When Mexico announced the passage of its energy reform legislation, the international E&P community rejoiced at the possibilities. International oil companies (IOCs), in particular, would soon have access to Mexico’s abundant and recoverable oil and gas reserves. For the four large-cap oilfield services companies – Schlumberger, Halliburton, Baker Hughes, and Weatherford – the news meant two things: a slow 2014 in Mexico, and a potential spike in investors who have great expectations for 2015.

Short-term slowdown

According to the companies’ 4Q 2013 earnings reports, production in Mexico is expected to remain flat in 2014 as the country’s congress spends the majority of the year working out the legislation details and Petróleos Mexicanos (Pemex) determines which E&P assets to retain and which to share in joint ventures.

However, Halliburton and Schlumberger both stated in their 4Q earnings calls that they had significant work already planned for Mexico and would be able to report gains to that end by 2015.

Schlumberger’s Chairman, President, and CEO Paal Kibsgaard said his company had already seen strong activity on land in Mexico, and he expected the country’s reform to turn out “very positive for us, suggesting a solid gain in market share.”

David Lesar, chairman, president, and CEO of Halliburton, said the company expected 2014 “to be a challenging year” in Latin America, with slower activity expected in Mexico due to its transition.

“In Mexico, reduced activity levels on land are expected to continue through the first half of 2014 as we transition from our prior South Alliance 2 projects to already-identified new opportunities in the country,” Lesar said.

Like Halliburton and Schlumberger, Baker Hughes has projects in Mexico that will keep it well positioned for future business in the country, according to Martin Craighead, chairman, president, and CEO. However, he said in 2014 the company plans to “reduce [its] exposure to markets [in Latin America] where activity is uncertain and collections are doubtful.

“We will replace those reductions with other opportunities in the region that provide lower risk and higher margins,” he said during the company’s 4Q earnings call. “The result will be less working capital and a more stable mix of business going forward.”

For Weatherford, which has a lot of other changes planned for 2014, Mexico appears to be the least of its worries. In the 4Q earnings call, Bernard Duroc-Danner, the company’s chairman, president, and CEO, said that while the company’s North American activity was expected to be stronger than anticipated, particularly in 2Q 2014, its Latin American business was not, especially in markets such as Mexico, Colombia, and Brazil.

“Although the prognosis in Latin America is excellent long-term – Mexico in particular – 2014 is expected to be a down year,” he said.

Each of the four CEOs expressed some uncertainty where Mexico’s future was concerned, but they remained optimistic about what it could mean for their service companies going forward. After all, each had worked with Pemex in the past and present and had knowledge of the country’s geologies and proclivities.

Windfalls expected in the long term

According to multiple investor sites such as Seeking Alpha and Barron’s, the stock in these four service companies is prime for the picking. Investors anticipate the companies’ shares will pay off starting in late 2014 into 2015. It is a widespread belief that it will be these four service companies that are called upon initially by the IOCs that win bids for work in Mexico – onshore and off.

“The integration of technologies and services, the ability to buy in scale, and the ability to discount bundled services gives the large-cap stocks a significant advantage in a more cautious growth environment,” said Credit Suisse investors in an “Investors’ Soapbox” column titled “Big oilfield-service names sitting pretty,” published Feb. 20 on Barron’s website.

Sarfaraz Khan, a research analyst whose article, “Mexican reforms: Time to buy these oilfield services titans,” was published on Seeking Alpha’s website, was especially keen on the potential for future success at Schlumberger and Halliburton.

“The two were already eyeing more than [US] $8 billion worth of large integrated projects in Mexico,” he wrote. “The new price targets on these firms represent a 30% upside.”

Khan’s article, published Aug. 29, 2013, foreshadowed the events in Mexico that would result in the government’s decision to move forward with reform and events that would be announced in Halliburton’s 3Q 2013 and 4Q 2013 earnings reports.

“[In 3Q 2013] we announced the win of the largest incentivized project contract [in Mexico], called Humapa,” Lesar said in the 4Q earnings call, referring to the fee-for-barrel contract in Mexico’s Chicontepec basin. The Humapa block contains 341 MMboe in proven and potential reserves spread across 128 sq km (49 sq miles) of land.

“I am pleased to say that based on the preliminary tender results, we are also positioned to win Mesozoic 1 – the largest of the integrated megatender projects,” he added. “These large contract wins will result in higher revenues in Mexico, but the mobilization for them will take some time. We are strongly committed to Mexico through this transition period.”

Khan didn’t mention Baker Hughes in his article – he couldn’t have yet known about the company’s exploration and development contract in the Soledad field in Mexico, which was firmed up in 4Q 2013.

“This begins a 35-year production enhancement agreement, leveraging our success on the neighboring Corralillo field where we used new technologies and project management capabilities to triple production in less than four years,” Craighead said in his earnings statement.

Pemex weighs in

Access to that new technology is critical for Pemex, according to CEO Emilio Lozoya, who spoke March 3 to a crowd attending a CERAWeek 2014 dinner. He said the cost to produce a well continues to climb, but Pemex’s production has hit a plateau, causing the company to lose money on its investments.

Using the knowledge gleaned from its service company partners and now by joining forces with IOCs, Pemex has an opportunity to learn new production techniques and grow its resources, he said. A little healthy competition won’t hurt Pemex. Instead, he said it will help provide employment in a country that desperately needs it, and it could potentially reduce the number of people attempting to leave the country for better opportunities across the border.

“What people need in Mexico are jobs,” he said. “That’s what we want for our people.”

Conversely, Lozoya said there was a distinct lack of engineers in Mexico, a trend he hopes will change once the IOCs and service companies help increase production in the country. Right now, educated engineers are finding jobs with other companies that can pay higher salaries. It’s just one more reason he is ready and willing to learn from the other companies interested in bidding for work in Mexico and turning things around for Pemex.

“You can imagine, after 75 years, people are very excited – especially about the opportunity to earn more money in salary,” Lozoya said. For the past 75 years Pemex has had a monopoly on oil and gas production in Mexico, a monopoly put in place in 1938 when Mexico legislators sought to reduce influence from the US.
Lozoya said Mexico “is one of the most open economies in the world” today. “We are big believers in free trade,” he said.

Now that the gates have opened and the welcome mat has been dusted off, analysts seem to agree on one thing: There is a bright future ahead for those service companies that are already positioned as some of the most knowledgeable about Mexico’s prospects. Both risks and rewards are there to share, and ultimately Lozoya says it will be Mexico and its people that win the day.

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