REFORM & PERFORM

Mexico 2017 | ENERGY & MINING | REVIEW

Reform has revolutionized the energy sector in Mexico, with foreign investors now playing a growing role across the spectrum.

Three years after the introduction of constitutional reforms to modernize the energy sector and bringing an end to national oil company Pemex's monopoly, Mexico is taking firm steps to open up the sector to foreign investors and change the structure of the whole value chain forever.

Uspstream

Although being the fourth largest non-OPEC producer in the world, Mexico's oil output has steadily been falling since reaching its peak in 2004, at 3.3 million bpd, and is expected to fall below 2 million bpd in 2017 for the first time since 1980. The reforms came at a time of low oil prices and tight economic measures, as in December 2016 the government announced bigger-than-expected cuts in public spending. Pemex's cut was announced to be the largest, in the order of USD5.4 billion, as the company is struggling under billions of dollars of accumulated losses. Upstream regulator the National Hydrocarbons Commission (CNH) announced at the beginning of 2017 that the country's proven oil and gas reserves are estimated at 9.16 billion barrels of oil equivalent, which represents a 10.6% decline compared to a year before. Over the same period, Pemex reported 2016 crude oil production of 2.15 million bpd, showing a 5% fall YoY as aging fields yielded less.
Pemex is set to benefit from the reforms in the sector as it is allowed to establish farm-out arrangements and strategic partnerships across its businesses, which will allow the oil company to increase its production while gaining access to the latest technology. Pemex will overcome the cuts arising from the government's public spending by receiving private investment, which will support the company's objective to become more competitive. Indeed, CEO José Antonio González Anaya was reported to declare in his opening address at the Mexican Petroleum Congress 2017 that Pemex's 2017-2021 business plan is already being deployed under the guiding principle of profitability.

Sector organizations are optimistic about the future impact of the reforms. In its Mexico Energy Outlook 2016, the IEA projected crude oil production to bottom out at under 2 million bpd in 2020 and to start rising as reforms start to bear fruit, especially with the exploitation of new deep-water development projects, as these are forecast to produce almost half of the country's projected oil output by 2040. This potential will only be tapped with the introduction of foreign know-how into the market. The IEA forecasts Mexico's crude oil output to reach 2.4 million bpd in 2040, while if natural gas liquids and some tight oil is included in the total, the output will go up to 3.4 million bpd. Already, the current stabilization of oil prices at around USD45 a barrel, and the successful completion of a first auction for the licensing of offshore blocks at the end of 2016 have definitely paved the way for a smoother process in expected further auction rounds.

After the reforms were enacted, Mexico's first round of bidding took place in July 2015, offering 14 offshore and unconventional blocks for exploration to private investors, but low oil prices and concern over the terms of the contracts led to the awarding of only two blocks. After the government eased some of the bidding criteria, three of the five blocks offered in the second tender were awarded, too. The third round exceeded all expectations as all of the 25 available fields were awarded. As disclosed by the President of CNH, the administrator of these contracts, 22 of the fields were awarded to Mexican companies, and the remaining three were awarded to the Canadian firm Renaissance Oil Corp. The commission revealed that the cumulative production of the fields included in this round would reach 77,000bpd in three years, which is composed of 33,000bpd of oil and 5.78bcm of natural gas, with a production cost of approximately USD14 per barrel.

As round 1.4 ended in December 2016, foreign investment appetite was finally back on track as eight of the 10 deep-water blocks in the Gulf were won by bidders from outside of Mexico. The Trion deep-water field, located less than 80km from the US-Mexico maritime border, at a water depth of about 2,400m, was awarded to Anglo-Australian multinational BHP Billiton as a Pemex farm-out deal. CNH president Juan Carlos Zepeda stated in a press conference that production at Trion is expected to begin in 2023, while exploration is set to keep going for another decade. Pemex disclosed estimates of Trion's 3P reserves to be 485mmboe, and to require exploration and production investment amount of approximately USD11 billion. In March 2017, BHP Billiton signed the contract with Pemex.

