Image credits: Gobierno de México
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Analysis

Oil, Gas and AMLO Two Years On

By Peter Appleby | Fri, 12/11/2020 - 12:28

Just over two years ago, Andrés Manuel López Obrador (AMLO) entered the National Palace on a wave of popular support. The avowedly leftist politician achieved a landslide victory in Mexico’s presidential elections and rode a ticket that promised to rid the country of entrenched corruption, reduce poverty and return Mexico to its rightful place among the world’s top energy producers. To put Mexico back on the energy map, the president pledged to turn around the fortunes of an ailing PEMEX and reverse the Energy Reform, so that Mexican oil riches would again be owned and extracted by the Mexican state only.

The 24 months following AMLO’s arrival have been turbulent for the oil and gas industry. The MORENA government has forced the suspension of bidding rounds for the development of oil fields by private companies. Contracts handed out by the former administration have been reviewed, criticized and renegotiated. More recently, a counter-reform has been tabled. Throughout this time, there have been constant whispers of the government pressuring autonomous industry authorities to bolster the state’s productive enterprises, including PEMEX, at the cost of an even playing field.

The president is now a third of the way into his term and his energy vision is well underway, though certainly far from complete. Where does the private sector stand?

 

Investment Opportunities on the Wane?

From the beginning of his presidency, AMLO said he would review all 111 private contracts that were awarded during the Peña Nieto administration. He criticized private companies for not living up to production promises and denounced pipeline contracts given to TC Energía, Grupo Carso, IEnova and Fermaca as “leonine.”

Messages from the government flip-flopped between promises to respect contracts that had already been signed and the desire to stop the same contracts that, according to the government delivered no benefits to the Mexican people. The concern from private industry and international governments was clear, and was sufficiently worrisome for Canadian Ambassador to Mexico Pierre Alarie to publicly criticized CFE, the body in charge of the pipeline contracts, on Twitter.

“I’m deeply concerned about the recent actions of the CFE and the message they send that, despite López Obrador’s statements, Mexico doesn’t want to respect gas pipeline contracts,” Alarie wrote.

Though the pipeline contract situation was resolved, the possibility of the government reneging on its contracts sewed doubt in a market that had taken its first steps along a path that would take serious investment in time and money to complete, according to experts. Alfredo Garcia, Executive Managing Director at financial services company Sie7e Energy, said a lack of legal certainty that has marked the president’s first two years has had a knock-on effect in a country struggling to kickstart its economy following a devastating global pandemic. “There is a diminished appetite for investment into Mexico,” he told MBN.

Serious investments had already been committed to the pursuit of new oil before AMLO became president. The Mexican state received close to US$11 billion in fees and taxes from contracts awarded, according to AMEXHI’s 2019 report, Vamos Bien. In 2019, private operators invested US$4.542 billion across their fields. By the end of 2020, a further US$4.542 billion is to be invested, according to CNH data. The great majority of investment comes from offshore operators, whose fields will take years to develop.

Merlin Cochran, Director General of AMEXHI told MBN in May that “up to now, operators have completed 100 percent of the contractual commitments they signed up for across the bidding rounds.”

For those companies hoping to continue with developments on areas already won, permitting processes have become more arduous since the president’s arrival, said Fernando Flores, Director General of Frap Soluciones Integrales.

“It (the permitting process) has changed radically since the arrival of his mandate. The permits delivery times have been affected because many personnel were fired, while some personnel who worked in other areas had to relearn the new permits that were assigned to them. Internal policies changed to favor state enterprises and this directly affected private participants,” Flores explained to MBN.

For now, the only opportunity for operators to expand their business in Mexico is via a secondary market that is beginning to grow. But whether operators choose to go beyond the requirements of their contracts will likely depend on the federal government’s stance. Should uncertainty remain, operators may decide against drilling an extra exploration well or subsea pipeline that would demand further investment, create more jobs and offer taxation benefits to Mexico.

 

The Local Talent Outlook

A key component of the Energy Reform was knowledge transfer and the upskilling of local content. The Mexican government had predicted that 2.5 million jobs would be created within the energy sector by 2025, and PEMEX, whose world-class expertise in shallow water and onshore drilling has not transferred to deepwater fields, would benefit from knowledge transfer as arriving IOCs brought cutting-edge technologies to bear.

Local content has quickly learned to meet the higher standards of international oil companies, believes Guido van der Zwet, General Manager of international recruitment firm IPS Powerful People. “The Energy Reform has helped the overall skillset, training and safety in the oil and gas sector. The IOC’s have shown high standards and training for their personnel, with the Mexican workforce rapidly growing in knowledge and improving in safety procedures rapidly,” he told MBN.

