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Analysis

The Year in Review

By Peter Appleby | Tue, 01/21/2020 - 10:04

The long transition period between the election of Andrés Manuel López Obrador on July 1, 2018 and his formal inauguration into the presidency on Dec. 1 2018 hung heavily over Mexico’s oil and gas industry. During his campaign, the president had promised to revise contracts signed between CNH and private companies awarded from Rounds 1.1 to Rounds 3.1, held between 2015 and 2018. In December 2018, CNH formally canceled the Rounds 3.2 and 3.3 while in June 2019, the long-awaited suspension of farmouts became official.

Outside of oil and gas, the new administration also signaled its intent to make changes to the economic direction taken by its predecessor and its willingness to halt megaprojects already in development. In October 2018, before the official start of the new government, a national referendum was held on the construction of the New International Airport for Mexico in Texcoco (NAIM), State of Mexico. Despite a low voter turnout of less than 1 percent, the decision was taken to abandon the original Texcoco airport, already well underway, in favor of expanding a military base in Santa Lucia, State of Mexico.

While these changes caused ripples of uncertainty throughout the oil and gas industry and the economy at large, private contracts were reviewed and remain untouched. Merlin Cochran, Director General at AMEXHI, an association representing most of Mexico’s largest operators, underlines the point: “In the last year, a new federal government was elected but none of the long-term contracts that our 43 members signed have changed. These contracts last between 30 and 40 years and the government’s commitment remains exactly the same,” he says.

NEW LEADER, NEW VISION
While contracts and legal frameworks remained untouched after López Obrador came into power, the personnel directing the industry’s agencies and regulators were completely changed. Rocío Nahle García, an experienced chemical engineer who held a number of prominent positions in the oil and gas industry, including within PEMEX, was appointed to head the Ministry of Energy. Miguel Ángel Maciel Torres, a petroleum engineer with over 30 years’ public sector experience and the Vice President of New Business Development for PEP between 2016-2017, was appointed Deputy Minister of Hydrocarbons at the Ministry of Energy.

Meanwhile, Octavio Romero Oropeza, an agronomy engineer with long political experience, was appointed as PEMEX Director General. The appointment was met with mixed feelings from the industry, amid questions regarding the suitability of Oropeza’s background. The administration’s new strategy for PEMEX was crystallized when its new slogan was unveiled: Por el rescate de la Soberanía (For the Recovery of Sovereignty). The slogan placed PEMEX’s revitalization as the central lever for the propulsion of Mexico’s flagging energy sector and was subsequently marked as such in the government’s National Development Plan 2019 – 2024.

The oil and gas industry’s main regulating bodies also saw change at the top. In November 2018, Juan Carlos Zepedaresigned as President of CNH and Héctor Acosta left his position as CNH commissioner to take a position in the state of Chihuahua government. Gaspar Franco, a commissioner that was sworn in for six years in 2016, also departed in February 2019. Alma América Porres Luna, Héctor Moreira Rodríguez, Sergio Pimentel Vargas and Néstor Martínez Romero continued in their positions as CNH Commissioners, while on Nov. 7, 2019, Rogelio Hernández Cázares was sworn in as the new CNH president. On Aug. 12, 2019, Luis Vera Morales resigned from his position as director of ASEA. In November 2019, José Ángel Carrizales, a trained chemical engineer, took over the directorship.

BIDDING ROUNDS, FARMOUTS
The government’s suspension of Rounds 3.2 and 3.3 and PEMEX farmouts set the stage for its first few months in office. While the logic of this divergent approach was questioned by the private sector, the move was seen as another step in President López Obrador’s plan to recover PEMEX’s position.

América Porres is clear that this step was supported by the industry’s regulatory body. “While future bidding rounds have been put on hold, this in no way represents a negative development from CNH’s perspective. In fact, we see it as a positive for Mexico. Unfortunately, what had become evident in the last few years was that while PEMEX’s technical, administrative and project execution capacities met general standards, its financial capacity lacked support. This unfortunately resulted in PEMEX’s struggle to meet its goals and objectives for a number of its projects, among them the Round Zero assignments,” she says. “The new policy calls for the reversal of these budgetary limitations and greater fiscal support for the NOC. The majority of the commissioners have a positive view of this policy and how it allows PEMEX to plan its working strategy.”

