Juan Carlos Zepeda
President Commissioner
CNH
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View from the Top

No Need to Fear Future of Licensing Rounds

Fri, 06/22/2018 - 11:08

Q: How would you describe the highlights of the licensing rounds?

A: We have completed 14 bidding rounds, resulting in 107 awarded contracts. The first indicator of CNH’s success is that we have completed these 14 bidding rounds without a single legal challenge or observation from our internal auditing office or from Congress’ federal auditing office. Accountability is our main priority, so if the next administration would like to review the 107 awarded contracts then we are very ready to do this with them. The main purpose of CNH is to deliver transparency and accountability.

The second indicator is investment. The bidding variables are the royalty rate and the minimum work commitment and the Ministry of Finance establishes a weighted average of these variables. Most of the weight has been placed on the royalty rate. Although I would prefer to see more weight placed on the minimum work commitment, we have achieved very good results nonetheless. The winners of blocks in the bidding rounds have committed 138 wells, of which 74 are onshore and 64 are offshore. As a reference, 64 offshore exploration wells is equivalent to 20 percent of all exploration wells in the history of Mexico. The drilling of offshore exploratory wells has doubled in Mexico. The country drilled 15 such wells in the 2011-2017 period, two of which were the result of the new contracts. In the 2018-2021 period, based on commitments, the country will drill a total of 26 offshore exploratory wells, 13 of which will be drilled by new operators. This is especially important given the fact that Mexico’s oil production decline was the result of limited exploration activity. Having exploration activity back on track is a good indicator of the success of the licensing rounds.

The third indicator is the government take, which is an indicator that combines the different taxes and royalties paid by operators and is expressed as the amount of taxes paid as a percentage of profit. The government take in Mexico is significantly higher than the government take in the US Gulf of Mexico, which stands at 55 percent. When we compare the government take of Mexico’s licensing contracts with the government take of the concessions in Brazil, ours is higher, at 63 percent versus 59 percent. In Brazil and Mexico, we have both licenses or concessions and production-sharing contracts, which usually have a higher government take because profit rather than revenue is taxed. Both countries have a government take of 75 percent for production-sharing contracts.

Q: How do you measure the uptake in exploration activity and what are the implications of this? A: Mexico has not only achieved higher government takes than its main competitors but the investment committed through minimum work program is very high, and our processes have been very transparent. Apart from strong performance on these three indicators, we have seen a strong increase in investment in seismic activity. We have awarded 40 geological and geophysical permits (G&G permits). Based on these contracts, the industry has invested more than US$2 billion, which resulted in seismic coverage of the Gulf of Mexico growing from 35 percent to 100 percent over the past three years as the volume of 2D seismic tripled and the volume of 3D seismic with WAZ technology quadrupled.

Finally, exploration activities in blocks awarded in Rounds 1.1 and 1.2 have already resulted in important discoveries. The consortium of Talos, Premier and Sierra Oil & Gas announced a significant shallow-water discovery of more than 2 billion barrels resulting from the drilling of the Zama-1 well in Block 7, awarded during Round 1.1. Round 1.2 included blocks with discovered fields, and both ENI and Hockchi have tripled their reserves through successful exploration wells. So far, the indicators are looking very good at every step of the value chain.

Q: How can these initial results be translated into the desired production increases?

A: If we want to return Mexico’s oil production level to 3 million b/d, we need to substantially increase average E&P capital expenditure. As a reference, PEMEX is investing around US$8 billion per year in E&P, which is a low figure compared with the US$18 billion PEMEX was investing in 2013 before the opening of the industry. To return oil production to 3 million b/d, PEMEX and new operators will have to raise their collective E&P investment to US$20 million in the short term and gradually increase it to US$60 billion by 2030. This investment will have to be directed at various areas to return production to levels approaching Mexico’s 2004 production peak. One area of opportunity is investment in onshore basins, where Mexico has no production. TampicoMisantla is the most important basin is this regard. The first important E&P strategy recommendation is that we must develop Tampico-Misantla, which has a production potential of 700,000-1.5 million b/d that can be activated in the short term. We need to attract private operators that can work side by side with PEMEX to develop this area.

Currently, Mexico has 25.5 billion barrels of oil equivalent of discovered 3P reserves, 76 percent of oil and 24 percent of natural gas. Additionally, it is estimated that there are 112.8 billion boe of prospective resources (to be discovered), 53 percent of unconventional resources. The Tampico-Misantla basin concentrates a great potential: the discovered fields within this basin represent almost 30% of total 3P reserves and its unconventional exploratory potential accounts for the 58% of the total non-unconventional resources.

Focusing on the development of Mexico’s extra heavy oil potential is the third E&P recommendation. Extra-heavy oil is an important opportunity because Venezuela has seen a substantial decrease in heavy oil production and the declining production of Cantarell has reduced Mexico’s heavy oil production. Mexico has important heavy and extraheavy oil fields that we have not started developing, with the exception of Ayatsil-Tekel. There is an important cluster of extra-heavy oil fields in proximity to Ku-Maloob-Zaap where PEMEX was awarded Ayatsil, Tekel and Utsil and the Ministry of Energy retained a number of attractive giant fields, such as Pit and Kayab. When we started the bidding rounds, oil prices did not allow for the development of such fields, but at current prices this is profitable. Moreover, Mexico’s refineries were designed for this type of oil and the economies of scale that the cluster of fields offer represents an important economic opportunity.

The fourth E&P recommendation is to increase natural gas production, which is the most important energy security concern for Mexico. We will continue to import competitivelypriced natural gas from the US, which in recent years has been an important driver of lower electricity costs for the industry. Given that we are importing around 85 percent of the natural gas we consume from one country, we have to diversify. To do so, the Mexican government will have to implement a natural gas policy to make it feasible to support natural gas in Mexico. Tax incentives can be used to achieve this purpose without removing income from the federal budget. The US offers different incentives to the oil and gas industry, such as the intangible drilling assets deduction that allows companies to deduct most of the costs of drilling wells in the US from income taxes. These types of tax incentives should be introduced in Mexico for non-associated gas. In terms of royalties we have to understand that there is no economic rent to capture from non-associated gas, so there should be no royalty.

If the new administration wants to pause the bidding rounds, my humble recommendation would be to continue with the deepwater, unconventional and onshore rounds to ensure that the first two do not leave resources idle and the last continues the development of the new Mexican industry. If we pause bidding rounds in shallow water then we need to provide additional investment capital to PEMEX.