Low Oil Prices Dampen Post-Reform Enthusiasm

Q: How would you evaluate the attractiveness of Mexico, given that the fiscal regime for the first phase of Round One has been released during a steep decline in oil prices?

A: The attractiveness has dropped substantially for three main reasons. Firstly, low prices make oil ventures unattractive anywhere in the world. Secondly, competition has increased since Mexico is now competing with bidding rounds taking place in other countries. And finally, to the dismay of the private sector, the Treasury’s economic model focuses on components that are not representative of the attractive offer that companies were expecting. Industry experts have already been criticizing Mexico’s post-Reform economic model for its first contracting terms. For example, if profits exceed normal levels according to criteria outlined by the state, then profitability will reach a limit. Therefore, it is only obvious that companies feel discouraged to invest. Who would want to invest in a business where the probability of losing money is high due to exploratory risks and low oil prices but where profits are capped by the government? Evidently, no key stakeholder of the oil and gas industry is rejoicing over the Mexican government’s economic model for the first set of contracts. However, I remain optimistic, given the size of the discoveries that companies may strike while large prospects may attract significant investment. These ventures typically involve long-term targets, which may attract operators that are ready to take serious investment decisions in the hopes of materializing commercial discoveries. Companies like ConocoPhillips, ExxonMobil, and Shell, among others, would like to capitalize on new commercial discoveries in the Mexican Gulf. Through successful exploration, these companies will be able to increase their reserves. One must keep in mind that IOCs control 10% of the world’s reserves, so Mexico does still evoke exploratory attractiveness for these companies’ strategies. As a result, I do believe that Mexico is still considered attractive for these players as the Gulf still holds plenty of reserves that could be added to their portfolio.

Q: How do the financial requirements that companies must meet in the first set contracts for shallow water blocks compare to international standards?

A: In this regard, the Mexican government took the right route. Companies taking on projects in the offshore segment must operate in line with international best practices, because any mistake, blowout, spill, or similar catastrophe could be very detrimental to the country. Therefore, setting strict requirements and financial guarantees makes it possible only for the most experienced operators, with high safety standards, to bid for offshore opportunities, be it in deep or shallow water. For onshore projects, setting up rigid mechanisms is not the way to go, because this would mean only certain companies will be apt to bid and the development of Mexican operators will be constricted.

Q: What types of financing profiles do you expect the potential winners to have?

A: The only companies able to take on projects under current market conditions will be those that can rely on internal financing. It is very difficult for a new company or one with debt and low cash flow to obtain capital. Essentially, external financing is going to be scarce given the current low oil prices, or rates are going to be very high. As a result, the number of participants in Round One will be significantly less than what was expected one or two years ago. The typical profile of newcomers will be large enterprises with their own cash flow and resources, such as Shell, BP, or Chevron, since relatively small companies will not have enough capital to invest in expansion endeavors. This brings me to another topic. Mature fields or producing onshore fields typically attract investment from American SMEs and, as of now, most of these are drenched in debt. Therefore, it seems unlikely that many will want to take on developments here in Mexico. The oil and gas industry is cyclical but the main problem lies in the fact that US companies put down reserves as a guarantee, which results in a vicious circle. Since reserves automatically devalue as a result of low prices, companies struggle to meet their guarantees. Companies must battle to cut costs and pay up, so they cannot grow. Finally, the playing field for Mexican companies is somewhat restricted since offshore opportunities seem highly unlikely for Mexican operators and onshore assets will be in the hands of a select few. Current conditions are also not fostering the creation of new Mexican operators.

Q: What changes are you seeing in the supply chain?

A: We have seen a growing tendency of firms consolidating themselves in order to meet the new requirements of the Mexican oil and gas industry. Integrated solutions will now be the preferred choice for operators seeking service providers. Similarly, higher quality standards, improved efficiency, and minimizing lost operating time will also be the norm as we see providers building up their capabilities to adhere to such conditions. The industry players are seeking to become much more sophisticated to offer better solutions. The short-term will see fewer providers than before, given that many will be joining forces to improve services. In the long-term, there will be many more specialized firms that cater to project-specific demands.

Q: What do you think about Mexico’s strategy to boost domestic gas production?

A: Current gas prices are now independent from crude as non-associated gas fields have become more prominent. Many companies migrate to gas because the electricity sector’s demand is booming. Mexico’s strategy has long been to import gas and I still find it difficult to see the national gas industry developing. We cannot compete with the production and infrastructure that is in place right across the border. Additionally, the government’s export strategy with production at Lakach and its satellites, transportation through the Isthmus of Tehuantepec, and an LNG terminal at Salina Cruz to cater Asian markets does not make sense once Australia’s Gorgon Project is factored into the equation. Gorgon is designed to produce 15.6 million metric tonnes of LNG per year alone. How can such ambitions be profitable? This might have made sense 15 years ago but not now. These developments might seem visionary in the long-term, but too many questions remain unanswered at the moment. The timing for these projects and Round One does not seem right. However, while exports may not seem feasible at the moment, making natural gas available for Mexico’s underdeveloped regions is a better way to go. It would be better to destine Mexican gas production for internal consumption.