Mexico’s July 15 auction of oil and gas offshore blocks was a mixed piñata. It marked the end of the inaugural tender in a planned series of five and was the first since 1938. Industry observers applauded the country’s effort to rekindle investment in its energy sector but noted room for improvement. Only two of 14 shallow-water offshore exploration blocks on offer were awarded, and many of the pre-approved 18 companies and seven consortia declined to bid or did not meet the government’s required minimum. In the aftermath, stakeholders speculated on how best to promote further energy development in North and Central America and the Caribbean.

Formalizing the process of private investment in Mexico’s oil and gas resources is a worthy achievement despite the lackluster response, an IHS senior vice president told the U.S. Congress. Speaking before the House Foreign Affairs Committee, former ambassador to Mexico and current IHS senior vice president Carlos Pascual said regional businesses will benefit from the reforms to investment opportunities in Mexico’s hydrocarbon sector.

Unfamiliarity with Mexican markets and a fall in commodity prices affected the first phase of bids, Pascual acknowledged. Mexico’s energy leaders suspect other factors also limited participation. The offerings of small fields may have been less interesting to the larger international companies, while four-year contracts with two-year extensions may be too short, especially in fields needing extensive exploration. The government minimum bids may have been mis-estimated, influenced by historic Pemex production costs. And unsatisfactory fiscal terms may not have provided enough incentive to mobilize capital, especially in light of lower oil prices and the pressure to cut costs and capex.

Other uncertainties involve the capacity of the Mexican service sector, the role Pemex will play in future rounds, whether Mexican companies can secure international partners, and pipeline and storage capacity.

“The important point is that all of these issues can be addressed,” Pascual said. “Mexico took a historic first step, demonstrating the potential for an important combination of international oil partners, American capital and a start-up Mexican private industry.

“With the sector now open for investment, these potential issues can be turned into business opportunities,” he added.

Lessons learned

In assessing the auction, the first lesson learned was that good geology matters more than the commodity price, according to David Goldwyn and Cory Gill of the Atlantic Council, a Washington, D.C.-based think tank. The two blocks that were awarded attracted heavy competition, while the others were not viewed as having the necessary rock quality.

“The lack of interest in some blocks should not have been a surprise to the government, as Pemex chose not to retain those blocks in ‘Round Zero’ where they had the first pick, indicating Pemex’s low enthusiasm for the overall prospectivity of these blocks,” they said in a report. “For the next rounds, the acreage needs to be top flight and, especially, if middling prospects are instead on order, the price and the terms of investment need to be right.”

Goldwyn and Gill linked this lack of enthusiasm to a Mexican mistrust of free market prices. “Auctions are an efficient mechanism for price discovery because sellers can greatly under- or overestimate the value of an asset to the buyer. Mexico’s finance ministry, known as Hacienda, just re-learned this lesson the hard way,” they said.

Some of the blocks were divided unnecessarily and were not large enough to attract international oil companies [IOCs], the authors added. “The heavy oil and deepwater blocks will be subscribed at a much higher rate if they include blocks sized to be material to IOCs.”

Despite the disappointing response to the tender, the auction process “worked beautifully,” Goldwyn and Gill said. “This efficiency, plus the energy ministry’s active consultative style, has built confidence in the auction system.”

They suggested that Mexico revise its contract forms to meet international standards so as to ensure more investor protection. Currently heavy penalties for a “surfeit” of reporting requirements and “elastic” provisions by which the government could rescind contracts create uncertainty for investors, they said. And they suggested Mexico consider switching from production sharing agreements to licenses, which are less complex to administer.

The Mexican government lost credibility in the first phase, said George Baker, publisher of the newsletter Mexico Energy Intelligence.

“For the outcome that the government needed,” he wrote, “the prequalification process failed to screen out bidders who, although technically qualified, did not meet the government’s very specific agenda on two crucial matters: credibility and a strong, positive message to financial markets.”

One way to have attracted more qualified and diverse bidders would have been to directly assign high-quality blocks. Additionally, he suggested that Mexico use a restricted tender, handicap the bidders and provide a process for resolving a technical tie.

“The government needed a diversity of winners, including oil companies that were familiar names (like Chevron, Anadarko and Petronas). Instead, it got an ad hoc consortium that has no track record,” he said.

Next on the auction block

Mexico will begin accepting bids September 30 for the next phase, which will offer five blocks of shallow-water production. Phase three will offer 26 onshore blocks, beginning December 15. Dates have not been set for the fourth phase, which will auction off 13 blocks of deepwater and 11 blocks of extra heavy oil, and the fifth, which will solicit bids for 61 unconventional fields and 12 blocks of the Chicontepec onshore field.

Pascual cited studies by the U.S. Energy Information Administration that forecast the U.S. reaching 13.3 MMbbl/d of crude production in 2020 from 9.3 MMbbl/d today, and by Canada’s National Energy Board that look for an increase in Canada’s crude production to 4.3 MMbbl/d in 2020 from 3.6 MMbbl/d.

“Mexico now has the chance to enter this club of rising production as its energy reforms attract investment,” he said. “North America will not act like an oil cartel. Rather, it represents three democratic and market-oriented states establishing a reliable base of production that will set standards in international conduct and transparency in energy development and trade that can influence the global industry.”

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