Stratfor Analyzes Next Steps in Mexico’s Energy Reform

Mexico has taken its first official step toward implementing the energy reform that Mexican President Enrique Pena Nieto signed into law roughly a year ago. The government recently unveiled many of the contractual terms for the first 14 shallow offshore blocks that will be auctioned off to oil companies early next year. Bidding for the blocks will end July 15, 2015, and the results will be announced shortly thereafter.

Since 2004, Mexico’s oil production has dropped from about 3.4 million barrels per day to around 2.3 million barrels per day for a number of reasons. Petroleos Mexicanos, commonly known as Pemex, has fallen significantly behind its international peers in terms of technological expertise, and high tax burdens have limited the company’s exploration efforts. (Until the energy reform law was passed last year, Pemex was the only company allowed to explore and produce oil in Mexico since the country’s oil industry was nationalized in 1938.) At the same time, the supergiant Cantarell Field, which was the main source of Pemex’s production boom in the late 1990s and early 2000s, is quickly being depleted.

But now that the energy reform has passed, Mexico City has announced it will auction off 14 new offshore exploration blocks. Pemex does not control these blocks, but it can attempt to qualify for and bid on the blocks like any other company, though its limited financial resources could hinder its success. Once the initial auction is complete, Mexico City will hold subsequent auctions for unclaimed deep-water offshore blocks, unconventional natural gas blocks and onshore heavy oil blocks later in 2015. Meanwhile, Pemex will be seeking joint-venture partnerships for the blocks it currently controls, including the shallow-water Bolontiku, Ek and Sinan fields; the heavy-oil Aatasil-Tekel-Utsil field; the onshore Rodador, Ogarrio and Cardenas-Mora fields; and the deep-water Kunah-Piklis, Trion and Exploratus fields.

The first 14 blocks up for auction cover a relatively small area and are only expected to collectively produce about 80,000 barrels of oil per day, but they are just the first of many blocks that Mexico will auction off. The process serves as an important benchmark that shows the energy reforms are proceeding smoothly, but even more important, contractual terms provide insight into how contracts for more lucrative blocks will be structured in the future. Mexico City is offering 25-year production-sharing contracts for the blocks with the option to renew the agreements twice for an additional five years. Production-sharing contracts and joint ventures are boons for international oil companies because they allow changes in ownership to be reported to the U.S. Securities and Exchange Commission. It seems likely that because such contracts have been offered for the first 14 blocks, Mexico City will continue using the production-sharing contract in future auctions as well.

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Oil Price May Slow Development of Mexico’s Burgos Basin

Mexico is getting ready to welcome the U.S. shale revolution into its borders after 75 years of state monopoly. The timing couldn’t be worse.

As a flood of supplies from Texas to North Dakota sends oil into a nosedive, U.S. producers are reducing investment budgets for 2015. The cuts dim the chances they’ll take their fracking and horizontal drilling capabilities down south anytime soon.

After changing the constitution last year to allow foreign oil investment into its territory, Mexico is having to adjust, too. Regulators are considering reworking and potentially delaying leases for the country’s portion of the giant shale formation that encompasses the Eagle Ford in Texas.

“They’re going to have all of the issues of depressed price that the people in the Eagle Ford are having now,” said Michael P. Darden, global chair for oil and gas transactions at law firm Latham & Watkins LLP in Houston.

Energy ministers from the U.S., Canada and Mexico are set to meet Dec. 15 in Washington to discuss the implications of Mexico’s energy reform for the rest of the continent.

Mexican offshore assets have drawn interest from oil majors from Exxon Mobil Corp. (XOM) to Royal Dutch Shell Plc (RDSA) as the end of the monopoly triggers a race to gain a foothold in the country. The question is how quickly producers will be willing to move into the higher-risk, more costly prospects.

With Mexican shale possibly having to wait, cheaper offerings in shallow waters might have to do for now.

“In response to the falling prices, the government is bidding out the most attractive, better margin projects first,” said James K. Alford, a partner focusing on Mexico energy reform for the law firm Locke Lord LLP in Washington.

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