Pemex Explores New Opportunities

Q: What are the main tasks and responsibilities of PEMEX’s Alliances & New Business division?

A: The Alliances & New Business division of PEMEX opened in July 2015. The Board of Directors authorized the creation of this unit with the purpose of providing support to PEMEX’s business lines by financially structuring the new toolkits provided by the Energy Reform. Our role is to work with the company’s various divisions in order to implement the new forms of associations and contractual arrangements resulting from the reform. This will attract new investors and allow us to use our assets in an improved and more efficient manner. We promote partnerships with other companies in order to bring three key elements that will help PEMEX evolve: technology, capital, and execution capacity.

Q: Why is it important to put in place all of the new contract types simultaneously, especially given the fact that it is the first time PEMEX is doing something like this?

A: When González Anaya was appointed by President Peña Nieto, he gave two instructions, one of which was to implement all the new tools granted by the Energy Reform as quickly as possible. All of these tools are new to us, and we have yet to experience the relative speed and efficiency of each one. PEMEX has the capacity to engage in different initiatives simultaneously, and in fact we have always done so. We can afford to experiment with all the strategies at once because we are only testing each in a small amount of fields, which we treat like pilot projects. If we were to test these schemes with all available fields, then we would admittedly face a priority problem. One of our tasks is to start implementing all of the strategies so we can get to know them and develop the different processes for their rapid implementation. We prefer to build all processes at the same time, as it will be easier to increase the use of each procedure when we know which works best, rather than doing them one by one.

Q: What are some of the new business models that PEMEX will benefit from?

A: Even though the E&P area remains the most attractive, we want to concentrate on implementing the new tools brought about by the reform in this business line, including farm-outs, farm-ins, JVs, and joint bidding agreements. These will allow us to reap even more advantages than before. In addition to the traditional farm-outs, farm-ins, and contract migrations, the law also gives us the possibility to create new contractual arrangements. One of the available options is to redesign service agreements in which we do not necessarily have to go all the way to a farm-out, but we do not have to go to a service agreement either. We can be somewhere in between and have incentivized production contracts or profit-sharing contracts in which PEMEX can transfer part of the risk to a third party. The risk-based service contract is a new and particularly interesting legal mechanism that allows PEMEX to share risks and rewards without giving up operatorship. We can rely on an external party to bring funding, technology, and capacity. This is the additional legal mechanism brought by the reform that allows PEMEX to have a service contract structured according to its preference. We can now share operations risk, as well as other types of risk, and the investors can obtain compensation.

The main opportunity lies in the flexibility to implement new arrangements. We are looking into designing these and filtering them with the authorities, including CRE, the Ministry of Energy, and the Ministry of Finance, to make sure that we comply with the law. Just like it is done around the world, Mexico can now tailor a contractual arrangement to a specific field, according to the nature of the field and the company’s capacities.

Q: How do you decide what new tool provided by the Energy Reform you will apply to each individual field?

A: If you think of a field in the simplest possible way, it has two main characteristics. The first characteristic is the size of the field, which strongly impacts decision- making processes. The bigger the field, the more money it requires. The second characteristic is the complexity of the field, which refers to the level of risk and difficulty involved in the extraction of hydrocarbons. When deciding upon the type of contract each field will be offered with, we will consider these two variables. Complex and large fields will usually be offered as a farm-out because PEMEX does not have the capital, technology, or the experience to develop them alone. We should only keep the fields that we are experts on, such as shallow waters, as we are internationally recognized for our leadership in this area, as well as the ones that have a strong potential to increase national production. There are also some fields that are not in the interest of PEMEX but would be attractive for investors, such as small-scale fields. These can be complex, like non-conventional fields, which are also costly and require a team approach.

Q: Why has the industry experienced so many delays when it comes to the migration of contracts?

A: The reform allows for many new schemes. CIEPS and COPS are some of them, although these were implemented under the old law. Those contracts worked well in the previous legal environment. We are now trying to stretch the law to see how much risk could be transferred to another party, as the reform gives us an additional inch of legal flexibility. According to the new law, all CIEPS and COPS can be migrated to a production or profit-sharing contract. There is a process that has to go through the regulators, and we are currently in the midst of it, after which we will face three critical steps. Firstly, both parties must want to migrate. If this is the case, we change from a traditional service contract, where PEMEX bears all the risk, to a new contractual arrangement where the risk is shared between both parties. We have to decide how much to invest in a given field and ensure that everyone, including the state, gets a bigger share. If we have the agreement and there is a good business proposition for the government, then we can invest more together, and the authorities will allow us to migrate the contract. Instead of PEMEX paying the service contractor, we will simply share the profits of the additional production that comes from the field.

There are a few factors that have caused the delays experienced in the contract migration area. Firstly, PEMEX is expected to have a final agreement with its counterpart. It is the first time that we are migrating contracts and we realize that we underestimated the time required to perform this transfer. We now better understand the path and have engaged in a constructive discussion with the regulators to increase the efficiency and speed of this scheme, both for the contactors and PEMEX. Hopefully, we will be able to carry out the first migration in 2016.

Q: In which areas will PEMEX find the most attractive opportunities?

A: Since PEMEX was created in 1938, our mandate has been to cover the entire value chain, regardless of our preference or capabilities. Now that the Energy Reform is

in place, we can choose whether or not we want to be in a certain business, and we can choose which areas to focus on. We are currently evaluating all of our activities, trying to understand what areas are worthwhile for us, and I believe we may end up concentrating on fewer business lines.

The area that provides PEMEX with the most opportunities is certainly the E&P division. In PEMEX, just as in most
integrated oil companies, E&P is the most profitable unit. The NOC has typically dedicated 80% of its budget to this this area. Admittedly, the risk associated to E&P is higher, but so is the expected return. It might thus sound contradictory that PEMEX’s E&P division was hit hardest by the budget cuts, but in fact areas with the most budget see the biggest reduction when a budget is slashed. We are not trying to send a signal that we are less interested in E&P, as this allocation of CAPEX is simply natural. It is also important to keep in mind that the Energy Reform allows us to bring in external capital, which will not only compensate for that budget deficit, but will also provide 321 us with a larger spending capacity than we had in the past. When entering a new JV, PEMEX offers its fields, expertise, operational capacity, and existing infrastructure. Our partners will bring in capital, execution capacity, and technology. Combining these capabilities will transform our business into a larger one.