/
Analysis

The Year in Review

Wed, 01/18/2017 - 10:24

Mexico’s oil and gas revolution continued unabated in 2016 and through the first half of 2017. The country’s unfolding Energy Reform bore fruit across segments and resulted in historic firsts: the first deepwater round, the first farm-out and the first foreign IOC to strike oil in the country’s shallow waters.

There is no doubt that since 2014’s Energy Reform, the industry has undergone a profound transformation. The end of PEMEX’s near 80-year monopoly over the country’s hydrocarbon reserves and its transition into a productive state enterprise has resulted in far-reaching consequences for every part of the oil and gas value chain; from upstream exploration and production, to midstream logistics and downstream refining and gasoline commercialization, and all associated business services.

“I do not know how you cannot admire what has been happening in Mexico during the last two years. Very few countries have pulled it off in this fashion, at this rate, building this much momentum,” says Jorge Leis, Partner and Lead of Bain & Company’s Oil & Gas Practice in the Americas.

As well as each segment’s specific highlights, the Ministry of Energy updated its oil and gas energy policy in February 2017 to reflect changes in the industry since the document was first published two years ago. The overarching document, titled “Five-Year Plan for Exploration and Production of Oil and Gas Bids 2015- 2019,” announced a standardization of the process that dictates how Mexico’s oilfields are auctioned to private companies.

In completed rounds, the blocks involved were selected by the authorities and were of varying sizes. With the Ministry of Energy’s updated plan, the industry is granted the autonomy to nominate blocks, which will all be of a standard size depending on whether they are found in deepwater, shallow water, onshore unconventional or onshore conventional. Additionally, the revised plan outlined a new process for inviting companies to bid in rounds, which has now been simplified to two invitations to bid per year according to the type of areas and resources.

Invitations to bid on deepwater and onshore unconventional areas will be released in the first half of the year; shallow water and onshore conventional will be held in the second. The actual bidding will be carried out about six months after the invitation to bid is announced.

Welcomed by operators and hailed as “industry-friendly,” the changes to the FiveYear Plan demonstrate Mexico’s oil and gas authorities’ willingness to incorporate the voice of the industry into policy, which remains fluid as the Energy Reform continues to unfold.

“All this gives us a chance to think about scaling up our process so that through the nomination and standardization we can get to greater volumes of production and exploration,” says Aldo Flores, Deputy Minister of Hydrocarbons.

PRODUCTION GOALS

Increasing oil exploration and production is the main objective of Five-Year Plan, with a target of stabilizing PEMEX’s production at 2 million b/d. Flores believes this is already achievable. “The target for 2017 is around 1.94 million b/d, so with the private sector’s contribution to production we should reach close to 2 million b/d,” he says. He is backed up by the results of the deepwater round, which attracted an estimated investment of US$34.4 billion over the next 35 years from the private sector.

CRUDE OIL PRODUCTION 1Q17

TOTAL CRUDE PRODUCTION (million b/d)

The private sector’s participation is accelerating at an impressive rate. By March 2017, a total 4,329 miilion boe of the country’s prospective resources and 273 million boe of its 2P reserves had been auctioned off through Round One, representing 4.9 percent and 9.5 percent, respectively, of all available resources under state control. Should the process continue at the same rate, the ministry says, it would take between 20 and 40 years to get through all of Mexico’s identified resources.

CRUDE PRODUCTION IN DECLINE

One area of concern is Mexico’s crude oil production, which has been in decline for over a decade. In 2016 total production averaged 2.155 million b/d; a drop of 5 percent on year. Production of crude oil has seen a steady decrease since peaking at 3.383 million b/d in 2004.

“The only solution for PEMEX to reverse its 12-year production decline is to seize all the opportunities the Energy Reform offers. This involves seeking out private investment and productive partnerships,” says Ernesto Marcos, Founding Partner of Marcos y Asociados.

Until it fully takes advantage of the possibilities offered by the Energy Reform, PEMEX must face the challenge of the aging nature of the oil fields it has relied on most in recent years. The NOC saw a reduction of 9.1 percent in its total crude oil output in the final quarter of 2016 compared to the same period in 2015.

A 13.5 percent reduction in light oil is noted as a contributing factor to the over decrease That is put down to the natural decline of the NOC’s Chuhuk, Chuc, Ixtal and Onel fields from the Abkatún-Pol-Chuc asset and also the aging Tsimin field in the Litoral de Tabasco area. A 16.6 percent fall in super-light crude oil has also been cited, given the maturation and increase in fractional water flow at its Bellota-Jujo, Samaria-Luna, Macuspana-Muspac and Litoral de Tabasco areas. Heavy crude production also fell but less significantly, by 3.8 percent, given the fractured nature of Cantarell’s deposits.

Previously Mexico’s most productive oilfield, Cantarell’s production fell to an all-time low of 216,000mbd in 2016, down from a peak of 2.123 million b/d in 2004. The most productive of the area’s 10 oil fields, Akal, accounted for 31.7 percent of Cantarell’s production in January 2017, at an average 63,240b/d. But two years ago, Akal’s production stood at 120,310b/d, meaning it almost halved in the 24 months from January 2015.

