The Pros and Cons of Mexico's Contracting Model

Multiple debates have lead to diverse opinions on how to successfully capitalize on the experiences of Brazil and Norway’s energy sectors. However, in order to achieve a comprehensive reform that is beneficial to Mexico, there needs to be an in-depth analysis of the economics related to oil exploration and production projects, as well as a general understanding of existing international legal frameworks.

The pros and cons of each contracting model depend greatly on the development challenges of a country’s reservoirs. Concessions and joint ventures tend to be used more frequently when a substantial exploration program is required That creates a need for the diversification of the high geological and developmental risks. On the other hand, countries such as Mexico tend to use service contracts for oil production, given the presence of reservoirs with low geological and development risks, combined with a strong knowledge base gained through a long history of operation. These contracts stem from the premise that the private service provider will assume a low level of risk and uncertainty and, therefore, needs to be compensated only with a service fee. It is also relevant to mention that, on an international level, there is no precedent of using service contracts for the development of deepwater or shale gas.

The wide variety of priorities and development challenges that the global oil industry have led to the creation for a range of contracting models, of which the most widely used is the concession model. At present, 60 countries use concession systems, 20 use joint ventures, 41 work under the production sharing agreement (PSA) model, four use service models, and 16 work with hybrid models. Anglo-Saxon countries tend to work with concession models, African and Asian countries usually prefer PSA frameworks, and models used in Middle Eastern countries tend to vary significantly.

Brazil uses a hybrid model, by a concession framework is in place and a PSA model is about to be implemented for the country’s pre-salt deepwater reservoirs. It is important to note that the structure of the Brazilian model is extremely open but maintains a public-private modus operandi. In fact, Petrobras could be classified as a national champion with access to private investment, since it combines federal and private resources, operates as a private company, and is listed on the Stock Exchange; nevertheless, the State keeps control of the majority of the voting stock.

What model is Mexico considering implementing through its Energy Reform? The answer is simplified when we look at the 54th commitment in the ‘Pact for Mexico’, which states: “The nation will keep the ownership and control of hydrocarbons and of Pemex as a public company through the state. In all cases, the nation will receive the totality of hydrocarbon production.” The first statement of this pledge eliminates the possibility of using concession and joint venture models, and the second statement also prohibits the use of PSA models.

While this might imply that the energy reform will focus on looking for more sophisticated service contracts, it also leaves open the possibility of using a hybrid model, such as the one that Venezuela developed two decades ago: a riskbased exploration model, also referred to as a shared profit model. Along the spectrum of di†erent types of development models, these risk-based exploration contracts are located in between PSA models and service contracts. They establish the necessary incentives for e·cient exploration and production of oil resources by private companies, and allow for the maximization of oil income for the country.

The most feasible outcome of the energy reform will therefore be the creation of new service contracts, applied to oil production in mature fields, onshore, shallow water conventional reservoirs, and risk-based exploration models for unconventional reservoirs, such as shale gas and deepwater fields. But the success in the implementation of this new business model and of e·cient management for the industry requires the energy reform to clearly define the division of responsibility between the Energy Ministry, CNH, and Pemex.

MODELS FOR PRIVATE PARTICIPATION IN E&P

Concession agreements: private operator has ownership of both reserves and production.

Joint venture: state and private operators are coowners of reserves and production.

Production Sharing Agreement: state is owner of the reserves but production benefits are shared with the private operator.

Service contracts: state is owner of both reserves and production, while the private operator receives compensation for services provided.