in certain areas. Nevertheless, even when taking transport into account, the price of natural gas remains historically low .

We are working on the creation of a natural gas market to be announced within the next two to three months. I view it as an important component in ensuring that the electricity market functions efficiently. Gas and power are intrinsically linked, so it is vital that both these markets work in harmony. If the natural gas supply is controlled by a utility, it is extremely difficult to generate competition in the electricity market, so I view it as a healthy decision to establish two markets, both run by independent system operators. This will happen before the end of this administration. We are aware that natural gas has other uses apart from energy generation, and for us, as a policy maker, boosting the petrochemical industry is a priority, as the liquids and condensates from natural gas are integral to this process.

Q: At which level do you expect production to bottom out, and what should be fueling the reversal to increase production again?

A: The political concern involves a production drop below 2 million b/d, which could occur at the end of 2016. The following year, however, production should start ramping up again thanks to the initial production from the blocks awarded in Round One. In addition to the first oil from these fields, farm-outs will also contribute to increasing production in the 2017-2018 period. The farm-outs and migrated contracts should also compensate for the share of the drop in production led by PEMEX, a consequence of its severe investment cuts.

Q: What else can be done to boost the Mexican oil and gas industry?

A: PEMEX, the Ministry of Finance, and the Ministry of Energy do not expect to see a price of US$80/b during this administration. One of the reasons why PEMEX had to undergo such a severe budget cut is because its budget had been planned under the unrealistic expectation of a US$53/b scenario. The newly appointed Director General of PEMEX is aware that he is beginning his tenure at US$25/b and has adapted operations accordingly.

The PEMEX Board of Directors, the Ministry of Finance, and the Ministry of Energy have been working on a plan that has several components, one of which involves the provision of more favorable fiscal terms for the NOC. The law offers different ways of achieving this, such as migrating some of the entitlements to new contracts types, something we are already analyzing with PEMEX. We have talks with the Ministry of Finance regarding issues related to the cost cap because this aspect was established in the Law of Income from Hydrocarbons. The current price cap is lower than what PEMEX had before, so we are seeking to give it a similar one to the one prior to the reform.

Another aspect relates to the fact that when the oil price is high, companies are free to think about expanding their business to areas that are not necessarily related to the industry. However, with prices such as the ones experienced today, oil companies have to go back to their core business. In the case of PEMEX, these areas are E&P, refining, and hydrocarbons processing. I expect to see a more selective PEMEX soon, divesting from projects that were recently created and are not part of its main activities.

In addition, the NOC, as a productive enterprise of the state, has to play the same game as other oil companies, which is reducing costs and becoming efficient. We have been adamant about the fact that PEMEX needs to review its benchmarks in every area, such as oil production, and ensure that it becomes more productive, investing where it is more profitable. High taxation levels have definitely impacted PEMEX, but the company could still do better in terms of production costs and efficiency in its core activities.

Q: Given its complexity, do you expect the tenders for R1- L05 to be released after R2-L01 and R2-L02?

A: This is likely but the names of the rounds may change. Regardless of this technicality, the importance lies in ensuring the development of each round and maintaining momentum in order to increase oil production as quickly as possible. We will continue working on the implementation of the reform, and once we have the regulation ready, the unconventionals round will be launched. R2-L01 and R2-L02 will focus on shallow waters and onshore, and the latter will cover a wider area than R1-L03, with both exploration and extraction activities combined.

Q: What would you look forward to as the 2016 highlight for Mexico’s oil and gas industry?

A: First of all, the contracts from R1-L03 will be signed in May. Although it would be fantastic to have all 25 companies sign, I would prefer it if the companies that have reservations about their bids did not sign, because we always have the second bidder as a backup option. I would rather have a company that is truly committed to what it offered, rather than a company that will struggle. This responsibility lies with CNH, which is currently liaising with the contractors. R1-L04 is also upcoming, and Round Two will most likely develop in December. Additionally, we are expecting to tender the farm-outs, and the contract migrations, and to process both the CIEPS and COFPs