In 2009, Ku-Maloob-Zaap overtook Cantarell as Mexico’s most productive oil field and its 2016 production output was 867,000b/d. This figure has been relatively steady since 2010, varying by only 25,000b/d since that year.

AVERAGE OPERATING WELLS BY FIELD

NATURAL GAS PRODUCTION BY ASSET (MMcf/d) PRODUCCIÓN DE GAS NATURAL POR ACTIVO

NATURAL GAS PRODUCTION

The year 2016 saw Mexico’s average daily natural gas production drop to 5,825mmcf/d, the first time in a decade that production was below 6,000mmcf/d. In the last quarter of the year it dropped even further, reaching 4,580mmcf/d. In its 2016 yearly report, PEMEX cited the natural decline of its Litoral de Tabasco and Abkatún-PolChuc fields as a contributing factor to lower natural gas production, where the drop in crude oil production led to an increase in fractional water flow. It also mentioned the natural decline of fields in the Macuspana-Muspac, BallotaJujo and Samaria-Luna assets as an additional factor.

In the final quarter of 2016, natural gas production originated almost evenly between onshore and offshore fields, with 49 percent and 51 percent produced from each type of field, respectively.

RESERVE REPLACEMENT

As well as falling production, Mexico’s reserve replacement ratio had been in decline year on year since 2012, before rising in 2016 to 62 percent, up 7 percent on the previous year. Still, the figure remains low compared to previous years, especially compared with its 10-year peak of 129 percent in 2009.

For every 10 barrels of oil Mexico produced in 2016, just over six were discovered. The deficit between the two does not bode well for a country desperately trying to increase its crude oil output. To remain sustainable, the rate must be 100 percent or over. In Mexico’s case, it will have to be above this to address the debt it has racked up in the past year, given that an average of 32.75 percent of its hydrocarbon reserves have not been replaced since 2013.

ANNUAL PRODUCTION AND RESERVE REPLACEMENT RATE

EVOLUTION OF 1P, 2P AND 3P RESERVES, VALUES TO JAN 1 OF EACH YEAR (million boe)

As well as defining one solution as reclassifying potential reserves into proven reserves, particularly through deepwater exploration activity, the Ministry of Energy’s Five-Year Plan mentions CNH’s various licensing rounds as a catalyst for successful exploration activity to get underway in the country.

ROUND ONE

With the completion of Round One, a total of 38 E&P contracts had been signed, including one between PEMEX and a third-party operator. After getting off to a sobering start with shallow-water Round 1.1 in 2015, which saw only two out of 14 contractual areas awarded, things started to look up with Round 1.2, when three out of the five shallowwater blocks up for grabs were awarded to three bidders: one independent and two consortiums. One notable difference between the two rounds was the fact that Round 1.1’s blocks offered only exploratory potential, while Round 1.2 was an extraction round, increasing certainty and reducing risks for vying companies.

The first categorical success of CNH’s licensing rounds came in December 2015, when 25 onshore extraction blocks were awarded to a range of predominantly Mexican companies through Round 1.3. Of the 25 contracts, which were all signed by August 2016, 18 were signed by wholly Mexican companies, three by consortiums including a Mexican entity, and four by a foreign company. With production underway on several of the blocks, and others awaiting permits and approval, the development marks an exciting step forward for the Energy Reform, with several examples of completely new Mexican companies taking on E&P challenges, as well as established service companies such Grupo Diavaz diversifying to become operators.

If Round 1.3 was a goldmine for national companies, Round 1.4 was the equivalent for international businesses. Mexico’s first-ever deepwater licensing round lead to the successful allocation of eight out of 10 available blocks to an impressive range of IOCs, NOCs and independents. Thrusting Mexico into the global oil and gas limelight, the round attracted an estimated US$34.4 billion in investments over the next 35 years, and 13 companies from nine countries are counted among the winners. PEMEX won one block in partnership with US company Chevron and Japan’s INPEX. The NOC was joined by Sierra Oil & Gas as one of two Mexican companies to experience deepwater success.

Besides BHP Billiton, 2016 was defined by an influx of some of the world’s largest IOCs into the Mexican market. France’s Total, the UK’s BP, the US’s Chevron and Exxon and Norway’s Statoil are some of the big names which feature among Round 1.4’s winners. China Offshore Oil Corporation took away two blocks in the same round and stood out for the high-royalty rates it bid to snatch them up. Sierra Oil & Gas, Murphy, Ophir, INPEX and Petronas were also among the winners.

