Good News in the Pipeline

November 28, 2017

Last July, as part of Mexico’s energy reform, the National Hydrocarbons Commission (CNH) – the government’s upstream energy regulator – successfully carried out the second and third bidding round of the second tender process (Round 2.2 and 2.3) for 24 onshore blocks, and awarded 21 of them. The government estimated that, in total, the bids will generate investment of $2billion and at least 20,500 direct and indirect jobs. According to CNH head, Juan Carlos Zepeda, these investments will add 80,000 crude barrels per day and 378 million cubic feet of natural gas to Mexico’s current production of around 2 million barrels per day.

More good news came in August when Mexico’s Finance Ministry announced plans to lower the fiscal pressure on state-owned oil firm Pemex to free up funds so the firm can fix declining production. The new proposed framework is expected to allow Pemex to increase the share of revenues it can count as costs on the output of its onshore marginal and mature fields, therefore leaving more resources for its investment and exploration activities. It also suggested that Pemex should form partnerships with private enterprises to boost the profitability of its current projects. The new measure demonstrates the government’s genuine desire to get foreign firms involved in tapping into Mexico’s vast potential of energy sources.

Welcoming investors

Following the 2.2 and 2.3 bidding rounds, the CNH modified most bidding rounds to make it easier for international private firms to take part. Tender requirements were streamlined while it has become easier for firms to form consortia with other competitors. There is also a mechanism for companies to suggest new areas for bidding. Meanwhile the federal government modified the constitutional mandate of the CNH to enhance its position as an independent entity and to protect it from any changes in the political environment, especially resulting from the 2018 presidential elections. Finally the CNH’s reputation as an oasis of honesty in Mexico’s sea of corruption was enhanced in July when UK-based commodity-focused NGO, Natural Resource Governance Institute, praised the transparency of the CNH’s bidding rounds.

The CNH’s reputation as an oasis of honesty in Mexico’s sea of corruption was enhanced in July…

It has also become clear that the federal government is keen to push the progress of the energy reform as much as possible before the elections in 2018. Minister of Energy, Pedro Joaquín Coldwell, announced that authorities are looking into launching a Round 2.5 prior to the polls. This round will look to involve shale oil, gas leases, and other unconventional resources to encourage natural gas exploration and extraction contracts. With regards to the areas assigned to Pemex in Round Zero, Pemex has a two-year period to achieve its exploration objectives – a very short timeframe by international standards. The government seems keen to establish as many partnerships as possible to capitalise on the potential benefits. This will certainly open up further opportunities to international firms in the industry.

Will politics get in the way?

Andres Manuel Lopez Obrador (AMLO), the left-wing populist leader of the opposition National Regeneration Movement (Morena), is the frontrunner in Mexico’s 2018 presidential election. AMLO has vowed that, if elected, he would seek to review all exploration and production contracts signed as part of the 2013 energy reforms. This would be part of a crackdown on corruption, which will increase scrutiny into the current administration. However, investors needn’t worry – a reversal of the energy reform is highly unlikely. On top of the various regulatory and economic obstacles, AMLO will face stiff opposition from Congress and the courts to make changes to the reform. Nonetheless, the rapid pace of energy reform implementation undertaken by President Enrique Peña Nieto’s administration is likely to slow. AMLO is expected to call for a national public consultation to assess future bidding rounds in the hydrocarbons sector. Further measures might involve increasing minimum bid requirements and making changes to the regulatory environment, so as to discourage foreign investors.

AMLO’s rhetoric has raised investor concerns over future contractual uncertainty or potential political interference in the oil industry. Overall, however, the business environment is unlikely to undergo immediate radical changes under an AMLO presidency. The energy sector remains a special case because of its importance to the economy and the state’s historical role in the sector, but elsewhere AMLO is likely to prioritise other issues, such as a stronger public crackdown on corruption and increasing social spending, rather than taking steps to alienate investors. It is important to consider that, his sometimes anti-capitalist and nationalist rhetoric notwithstanding, AMLO’s track record as mayor of Mexico City between 2000 and 2005 points to a more pragmatic approach to business once confronted with the realities of office. Throughout his tenure as mayor, for example, he worked closely and efficiently with private investors on major infrastructure projects. It would not be surprising to see an AMLO administration seek to increase the government’s participation in energy but maintain the new role of the private sector. AMLO will likely promote investment to modernise and expand the country’s oil refining capacity, so as to take advantage of the increases in oil production brought by Peña Nieto’s energy reform.

What next?

The CNH announced on July 19 that the next bid round, 2.4, will take place on January 31, 2018. The round includes 29 deepwater blocks for exploration in the Perdido area, Salinas basin, and the Mexican mountain ranges. According to government authorities, the round is likely to generate investments of up to $31billion, assuming only seven of the 29 blocks are awarded.

Similarly, on September 28 the CNH announced the first round of the third tender process, Round 3.1, to be held on March 27, 2018. It will comprise an auction for natural gas and oil exploration and production leases in 35 shallow-water blocks amounting to over 26,300 sq. km. located in the Burgos, Tampico-Misantla-Veracruz and Cuencas del Sureste basins. There is also talk of a round 2.5. However, for it to be completed before the elections government authorities would need to make it official by the end of this year.

With several positive factors in place expect Mexico’s oil sector to keep pumping out good news for investors….

The implementation of the energy reform will remain a priority for the federal government over the next year, as it is one of President Enrique Peña Nieto’s legacy policies. The looming elections mean that the ruling party has a strong incentive to ensure that it is a success.  The reform has also been given added impetus by uncertainty surrounding the North American Free Trade Agreement (NAFTA) renegotiations, as energy could provide a useful alternative source of economic growth.  With several positive factors in place expect Mexico’s oil sector to keep pumping out good news for investors.