However, from the perspective of a competitive and globalized oil industry, these suspensions have potentially negative consequences. As John Padilla, Managing Director of IPD Latin America, notes, Mexico “is competing for investment in the global market where other jurisdictions, like Angola or Argentina, are becoming more attractive.” Similarly, Ruben Cruz, Head of Energy and Natural Resources at KPMG in Mexico, explains that the government’s shortterm objective to stop falling production rates must be aligned with medium and long-term goals, the grounds for which, he says, must be laid now. “It is important to note that the medium and long-term trends are much more important in this industry. We have seen this previously in Mexico, where an exclusive application of short-term measures leads to increases that cannot be sustained and are inevitably lost to another decrease,” says Cruz.

FINANCIAL CONCERNS
The financial health of PEMEX has been a constant concern over the last several years. Mexico´s Superior Audit Office (ASF) stated that during the presidency (sexenio) of Enrique Peña Nieto, PEMEX debt spiraled by 146.6 percent and led the NOC to become the world’s most-indebted oil company. As of 2019, its total debt stood at US$99.6 billion. An estimated US$44 billion of debt is due to be paid off in the next four years while rising pension payments present future fiscal challenges to overcome. 

PEMEX’s heavy tax burden has restricted the NOC’s ability to invest into a variety of vital issues, including maintenance of the National Refinery System and, principally, exploration to revive flagging reserves. The deleterious significance of this was highlighted in the PEMEX Business Plan, which stated: “The high tax burden constitutes the most serious structural problem that PEMEX faces.” Fitch Ratings, one of the two global ratings agencies that downgraded PEMEX’s outlook this year, summarized the cost of the still high tax burden on the company’s ability to fund more exploration and restock the country’s 3P reserves, which fell from 25.85 billion boe in 2017 to 25.10 billion boe in 2019. “PEMEX’s exploration and production CAPEX for 2017 and 2018’s budget of US$4.5 billion and US$4.3 billion, respectively, was not enough to replenish annual production of approximately 1 billion boe,” noted Fitch. IPD Latin America’s John Padilla echoes Fitch’s concerns on Mexico’s immediate oil and gas future: “The long-term outlook for Mexico’s oil and gas sector is extremely positive based on the major discoveries that have been made by private sector companies over the past couple of years. Nonetheless, the short to medium-term outlook, depending on policy decisions made, is rocky,” he says.

The administration sought to combat the negative consequences on both PEMEX and the Mexican economy from the perilous financial situation of the national oil company. In its 2019 PEMEX Business Plan, the NOC stated it had “executed a series of actions intended to reduce the company’s tax burden, fortify its financial position and define the projects on which the recovery of its productive capacity will be based.” As part of these measures, the administration is lowering the PEMEX tax burden from its current 65 percent to 54 percent by 2021, a saving of MX$128 billion (US$6.6 billion) for the NOC. During this time, a further MX$141 billion (US$7.3 billion) will be invested. This investment is destined for exploration activities. Other positive milestones for the company’s financial outlook announced were the refinancing of US$8 billion of the company’s debt with the assistance of 23 banks in June, and September’s US$5 billion debt repayment.

PEMEX CONTRACTS CHANGE DIRECTION
As part of the new economic and energy outlook, the government is pouring money into the development of new fields. According to Ulises Hernández Romano, Director of Resources, Reserves and Associations at PEP, these new fields will help increase the NOC’s reserves by 35 percent and address the major criticisms of analysts and financial ratings agencies. PEMEX is set to develop 23 new fields from the second half of 2019 and into 2020, which are additional to the 22 set out in the National Exploration and Production Plan. While 19 exploratory PEMEX drills were completed in 2018, 50 were intended to be drilled by the end of 2019, and a further 300 wells drilled on fields already in production, according to the PEMEX Business Plan. The new field developments will be managed through a new contracting modality, the Integrated Exploration and Extraction Service Contracts (CSIEE). This model will allow PEMEX to contract companies to drill and prepare the new fields ahead of the production phase, including essential infrastructure from service providers. The PEMEX Business Plan states that between 2020 and 2023, 40 CSIEE contracts will be assigned.