Along with the eight blocks awarded in the round, the same day marked PEMEX’s first-ever farm-out, which involved the deepwater Trion block, won by Australian operator BHP Billiton. Taking on 60 percent of the share, BHP will enter into a production-sharing agreement with Mexico’s NOC to exploit the block, which has 3P reserves totaling 485 million barrels of crude oil equivalent. To win, the Australian heavyweight bid an additional royalty rate of 4 percent, on top of the 7.5 percent base rate, and offered a US$625 million after tying with BP. The amounts contributed by BHP mean that in four years PEMEX will not have to contribute any of its budget to the Trion project.

With Round One completed, the industry now awaits Round Two with baited breath. Shallow-water Round 2.1 and onshore Rounds 2.2 and 2.3 are scheduled to be held in mid-2017, while an unconventional and deepwater stage is due to be held later in the year.

CNH Commissioner, Gaspar Franco, says a higher number of blocks with unconventional and deepwater fields are expected in future rounds. “Areas in Round 2.1 are 1.6 times bigger than those from Round 1.1 and 1.2, while areas from Round 2.2 are 14 times bigger than those in Round 1.3,” he says. The larger sizes of the blocks involved could lead to the involvement of bigger, more capitalintensive companies in the rounds as compared to the corresponding rounds in Round One.

Three more farm-outs with PEMEX are scheduled for 2017. The shallow-water Ayín-Batsil field will be auctioned off at the same time as Round 2.1’s winners are announced in June 2017, while the onshore Cárdenas-Mora and Ogarrio fields are due to be auctioned off on Oct. 4, 2017.

table 1

SUPPLY CHAIN DEVELOPMENT

While Round 1.4’s winners begin signing contracts and drafting workplans, the international operators that entered the market through Round 1.1 and 1.2 are already receiving drilling permits, and in some cases, striking oil. In March 2017, Italian operator Eni announced the successful drilling of exploratory well Amoca on the block it won in Round 1.2. The drilling permit was granted only five months earlier in October 2016.

table 2

Operators entering through CNH’s licensing rounds will be looking to Mexico’s already well-established oil and gas supply chain to not only provide essential products and services but also to meet local content quotas and, in the case of IOCs, gain regional knowledge and experience. Despite the projection that more work will be coming its way in the future, Mexico’s oil and gas supply chain has various challenges to confront, including compliance with international standards, recovery from PEMEX’s payment and activity slowdown and from the wider oil price crisis. All this while learning the ropes of a newly opened market and PEMEX’s updated process for awarding service contracts.

REFINING

While a new supply chain is beginning to develop, PEMEX’s refineries are still presenting old challenges. Mexico’s crude processing capacity at its PEMEX-owned refineries at Cadereyta, Madero, Tula, Salina Cruz, Minatitlan and Salamanca has decreased dramatically since the start of the 21st century as the state-owned oil giant has faced problems related to maintenance of its aging infrastructure and has also struggled to maintain its oil production steady from maximums reached in 2004.

From the end of 2000 to December 2016, the total crude processing at the country’s refining facilities declined by nearly 24 percent to 933,062b/d from 1.227 million b/d. This increased slightly in the first three months of 2017, reaching an average of 1.108 million b/d. This is still below PEMEX’s nominal refining capacity, which its 2017-2021 business plan outlined as 1.640 million b/d.

Fuel and other product output have also been hit hard by operational problems and accidents at the refineries, the newest of which started operations in 1979. The refineries, now part of the PEMEX Industrial Transformation unit, are mentioned in the state-owned company’s business plan to 2021 to reverse economic and operational losses of close to MX$100 billion (US$5.1 billion) via initiatives such as cogeneration projects to cover the plants’ need for steam and electricity.

Another challenge is in the form of unplanned shutdowns at PEMEX’s refineries, 65 percent of which were due to unreliable hydrogen sources.

VARIABLE REFINING MARGIN ($US/b)

FUEL MARKET LIBERALIZATION

Mexico’s declining refinery infrastructure is leading to an increasing reliance on imported fuel from the US, but it is hoped this can be turned around as the country’s own gasoline market is fully opened to foreign participation. Fuel prices were liberalized in January 2017 after years of subsidization and price control. Despite public outcry as gasoline prices rose from one day to the next, the news was welcomed by the industry as a big step toward creating a competitive gasoline market in Mexico. One palpable change that has already transpired is the appearance of international brand BP in the country, which inaugurated its first Mexican gas station in March 2017 and plans to roll out 1,500 in the coming five years.

“In Mexico, we expect our planned 1,500 stations will lead to a 15-18 percent market share,” says Paul Augé, Vice President of New Businesses for Latin America at BP Downstream. As the first international company to sell fuel in Mexico, for the time being BP will be supplied by PEMEX’s gasoline before developing capabilities to import or produce its own products.

As well as eventually introducing different fuel qualities and prices into the market, the entry of international firms will transform the consumer experience, says Juan Gallástegui, President of Gallástegui Armella Franquicias. He says it will take more than just more competitive pricing to attract clients in the new look market. “Companies should also invest in creativity to provide added value to consumers. When people start seeing new brands, they will be loyal to the brand that provides the best service.”

THE JOURNEY TOWARD AN OPEN ENERGY MARKET