Providing Eagerly Awaited Answers About Round One

Q: Why was the production-sharing contract model selected for the first phase of Round One?

A: For the first phase, we evaluated different types of contract models such as licenses, production-sharing contracts, profit-sharing contracts, and service contracts. We chose the production-sharing model as it seemed the most attractive option for both the companies and the State. This contract model aims to strike a balance between our two main objectives: to make Round One attractive for the industry and to ensure that the government gets a fair return. Moreover, this contract model has proven successful in the industry worldwide. From an implementation perspective, we expect the State’s revenues to flow evenly over time. We are not trying to bank on the contract from the outset precisely because we want to ensure that these contracts remain competitive through price fluctuations and different administrations. Contracts can last up to 35 years, with a 25-year period set at the start and two possible five-year extensions. We will start reimbursing companies only when oil production begins.

Q: What are the highlights of the feedback you received from companies participating in Round One?

A: Companies showed great interest in the first phase despite the low oil price context. In addition, the registered companies are greatly varied, ranging from the majors that we knew would be interested to other smaller companies from around the world. Mexican companies are also beginning to establish consortiums. Regarding the second phase, which covers development fields with certified 2P reserves and many with certified 1P reserves, we are offering nine fields grouped in five contracts. By April 30, 2015, 23 companies had already shown interest, 22 companies had requested access to the Data Room, 17 had already paid their access fee, and seven started the prequalification process. The first and second phases will be awarded on July 15 and September 30 respectively.

Concerning the contracts, certain adjustments have been made following the strategy we have used throughout the Energy Reform. We have been studying international best practices, what has and has not worked elsewhere, and we have listened to the industry. From December 2014 when we presented the first contract to February 2015 when we presented the second one, we made adjustments based on three main aspects. Firstly, certain legal advisors were recommending their clients not to invest in Mexico as the contract lacked legal considerations for administrative rescission and corporate guarantees. However, these considerations were established in the Hydrocarbons Law. Therefore, we used the same rescission clauses outlined in the law and incorporated them in the contract. The original draft of the contract was intended to be slim and easy to read, as a fundamental part of the agreement is that companies understand the law. However, we later realized that, in order to have enough certainty, the companies expect what is written in the law to be clearly outlined in every agreement. Therefore, we included the law in the contract. A cure period and certain procedures are now defined while only CNH’s board can make unilateral decisions regarding a contract being rescinded. Furthermore, corporate guarantees were initially connected to the parent company. This raised some concerns amongst certain companies, especially the larger ones. Hence, we established that the guarantor could be either the parent company or a subsidiary with a net worth of at least US$6 billion. Other issues had to do with the contract’s fiscal terms and red tape. Some companies were concerned that too many authorizations needed to be filed, resulting in an excessive administrative workload. We again reviewed the law in order to simplify the procedures, extended some of the filing periods, and included deemed approval clauses. Finally, regarding the fiscal terms, companies saw that as their profits increased, the terms would very rapidly switch in favor of the government. Therefore, the Treasury finetuned the adjustment mechanism to make sure that reasonable profits will flow to the companies before the terms revert to the benefit of the State.

Q: There is a great need for transparency and speed at the same time. How will you make sure that the bidding process stays on track?

A: This is part of the reason behind the delay in the original schedule. We were overly ambitious in what we wanted to achieve. Moreover, transparency is a fundamental part of the Energy Reform. In order to succeed and have full support of the Mexican society, we have to be completely transparent throughout the process. This is why we have put in place procedures that can make companies that are used to doing business in other parts of the world feel somewhat uncomfortable. Everything about the Energy Reform will be made available on the Internet and done in the public eye. There is no direct interaction between CNH commissioners and the companies participating in the bid. Some companies have complained about this but we will not negotiate terms and conditions with anyone. It is true that complying with all these transparency rules can be challenging. CNH’s commissioners are sometimes under a lot of stress because companies want to meet with them and they have to decline. This applies not only to the commissioners but to all the staff working at CNH. Nonetheless, while the government is learning, companies also need to learn how to manage this process in Mexico.

Q: What were the main criteria you considered when structuring Round One?

A: We need to increase national oil production and the reserve replacement rate, and we need to do it fast, as the Mexican oil production is rapidly declining. We did not choose to embark on a Constitutional Reform to be fashionable, we did it because we have to increase our production. For Round One, we put forward a varied portfolio that includes opportunities for different types of players. Regarding the order of the bids, we agreed to start with shallow waters for two reasons. First, it will be easier and faster to extract hydrocarbons from shallow waters. Secondly, companies and industry analysts see the Perdido area as the jewel in the crown. We will offer onshore fields in the third phase, which includes mature fields. However, we must ensure that the selected areas are not only geologically attractive but also that the socio-political conditions are right for the fields to be developed. This entails conducting social impact assessments and ensuring that this is done before the contractors begin negotiating with the landowners. Extra-heavy crude areas will be included in the fourth phase, which will offer certified reserves but will also pose greater challenges. As for unconventional resources, when we originally defined Round One in August 2014, oil prices were at around US$100 per barrel. That is why we included unconventionals, in particular shale and tight oil in Chicontepec, which also has good access to infrastructure. In the current price environment, we need to re-evaluate the financial feasibility of these projects. Finally, SENER will be presenting a five-year plan for exploration and extraction activities and bidding rounds to send a signal to the industry.

Q: What are the critical success factors to ensure that production starts by 2017 in the shallow water production blocks in the second phase of Round One?

A: Mexico’s production level is expected to increase by approximately 126 million b/d resulting from the fields included in the second phase of Round One. To achieve this, the first priority is to allocate the fields. We further expect that companies participating in the first phase will establish synergies with players in the second phase. The third phase will focus on mature and abandoned onshore fields, where we are also expecting to rapidly reach first oil. Mexico has over 800 mature fields of which 300 were allocated to PEMEX in Round Zero, while the rest was kept for future licensing rounds. Two types of fields will be included in this phase. Some will be large mature fields, which are currently closed as it was more financially attractive for PEMEX to invest in Cantarell. The others will be smaller mature fields with potential production ranging from 100-50,000b/d, where we hope to see Mexican companies show an interest.

PEMEX’s farm-outs are also expected to contribute to the increase in production. The company must now comply with the stated calendar. For example, Exin and Bolontiku could be put up for tender in parallel with the second phase of Round One. We believe that, as we get more information about the areas that PEMEX will put forward for farm-outs, investment and technology will follow, resulting in an increase in oil production. This also means that two different types of contracts will be needed. One of them will be directed at smaller fields and Mexican companies, as it happened in Colombia. The other will be tailored for the bigger fields, where we expect larger companies to rapidly start producing.

Q: What results would make Round One a success?

A: We can define success in two ways. Firstly, that Mexican government and society get a fair share of whatever is awarded. Secondly, that in five to ten years, these contracts are still in operation and there have been no major challenges surrounding them. This would be a success as it would mean that companies got what they expected and that Mexican society is getting what it deserves.

Q: Could success also be defined by the production levels seen in the future?

A: Yes, it can be defined by increased levels of production and replacement of reserves. Success would also mean that we are developing our fields in a sustainable manner as we do not want to extract the last drop of oil as fast as we can. Success would be for Mexico to reach a level of production that allows it to satisfy its internal needs. We are still aiming to increase production by about 500,000b/d before the end of this administration in 2018. We are confident that Round One and PEMEX’s farm-outs will enhance our production capacity and help us achieve the 2.8 million b/d goal.