David Enríquez
Goodrich, Riquelme y Asociados

Deepwater The Peak of the Mexican E&P Contractual Learning Curve?

Wed, 01/25/2012 - 14:48

With almost eighty years in the market and the highest ranking in the areas of oil and gas - granted by international directories - from amongst full service firms, Goodrich has had the privilege of participating throughout the entire history of the Mexican oil industry. Our experience in this area has been additionally enriched by our equally recognized maritime practice servicing exploration and production operations.

In this context of intense participation in the maritime and oil sectors, we accepted the invitation as one of the consultants selected by the Senate of the Republic to present our opinion on the legal reform project that would culminate in November 2008 with Mexico’s new upstream legal regime. With the same innovative spirit, Goodrich represents some of the world’s main operators and oil service companies, both offshore and onshore. In this context, we wish to share some comparative ideas, as well as our responsibilities with one of our clients in the contractual implementation of mature fields awarded since Summer 2011. By doing so, we wish to contribute with some elements to the learning curve for deepwater projects to be awarded.

As may be observed from the First Annual Report by the National Hydrocarbons Commission (CNH) and the National Strategy on Energy, more than half of the prospective resources of the country are located onshore or in shallow waters. In an interesting observation, the CNH estimated that in order to comply with the government goal of 3.3 million bbl/day by 2024, PEP would have to (i) triple the number of fields in shallow waters; (ii) increase by 259 the existing number of onshore fields in operation; and (iii) develop 41 fields in the deepwater areas of the Mexican Gulf of Mexico.

While, in the context of presentations on reservoirs potentially subject to the model of Integrated Services Agreements, PEP has announced that during 2012 the first rounds of the bidding processes for deepwater areas will be held, there are at least two factors (one regarding the regulator and the NOC, and the other regarding the contractors) which generate certain skepticism of PEP’s ambitious schedule.

From the regulator’s and the NOC’s standpoint, skepticism lies in the fact that, from the location of projected resources of the country as well as comparatively higher risks and costs than other reservoirs, there is tendency to consider that there is still not sufficient justification to focus on developing deep and ultra-deepwaters.

As if that were not enough, from the standpoint of contractors potentially interested in these projects (international oil companies or IOCs), skepticism focuses on the fact that the compensation formula for the integrated services contractual scheme does not justify the level of risk and investment. This type of corporation claims that the imbalance between the upside and the downside would make their participation in these projects non-viable.

In this scenario of apparent mutual unattractiveness for projects of deep and ultra-deepwater, under the current regime and conditions, amongst others, a pertinent question emerges: Is there a contractual solution from which the business model for deepwater can learn? In our opinion, at least two major alternatives appear on the horizon: whilst the first is an external and temporary solution; the second is a proposal based on the recent national experience and with a rather stable mood.

Under the alleged preliminary solution, technical assistance agreements (TEA) seem to offer some pragmatic attributes. TEAs are based on the commercial philosophy of exploration and production that considers a more thorough understanding of the objective area, thus reducing exploratory risk.

Under such a dynamic, pragmatic and successful regulatory model as the Colombian, TEAs have served as catalysts for superficial exploration processes in fields and have, therewith, optimized understanding of prospective resources in such country, thereby contributing to partially mitigate exploration risks for oil operators which, at a later stage, become the selected contractor for such fields.

Under the TEAs, a contractor (known in Colombia as the evaluator) is awarded the right to perform technical assessment operations at its own cost and risk, leading to evaluation of the hydrocarbon potential in order to identify zones with higher prospective interest within the area being evaluated, by executing a previously agreed schedule. Therein, the bidding entity grants a preferential right to the evaluator to exercise an option and, thereby, become the contractor for the exploration, development and production stages. That way, while TEAs do not represent a definitive solution, they do allow for optimizing understanding of the objective fields.

The second alternative, with longer-lasting objectives and recently introduced at a domestic level, is the extrapolation of the integrated service model for mature fields to deepwater reservoirs. Two differences between the first and latter projects seem almost obvious and trigger the difference in treatment: (i) uncertainty and associated risks; as well as (ii) the level of required investment.

Thus, under the model for mature fields, certification of reserves is granted and the geological, technical and commercial risk is measurable with a reasonably high level of precision; with it, the level of investment required, especially in the case of onshore reservoirs, is radically lower than amounts required for deepwaters. Considerations for deep and ultra-deepwaters are, therefore, inverse with which participation and compensation models are equally diverse.

Upon acceptance of the preceding fact, there are at least, two treatment options that can be combined: (i) reducing the downside (risk and investment) for the operator, with PEP’s direct participation exclusively in pre-exploratory and exploratory activities; and/or (ii) increasing the upside (consideration) for the operator, both in terms of the fee per barrel and the investment recovery term. Of course, both options mean important challenges in human, material and financial capacities.

At Goodrich we are convinced that the Mexican upstream industry is going through a clear change of paradigm in which public-private cooperation is the key word for the game. While it seems recent experience with mature fields will be very positive, if the dramatic differences in the economic model for deepwater are not taken into consideration, the exercise of the 2008 Energy Reform and its implementation will have been fruitless. We make vows so that the stakeholders will have the intelligence and will to take the correct path.