The new contracting modality appears to reduce PEMEX´s financial burden, both in terms of CAPEX and OPEX, of a field’s development, while permitting PEMEX to remain as the operator. The PEMEX Business Plan outlines the principal characteristics of CSIEEs. The first noted is that “the service provider assumes the total investment and costs of the operation during the duration of the contract,” while the second states that “PEMEX maintains the control of the operation and its position as signatory.” Under the CSIEEs, contractors will be paid by calculating a US dollar fee per unit of hydrocarbon produced.

The CSIEE model is still under public consultation and it is therefore too early to see the definite interest that major private players may have in involvement. However, operators within Mexico, including Diavaz, have expressed interest in participating in the new PEMEX projects. Yet former CNH Commissioner Gaspar Franco believes the new contract model is far from certain to be a success. “This is an available option for oil 

companies that participate in the sector. However, the big companies will not want to participate in that way. This was demonstrated with the 2008 reform, in which the socalled Contratos Integrales de Exploración y Extracción were allowed: large operators did not participate.” 

GREENLIGHT FOR DOS BOCAS REFINERY
The decision to build a new refinery in Dos Bocas, Tabasco, was among the most far-reaching decisions the new administration made last year. At an expected cost of US$8 billion, it was also set to be one of the most expensive. While the project will certainly generate business along the supply chain – government approximations suggest up to 135,000 direct and indirect jobs will be created – questions were raised over the viability of meeting the three-year deadline and proposed budget for a project of this size. As of October, five of the six construction packets have been awarded: Flour Enterprises and ICA Flour (Packet 1), Samsung Engineering y Asociados Constructores DBNR (Packets 2 and 3) and KBR together with Grupo Hostotipaquillo (Packets 4 and 5). SENER will oversee project management responsibilities. 

Dos Bocas is part of the National Refinery Systems’ (SNR) MX$12.5 billion (US$647 million) refurbishment plan and a means to bolster the country’s energy security by decoupling the satisfaction of its energy demands from the importation of refined products. With an improved refining capacity, Mexico will be able to reduce the import of refined fuels, which recently rose to account for 77 percent of the national fuel supply, as well as reduce the export of crude for refining in international markets. Once completed, Dos Bocas will refine solely 22°API Maya crude and have a capacity to process 340Mb/d to produce gasoline and diesel for consumption in Mexico. However, considering the shortage of crude being supplied to the National Refinery System, the decision to fund an expensive larger refining plant with money that could address other underfunded areas of PEMEX has been questioned: “the Dos Bocas refinery will be part of a plan to increase national refining capacity over the 1.4MMb/d of crude that our six refineries are theoretically able to process once revamped and working at full capacity, but only 600Mb/d of crude production is available to input into this system,” says Rubén Cruz, Head of Energy and Natural Resources at KPMG in Mexico. Additionally, the work that will have to be undertaken to restructure national financial processes themselves based on the export of crude will be onerous. The shift from export to in-country refining will be complex, regardless of the increased revenue that it should deliver. “We have been an oil exporting country for a while, which finances a significant percent of our public expenses. As a result, reducing crude oil exports is not a simple matter, regardless of how much we may want to be self-sufficient in our production,” adds Cruz.

PRODUCTION PRESSES ON
From January to September 2019, crude oil production, from PEMEX and private operators averaged 1.675MMb/d while average natural gas production from PEMEX and private operators stood at 4.857Bcf/d. August and September, however, showed marked improvements on the rest of the year, driven in part by the entrance of private industry into production. Natural gas, meanwhile, showed an overall improvement on 2018’s 4.857Bcf/d average.

