One measure of the success of Mexico’s energy reform to date is the number and quality of companies active in the country’s upstream space. There are almost 60 E&P companies with positions, including most of the majors, which have long coveted the opportunity to operate in the country. This success is the result of the country’s prospective geology combined with the government’s willingness to listen to the industry and adapt the terms on offer to the low-price environment. With Pemex’s financial troubles constraining its capacity to invest and the easy-to-develop oil largely gone, tapping into external capital and technical expertise is essential if Mexico is to fully realize its hydrocarbon potential.

With the oil price seemingly stabilizing, the industry is slowly emerging from a downcycle in which survival was the buzz word, and stronger companies are starting to contemplate growth. Interest in Mexico is expected to stay robust. At the same time the global environment in which the country competes for upstream capital is by no means straightforward, and it’s essential the government remains vigilant to the value proposition on offer to attract investment. Factors that must be accounted for include 1) the strict capital discipline that remains a strategic priority for many companies, 2) perceptions under a Trump presidency, 3) the political backlash caused by the recent domestic gasoline price increases and 4) competition for investment from the likes of Iran and Brazil.

Pemex constrained, but a diverse corporate landscape emerges

The success of Ronda Uno (Round One) has brought 44 new companies to Mexico’s upstream sector. The breadth of opportunity—from worldclass deepwater exploration acreage to small onshore discovered resource opportunities—has drawn a diverse range of companies. Underpinning this is an attractive regulatory framework with an independent regulator, competitive fiscal terms, non-onerous work commitment obligations and local content rules that reflect the capacity of the domestic service sector to deliver. This has been facilitated by a government that has worked with the industry to adjust the terms on offer to reflect a “lower for longer” price outlook.

CNOOC was the big winner in the first deepwater licensing round. (Source: Wood Mackenzie)

Size of opportunity

No other group besides the majors has spent more time over the years building a relationship with Pemex in anticipation of the sector opening up. Every major placed bids and, with the exception of Shell, now hold offshore acreage. This underlines the prospectivity and scale of resource on offer. Given the majors’ recent exploration portfolio rebuild efforts, the primary focus was December’s deepwater round, and Wood Mackenzie’s Exploration Service estimates that 7 Bboe will be discovered by 2035 in the two basins where acreage was offered. Eni and Statoil also were active bidders for the shallow-water discovered resource opportunities offered in 2015, with Eni now holding a 100% stake in the Amoca-Mizton-Tecoalli project. The participation of the majors, with their strong balance sheets, technological expertise and project management skills, is vital if Mexico is to unlock its technically challenging deepwater resources.

Portfolio replenishment key for Asian NOCs

Most Asian national oil companies (NOCs) face a long-term growth challenge. Maturing domestic asset bases leaves them with little choice but to look to international business development and, like the majors, find that Mexico has the scale to attract their interest. Although it was somewhat surprising that none took part in bidding for the Trion discovered resource opportunity, CNOOC and PETRONAS successfully picked up deepwater exploration acreage through aggressive bids in the Perdido and Salinas Sureste areas, respectively. The same two companies had previously made unsuccessful bids in the shallow-water discovered resource opportunity round. ONGC unsuccessfully bid in the shallow-water exploration round.

International independents making a mark

The Energy Reform has drawn a group of credible mid- and large-cap companies. Full realization of the country’s hydrocarbon potential requires the active participation of many different types of companies. Leading the pack is BHP Billiton, which beat BP to win the deepwater Trion discovered resource opportunity, helping bolster its longer term growth outlook and bringing more balance to a portfolio that was increasingly weighted toward U.S. unconventionals. Murphy Oil marked a tentative return to frontier exploration, picking up a deepwater block after having sat largely on the exploration sidelines since the oil price collapse. Buenos Aires-based Pan American Energy, a tie-up between BP, CNOCC and Bridas, made its first meaningful move outside Argentina since the joint venture’s (JVs) formation back in 1997, taking the shallow-water Hokchi discovered resource opportunity. Private equity also was active, with Fieldwood Energy taking the shallow-water Ichalkil- Pokoch discovered resource opportunity and Sierra Oil & Gas picking up a pair of deepwater exploration blocks. Other notable winners include INPEX, Premier Oil and Ophir.

