In July 2017, Houston-based E&P company Talos Energy became the first private player to strike oil in Mexico for over seven decades with the discovery of the shallow-water Zama field in the Southeast basin, 60km off the coast of Tabasco. The 800MMboe discovery is one of the Top 10 biggest finds in Mexico’s history, certainly within the last two decades, and is considered one of the most promising shallow water fields in the world today. Soon after, however, it was discovered that the reservoir extended into the adjacent Uchukil block, operated by PEMEX. When the two sides failed to reach an agreement on who should operate Zama, SENER intervened to settle the first unitization case between PEMEX and a private operator, appointing the NOC as the sole operator in July 2021.
Talos responded to the unitization resolution, which left the American IOC with just a 17.35 percent stake in a project it had already invested US$350 million into, by asserting it would consider all ‘legal and strategic options’ to protest the decision, seeking to both maximize value for its investors and mitigate damage to the company. Even though the decision was not just a blow for Talos, its block 7 partners, Wintershall DEA and Harbor Energy, opted not to contest the verdict. The consortium was awarded the contractual area in round 1.1 in 2015, with the participation shares giving Sierra Oil and Gas (now Wintershall Dea) 40 percent, Talos Energy 35 percent and Premier oil (now Harbor) 25 percent. Crucially however, Talos made the discovery in 2017 and made the most significant investment, pushing CEO Tim Duncan to take on the mantle for an increasingly frozen out private sector amid President Andrés Manuel López Obrador's efforts to strengthen state control over energy. Indeed, what ensued was a year of turbulent negotiations and one of the most high-profile skirmishes between López Obrador’s government and the private sector. Talos initiated arbitration proceedings against the Mexican government in July 2021, before formally submitting a dispute notice under several unspecified violations against USMCA and another bilateral investment treaty.
This move opened a period of consultation for the two parties to come to a mutually beneficial agreement. On Talos’ side, CEO Tim Duncan voiced concerns about PEMEX running the operation, pointing to the NOC´s lack of experience in depths below 152m similar to Zama´s, as well as what he viewed as PEMEX´s track record of mishandling fields in a quest for quick gains. Marco Biersinger, Director of Oil and Gas Corporate Finance, Kroll, concurs: "PEMEX has on certain occasions shown to prefer bringing wells into production early and may therefore have sacrificed the total recovery volume at its fields." An example of this was Canterell. The mega-field, discovered in 1976, was once the world’s second-largest oil deposit with a peak oil rate of 2MMb/d in 2004. PEMEX’s all out focus on production, however, was criticized as a flawed strategy which caused the 40Bboe field to enter a premature decline. Biersinger emphasized that the goal of any governing team should be to pursue best international practices.
SENER defended its decision to grant PEMEX control over the field by citing the NOC´s shallow water expertise and its nearby infrastructure, while President López Obrador offered PEMEX´s superior size and production capacity (1.93MMb/d of crude and other liquids against Talos’ total output of 65.4Mb/d) as justification. López Obrador has argued that a larger portion of the reserves fall within PEMEX´s blocks, while highlighting Talos’ participation as only a minority partner in block 7. “Despite being a minority partner, they [Talos´s executives] want to have operational control. That cannot be, it is illegal and will be clarified,” stated López Obrador.
The first independent analysis of the reservoir was carried out by Netherland, Sewell and Associates, Inc. (NSAI) and indicated that 59.6 percent of the total resources of Zama are located within Block 7. This was by Texas consultancy firm Ryder Scott contracted by PEMEX, which concluded that 50.43 percent of the reservoir fell within PEMEX´s contractual area. The latter study also estimated recoverable resource volumes at 735MMboe and 950MMboe with production of 160Mboe/d once fully developed. Duncan rejected the importance that Mexico has placed on these percentages, arguing that they will evolve as the project progresses. “This dispute is not about the percentage of oil under each contract. It is about the process,” said Duncan. “Interests evolve over time in unitizations.”
Speaking to Bloomberg at the beginning of August, Duncan explained his company's predicament: “Our situation is a proxy for everything you do not want to see happen, which is investing under a certain set of conditions, developing an asset that had a specific amount of value, to not knowing exactly what you have due to government action.”