There is much more production to come from PEMEX. The development of at least 20 new priority fields and untapped capacity generate a strong medium and longterm outlook for the NOC once short-term difficulties are overcome. Nansen Saleri, CEO of QRI Group, describes PEMEX’s outlook as extremely positive and notes that with so few secondary recovery technologies applied to Mexican wells, there is likely more to come. “It is in a favorable position due to its abundant resources. It has approximately 320 billion barrels,” says Saleri. “Of that, I would say that Mexico has produced less than 25 percent.”

According to AMEXHI, private players’ investment into exploration and production activities in the first half of 2019 hit US$9.63 billion, and Cochran is clear of the role that private companies will play: AMEXHI’s Five- Year Plan targets 290Mb/d production by 2024,” he says. Similarly, John Padilla believes that based on the discoveries made this year, “private sector oil production will account for over 300Mb/d by the end of President López Obrador’s term. One of the major success stories of the past 12 months was Italian company Eni’s success in the shallow water Miston Area 1 field off the coast of Campeche. The field, won in Round 1.1 in 2015, entered production on July 2 with an initial production of 15Mb/d that is expected to become 100Mb/d by 2021. Though 2019 activity was dominated by ongoing exploration and some pre-production works, this private sector success was a welcome and positive sign. Fieldwood Energy and Petrobal announced that the Pokoch and Ichalkil wells drilled on its Block 4 will be producing 20Mb/d in 2020 with an expected peak flow of 100Mb/d and 120MMcf/d of gas. To hit this target, Fieldwood will invest some US$700 million for Block 4’s development. Clearly, the private sector is well-placed to deliver oil production for Mexico. However, not all private players saw success over the past year. October 2019 was not a good month for private interests as Hokchi Energy announced it would be returning its entire Area 2, which was the first oil contract signed by a private company in Mexico, won in Round 1.1, to the state. Hokchi discovered a noncommercial amount of gas with its Acan-1 exploratory well, while the second well Yaluk 1, reported saltwater intrusion. UK-based operator Cairn Energy, in a JV with Citla Energy and Eni on Block 9, also reported that its Alom-9 well was dry and will be abandoned.

THE ZAMA SITUATION
The Zama oil field was discovered in July 2017 by operator Talos Energy, as part of a consortium with Sierra Oil and Gas, which was subsequently acquired by Deutsche Erdoel AG (DEA), and Premier Oil. The field in Block 7, won by the consortium in Round 1.1, was found by the first privately-held offshore exploration well in Mexican history, the Zama-1 drilled by the Ensco 8503 semisubmersible drilling rig, at a depth of 165m in the Sureste Basin area. The Zama field was hailed by industry analysts as one of the most important shallow-water discoveries of the last 20 years and in 2018, won the “Discovery of the Year” Award from the Association of International Petroleum Negotiators. The Zama field holds an estimated 400-800MMboe and the Zama-2ST well is expected to have a peak rate of between 150Mb/d and 175Mb/d of oil equivalent. On Sept. 4, 2019, CNH approved Talos’ request for a two-year contract term extension for its production sharing contract on Block 7. On Sept. 9, 2019, CNH also granted approval to Talos’ modified Block 7 exploration plan. Both of these events were intended to grant the consortium headed by Talos time to evaluate further prospects on its block. However, at the end of September 2019, international news agency Reuters reported that according to two former energy sector officials and two PEMEX executives, PEMEX was attempting to wrestle away control of the Zama field, which holds an estimated 400-800MMboe. Reports suggested this was driven by PEMEX having rights to drill in the adjacent area and, as the reservoir extends into PEMEX-operated areas, the NOC also had a say.

In the report, Minister of Energy Nahle said of the situation, “we definitely have to hold discussions with PEMEX, with Talos — another company that is there — to see who will take charge of the operation because PEMEX is playing a big part there.” The US Department of State Bureau of Energy Resources’ Deputy Assistant Secretary Kurt Donnelly told Reforma newspaper that the suggestions were a “disturbing development.”