Nevertheless, the government and private companies must foster smooth relations to drive the sector’s growth and help local talent reach its full potential, he said.

“This must be initiated by both the private and public sector because there is much work to be done to be able to cope with the demand that is coming. It will also be vital to move back to either auctions or farmouts to keep the foreign investment coming in and develop the energy sector. (If this does not take place then) the results of the Energy Reform will last for a limited time only.”

 

Support for PEMEX

PEMEX has been backed to the hilt by the MORENA government and has had success with reversing the downward trend of diminishing 3P reserves, an issue that several major credit agencies have highlighted. Priority fields are being developed, albeit at a rate much slower than what the federal government had promised, and major discoveries like Ixachi and Quesqui – the country’s biggest discovery since 1987, according to PEMEX Director General Octavio Romero – have been made.

In the international arena, Mexico marked out its space by refusing to cooperate in the 9.7MM/d OPEC+ production cut. Rather than capitulate to the demands of larger producers, Mexico stood firm and won, only reducing its output in May and June, and only then by 100Mb/d. Whether that was a sensible decision given the low oil prices of the last several months may be incidental.

Nevertheless, PEMEX’s financial health remains a key issue and one that AMLO has not successfully addressed. Paying off a US$110 billion debt is not a viable short-term aim but certain actions that the president has taken, like the US$5 billion cash injection and a further US$4.4 billion contribution through cash and profit-sharing duty reductions, gave the company temporary breathing space when it was needed.

However, the fundamental support that the federal government gives PEMEX has had a negative consequence. In April, Moody’s downgraded PEMEX’s ratings to “Ba2” with a negative outlook following its downgrade of Mexico and said that, “We downgraded PEMEX's ratings and maintained the negative outlook on its ratings following the downgrade of Mexico's rating and its negative outlook given the critical importance of the government's financial strength and support in the assessment of PEMEX's credit risk.”

When AMLO took office, he said that PEMEX would produce 2.6MMb/d by the end of his term, and often repeated the claim that riches from black gold would be a “lever” with which to develop the country’s economy. Yet Fluvio Ruiz, former independent advisory board member at PEMEX, told MBN recently that the government needed to focus on PEMEX as a business in its own right, not solely on what it can bring to the state, if it is to succeed.

“PEMEX needs to be allowed to operate as a more or less normal oil company. For that to happen, the state needs to abandon this notion. The questions of how relevant this production really is and if PEMEX’s financial independence are more important are crucial. Production goals are always considered a function of the state’s short-term fiscal needs, instead of the actual relevance they might have to the goals of the company as an entity,” he said.

 

Refining

AMLO’s argument on the logic behind the Dos Bocas refinery has been simple: With a new refinery, the country will be able to refine its heavy sour Maya crude at home and stop sending it to the US for processing before buying it back. It will supply the national gas market and is another step toward self-sufficiency, he says. But industry stakeholders have questioned its value, given the original US$8 billion budget that has already grown by almost US$1 billion with 22 months of the project remaining. Mexico already has a refining system made up of six refineries, but those are dilapidated and have consistently performed under 50 percent capacity. If replenishing reserves and increasing production is key, would federal funds not be better used there?

“The government has concentrated its policy around one project: The Dos Bocas refinery,” said Enrique González, CEO and Co-Founder of Mexican maritime logistics firm Nautech. “The real problem is in exploration and production. The cheaper and more efficient we are at producing oil, the more our (and PEMEX's) margins will be.”

 

Looking Ahead

In October, Octavio Romero said that PEMEX would produce 1.94MMb/d by the end of the year and 2.296MMb/d by the end of the president’s administration. Private companies, meanwhile, were producing 112.946MMb/d on Oct. 1, according to government data, and should produce 250MMb/d by 2024.

Those outside of the industry may wonder why oil production has not jumped to the levels the Energy Reform promised when it was enacted.

“If we compare the promises that were made back then in regard to where the Energy Reform has led us today, then the results are not very flattering. These promises included production levels of up to 3MMb/d by 2018,” noted Fluvio Ruiz.

But, as Ruiz went on to say, “the promises that were made simply could not be fulfilled.”

The president is right to criticize the progress of the Energy Reform considering the production figures, among others, that were cited as reasons for its enaction. But with PEMEX’s rising debt and lack of expertise in deepwater fields, it would seem that private support could contribute to levering the industry to benefit Mexico’s national economy. The government receives almost 74 percent of profits that private projects generate, whether that be via royalties, taxation or other means.

If Mexico is to reap the rewards of private involvement, then the country should hope that the public and private sectors can find a more peaceful coexistence soon.

Photo by:   Gobierno de México
Peter Appleby Peter Appleby Journalist and Industry Analyst