David Enríquez
Goodrich, Riquelme y Asociados
View from the Top

Readjusting Inflated Expectations for R1-L04

Wed, 01/20/2016 - 17:19

Q: What were the factors behind R1-L03’s 100% allocation rate, and is this the best measure for success?

 A: Like in any other phase of Round One, success is multifactorial. The winning bidders of R1-L03 can be divided into three categories in terms of experience. There are the operators of various nationalities with experience in different jurisdictions, who offered a 35-50% additional royalty rate and were able to leverage their economic propositions particularly well thanks to their experience. As for the remaining bidders, we can divide them into two further categories. There are the oilfield service companies, such as Diavaz, with decades of experience in the market that have partnered with funds and will be running nonsophisticated assets with a relatively low level of investment. The 85-95% royalty rates should not hinder these firms from being successful in their undertakings as they know how to be efficient in the way they structure their organization. The final category of bidding companies, however, may seem more unreasonable in submitting proposals, with no prior experience in the fields they were awarded and should thus be more cautious than the aforementioned companies when it comes to operations and controlling their cost structure. A proposal of a 90% royalty rate added to the rest of the fiscal obligations leaves the companies with payouts of over 100%, which makes no economic sense. Unlike major NOCs or IOCs, these companies cannot subsidize this project or cover the losses using other, more profitable undertakings. In all cases, the level of revenue that companies can generate from R1-L03 blocks is substantially low, and I am particularly skeptical when it comes to the success of this latter category. I believe the winners will be those that were awarded the larger blocks, as they have experience as oilfield service providers and have the necessary knowledge to substantially reduce costs.

The economically unsound bids were made possible because of the absence of a maximum restriction as to the economic proposal. Bids were only required to be lower than 100%, as such a figure would be unrealistic. Companies were allowed to bid as long as they passed the prequalification standards, which were much lower in R1-L03 than in the previous phases. These results left an atmosphere of frustration for many players within the market, particularly the experienced operators. These had the level of sophistication and technology necessary to efficiently control the awarded assets and create value for the country, but were not awarded any blocks at this stage. This frustration does not negate the prospect of their participation in further rounds, and in fact, they are the most appropriate companies to engage in the production of heavy oil.

Q: What should be done to ensure that companies bidding in R1-L04 will create value for the economy and what impact should Mexico realistically expect?

A: Bidding phases cannot be compared, as each of them is completely independent, and the success of one does not guarantee the success of the others. Companies that will participate in R1-L04 are robust companies with a high level of sophistication, market share, and market capitalization. Although the vast majority of participants will be IOCs, a small amount of NOCs may enter the tender, but the prequalification standards will be nowhere near as low as those of R1-L03. The good news is that potential participants will have sufficient time to review not only the geophysical data but also to make comments on the various components of the tender.

When it comes to the impact on the economy, there is a misconception as to the outcomes of R1-L04. Mexico’s deepwater market will be mainly controlled by Houston, despite the national content element. Rather than direct investment into the country, it will bring money to the Ministry of Finance in the form of royalties, which will not impact the economy as a whole as much as the public expects. The main factor causing this is the geographical location of these blocks. Whereas onshore fields are in direct interface with the Mexican economy, calling for direct investment for the construction of roads, hotels, restaurants, and other infrastructure, deepwater fields are offshore and require global procurement. The latter blocks will have semi-submergible rigs and vessels from different jurisdictions around the world, but will be mainly controlled from Houston both in terms of the economic model and business structure, and of the real implementation of the project. Despite these financial specificities, R1-L04 will bring considerably more investment into Mexico than R1-L03. In order to compensate for the relatively low direct impact of R1-L04 on the Mexican economy, the government will be tendering fields that have a direct interface with the local economy, including heavy oil, onshore, and shallow water.

Q: How will the local content requirement work on a practical basis, and do you believe it will impact the decision of IOCs to enter Mexico?

A: Local content requirements are divided into two main categories. The first category is for deepwater activity and is determined in the structure of the bid, and the second category will be applied to all other block types. Although this tertiary regulation indicates who has to comply with it, and how it has to be reported, there is a need to further develop the components of this requirement, as the industry does not yet understand its nuances. So far, it is clear that compliance does not necessarily have to be met from the beginning of the project, but rather throughout its lifecycle, as has been the case with PEMEX’s COPS and CIEPS. The authorities need to bring clarity in terms of how this should be done. Compared to any other country, and particularly Brazil, local content requirements in Mexico are not a challenge. No IOC has expressed criticism toward Mexico’s approach to local content, only toward a lack of information when it comes to compliance methods.

Q: Why is it important for Mexico to carry out the unconventional resources round, and to develop this resource?

A: I am certain that Mexico’s unconventional resources will be developed at some point, but one has to take into consideration the impact of the dramatic drop in oil prices, as well as the way in which it will impact the country in the long term. This latter consideration will be essential to determining the occurrence and order of the remaining phases. It would be disastrous if Mexico decided to go ahead with a phase and there were no bidders because of the oil prices. In this regard, it is important to be pragmatic, not dogmatic, and to consider each phase of Round One separately, as each one is a planet in itself.