On Oct. 10, 2019, the Talos consortium announced it would be handing back 50 percent the 464.799km2 Block 7 area to the state in accordance with Clause 7.1, paragraph B of the CNH-R01-L01-A7/2015 contract. While the consortium’s initial investment was estimated to be US$783 million, it will now continue its work on the smaller area with a further US$325 million for development, expected to begin before the end of 2019.

Concern over the sanctity of private contracts was increased when President López Obrador repeated the intention of his government to review all 107 exploration contracts signed since the Energy Reform by the end of the year. While this review was not yet concluded in November, the president’s rhetoric may revive the unease among private companies that was present during the new government’s transition period. If such revisions are to be done and alterations to contracts are demanded, a consequence could be a reduced desire from private companies to invest much-needed capital into a Mexican industry that is still evolving.

UNCONVENTIONAL POSSIBILITIES
The PEMEX Business Plan states that PEMEX owns 25 billion boe in prospective resources, of which 37 percent are in unconventional plays, including shale. CNIH data published in August 2019 shows that 8,457 of the country’s onshore wells, representing 43 percent of onshore wells, have seen hydraulic fracturing at some point in their history, though only 27 of these were drilled for unconventional resources. To date, these wells have produced 1.476MMb of crude oil and 12.038MMcf of gas representing 7 percent of Mexico’s historic production.Despite the historical use in Mexico of hydraulic fracturing, commonly known as fracking, President López Obrador has repeatedly pronounced his opposition. In October 2018, the then president-elect told a press conference in San Luis Potosi that he would not allow the use of fracking in Mexico. In June 2019, the president canceled PEMEX’s authorization to use hydraulic fracturing in the Humapa field, which sits across the states of Puebla and Veracruz. However, with Mexico’s increasing importation of natural gas from fracked fields in Texas, and the likelihood of other accessible resources along the border, the argument against fracking has weakened. CNH Commissioner Moreira noted the proximity to the world’s cheapest and most developed natural gas market, saying: “There are large parts of Mexico that have the potential to hold unconventional resources, including Tamaulipas, Nuevo Leon and Coahuila. Despite being beside West Texas, the state of Chihuahua does not produce a single drop of oil or gas due to a lack of exploration.”

América Porres explains that the approximately 67 percent of Mexico’s potential resources that have yet to be exploited are “in large part composed of deepwater and unconventional resources.” However, their use must first be negotiated. “Unconventional resources represent an everincreasing potential, as each new exploratory campaign seems to reveal higher and higher volumes of available resources in these types of plays, but the political and social tensions that surround them must be very carefully addressed.”

The government, despite its public rhetoric, appears to be taking this on board. In the 2020 Budget Proposal, over MX$10 billion (US$523 million) was requested for continued use of fracking of shale in areas including the Sabinas, Burgos and Tampico-Misantla basins, as well as 29 productive fields in Veracruz and Puebla.

Many operators are hoping to see a permanent change in the government’s approach to fracking. Among them is Renaissance Oil Corp., which operates the Amatitlán block, as well the Mundo Nuevo, Topén and Malva blocks in Chiapas. Renaissance Oil CEO Craig Steinke believes that fracking suffers from outdated views on the technology. While he accepts that fracking has in the past been a less environmentally-friendly method for hydrocarbon extraction, modern techniques have advanced tremendously. “The common criticisms are of older legacy technologies, which are being phased out. Less is known about the modern, clean techniques now used in the industry […] The advance in shale technologies over the last decade has made the fracking process far safer and cleaner,” says Steinke. The role unconventionals could play in securing Mexican energy sovereignty if permission for their extraction was granted would be huge. “The potential of unconventional sources in Mexico is world class. It is a national treasure and could become a shale play tantamount to the Permian or Eagle Ford fields,” he adds. “Unconventionals offer the quickest and most direct way to achieve the government’s goals of doubling oil production.”

Peter Appleby Peter Appleby Journalist and Industry Analyst