Talos’ case is just one of a series of recent Mexican energy policies which have come under scrutiny for infringing international treaties, such as USMCA. In recent months, both US and Canada have presented complaints under USMCA, arguing that measures have been taken by the Mexican government to discriminate against American and Canadian businesses to prioritize PEMEX and CFE. However, fears that the López Obrador administration could lay claim to other private companies’ discoveries appear overblown when considering that Zama’s unitization process started before he became president. Moreover, the guidelines used by SENER and criticized by Talos were those outlined under Peña Nieto's 2013 Energy Reform.
July 2022 seemed to bring good news as discussions between a Mexican team, headed by Chancellor Marcelo Ebrard and Minister of Economy Tatiana Clouthier, and US representatives concerning possible violations of the USMCA appeared to be fruitful as Talos dropped its arbitration proceedings. Following crunch talks between President López Obrador and the US Ambassador to Mexico, Ken Salazar, Reuters sources suggest that Talos’ consortium might still hold sway in the field’s technical and commercial development, even if PEMEX is to remain the site’s operator. The Houston-based company’s vast experience puts it in the best position to guarantee profitability. Talos is now set to submit a development plan for approval of interested partners, a crucial step before a final investment decision can be made in 2023.
"Talos maintains constructive dialogue with PEMEX on how we can move this project toward a final investment decision in the most commercially attractive way,” said Duncan. “Talos is willing to move forward and not continue to fight over operatorship as long as it has a leading role in the project.”
While not ruling out further legal proceedings, Talos spokespeople voiced the company’s desire to work in good faith toward a fair and mutually beneficial agreement with the Mexican government. Once up and running, Talos puts Zama’s potential production at 160Mb/d, which would generate an estimate of US$30 billion in revenue for the Mexican government.
According to analysts sourced by MBN, “regulatory inexperience” and the government’s current “PEMEX-centric vision” have contributed to the underdevelopment of the Zama field. Similarly, a former country manager for a Mexican oil company, in conversation with EINNews, noted that “the opportunity cost to the State from foregone royalty payments has been in the hundreds of millions of dollars—and counting. The cost to Talos and its partners is also hundreds of millions of dollars both in sunk costs and delayed income.”
From a production standpoint, the worst-case scenario has already been realized, with the dispute causing Zama’s development to stall indefinitely. More than half a decade on the initial discovery and single barrel has yet been extracted, prompting Duncan to complain that, were it not for the delays caused by the disputes, Zama would already be producing this year, which would allow Mexico to take advantage of record oil prices and help stem the decline in its oil production. "Once it is fully developed, Zama will probably represent 10 percent of the country's production (...) it will be among the largest producing fields in Mexico," Duncan explained.
PEMEX made it clear in recent months that it is prepared to invest billions of dollars in Zama if it is given permission to run the project, with CEO,Octavio Romero, pledging in August 2022 to invest "whatever it takes" to develop the field. However, such an investment plan must coincide with PEMEX´s hefty debt repayment schedule over the next few years. The NOC is the world's most indebted oil company and is already saddled with negative working capital and combined debts of US$108.1 billion. PEMEX has also seen its credit rating downgraded by Moody's and Fitch Ratings to junk status.
It has been estimated that development of Zama will require between US$4 billion and US$5 billion over the next 30 years. It appears the NOC is not ready for this, however. "Pemex has not yet planned investment for Zama in its budget, its capital expenses continue to be limited and the government is using the company's extraordinary revenue to support subsidies, boosting the president's popularity," John Padilla, consultancy IPD Latin America's Managing Director, commented.
PEMEX's spending power has been further strained with resources diverted away from drilling in recent years to support the soaring costs of the Dos Bocas Refinery. Nevertheless, at least under the current administration, PEMEX can still count on strong government support as the NOC is re-centred as the primary lever for socio-economic growth and national development.
Settling on a development plan remains the final hurdle before a Final Investment Decision (FID) can be submitted to CNH. On Aug. 5, 2022, Talos announced during a 2Q22 earnings conference that it was working to finalize a field development plan with PEMEX before the March 2023 deadline.