Colombia has the highest number of active companies in Latin America, followed closely by Argentina. (Source: Wood Mackenzie)

Emergence of a domestic E&P sector

The onshore bid round was the most competitive, with 40 predominantly local companies placing bids. The high level of interest was positive, and a vibrant small-cap sector can fully exploit remaining onshore opportunities, which are smaller in scale compared to the offshore. However, the high additional royalty that many companies offered to secure wins possibly reflects the immaturity of this emergent group of companies, and it’s likely that some bids will prove to be uneconomic in the absence of a significant rise in oil price. Nevertheless, there is clearly appetite within Mexico for these opportunity types and, if nurtured correctly by the government, a thriving onshore sector can be developed.

Pemex’s participation reflects the challenge of its reality

The Mexican NOC is struggling to mitigate production declines while shoring up its finances. As of third-quarter 2016, its net debt stood at $87 billion, second only to Petrobras, which is the world’s most indebted E&P company. Consequently, Pemex mostly played an observer role in Ronda Uno, participating in just a single deepwater block award. This also might reflect growing discretion on the part of the company as it tries to reform itself into a more effective E&P company, particularly as developing, technically challenging new resource themes like deep water and unconventionals forces it out of its onshore/shallow-water comfort zone.

Without capital input from foreign companies, Mexico’s production will continue to decline. (Source: Wood Mackenzie)

Expectations for 2017 and beyond

As the Energy Reform continues, at least three rounds are planned for 2017 as part of a longer term program of licensing. The regular offering of new acreage is important since it provides new companies with entry opportunities and enables incumbent players the chance to grow their businesses. The current schedule calls for two onshore licensing rounds and a shallow-water round. Pemex also is expected to offer JV opportunities, and there might be a second deepwater round toward year-end 2017—indeed, several are planned before the end of the current presidential cycle in late 2018.

The Pemex JV opportunities continue to attract greatest interest. The company’s 36% year-on-year budget cut (in U.S. dollar terms) brings a greater urgency to strike JV deals to bring in fresh capital. This should speed up the long-delayed farm-out program and incentivize Pemex to improve the quantity and quality of assets offered. The company also should be encouraged by the success of the Trion offering, in which the Mexican NOC will benefit from a $1.1 billion cost carry. Larger producing assets in shallow water and onshore will spur the most interest from the industry and bring the most immediate benefits to Mexico as new investment will result in a quick production response.

There is already strong interest in shallow-water Round 2.1, with 13 companies prequalified, including familiar names from Round One like Chevron, BP, Eni, Statoil and Premier Oil as well as potential new entrants like ConocoPhillips and Noble Energy. The round was originally scheduled to close in March but has been pushed back to June following a formal request from several companies. A mix of exploration and discovered resource opportunities will be offered. Initial analysis suggests that the subsalt exploration potential in the Salinas- Sureste Basin will be the main attraction, with discovered resource opportunities only offering marginal economics on a standalone basis. Furthermore, 40% of the 15 blocks on offer are contiguous to acreage already awarded, allowing companies to build critical mass.

Finally, there are two onshore rounds planned. The first (2.2) is scheduled for April and will offer 12 exploration blocks, some holding small existing resource. However, with much of the gas-prone acreage located in the north of the country in the Burgos Basin, interest is likely to be constrained by security concerns and low gas prices caused by increasing U.S. imports—competitive full-cycle returns will be tough to achieve. More success is expected with Round 2.3, which offers 14 large blocks with proven reserves and the prospect of exploration upside, mostly located in the south of the country where security concerns are less of an issue. Interest in these rounds is likely to largely come from domestic companies.

Read the other two regional reports from the April E&P issue:

Mexico’s Round One: Building An Energy Industry

Unlocking A Mexican Prize

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