The stage is set for round 2.1, which will offer 15 shallow-water blocks off the coast of Veracruz, Tabasco, and Campeche. The CNH has recently listed a total of 25 groups pre-qualified for upcoming lease sale, including supermajors ConocoPhillips and Shell, and Eni, Repsol, and Total. The list is also reported to include some national oil companies such as CNOOC, Pemex, Lukoil, Petronas, Colombia's Ecopetrol, and India's ONGC. According to the CNH, the 15 blocks offered in the sale contain a combined 1.6bboe of recoverable resources, while the largest prospective resource is in Block 11 with a P50 of 300mmboe. The eager participation by the world's strongest candidates suggests that the sector is perceived to be recovering on a global scale. Round 2.2 and 2.3 are also expected to take place in summer 2017, offering 12 and 14 onshore blocks, respectively. The last round is expected to take place in December 2017 and will be the second deep-water block offering.
In May 2017, the first private offshore oil well in 80 years recently began drilling in the Zama-1 well by a joint venture between Premier Oil, Talos Energy, and Sierra Oil & Gas. The well is estimated to have a P90-P10 gross unrisked resource range of 100-500mmboe. Premier foresees a drilling period of 90 days, and a total estimated cost of USD16 million.

Downstream

Mexico's downstream sector is also in critical need of investments, as the country's six refineries are operating at barely half capacity of 1.65 million bpd, according to Bloomberg. 50% of total demand for gasoline is currently met through imports, and the fact that the import of fuel has been liberalized raises questions as to the possibility of locally produced fuel to ever be able to meet demand when imports will be a very easy alternative. But the IEA estimates that upgrades to refinery units will help to push up utilization rates toward 90% by 2040, reducing gasoline imports to a more modest one-third of consumption. The CEO of Pemex was reported to be seeking joint venture partners for its six refineries as recent reforms have enabled private companies to buy stakes in these refineries. In March 2017, Pemex announced having identified Japanese trading company Mitsui & Co. and South Korea's SK Engineering & Construction as among potential partners for a USD2.1 billion project at the Tula refinery. The project's objective is to turn lower-value fuel into products like gasoline and diesel as part of a larger expansion program.

Natural Gas

The IEA reiterates that imports from the US provide a highly competitive source of natural gas for Mexico. However, the agency expects domestic production—including shale gas—to pick up in the latter part of the projection period to reach 60bcm in 2040. As natural gas is expected to gain an increasing role in Mexico's energy mix, this will be facilitated by the regulatory and pricing reforms that will be effective in the market, which in turn will be liberalized by 2018. These reforms will allow extensive infrastructure development and the availability of cheaper gas via new pipelines from the southern US.

Power generation

In 2014, government-operated electric utility Comisión Federal de Electricidad (CFE) was restructured to allow the National Center for Energy Control (CENACE) to serve as an independent authority operating the wholesale electricity market. The liberalization of the wholesale market proceeded with the launch of two auctions in 2016, which paved the way for private companies to sell their electricity, starting in 2018, to CFE. The third auction, announced in June 2017, establishes a different market structure. This auction allows qualified service suppliers and qualified large-scale consumers to act as potential buyers as a result of the implementation of the Clearing House, an independent entity that will act as a counterparty between sellers and buyers. The results of the auction are scheduled to be announced at the end of November 2017, and the awarded projects must begin generating by January 2020. These auctions offer long-term (15- and 20-year) contracts, whereas CENACE is expected to launch a fourth auction toward the end of 2017 that will offer medium-term contracts. International companies including Enel Green Power, EDF Energies Nouvelles, Engie, and Fotowatio were among the companies that won contracts.

The Mexican government has set an ambitious target of 35% for energy use to be from clean energy (including nuclear) by 2024 and 50% by 2050. The IEA says that the sector needs to mobilize USD10 billion per year to meet an 85% increase in electricity demand until 2040. In May 2017, Mexico's Ministry of Energy issued three exploration permits to ENGIE and Icelandic geothermal development company Reykjavik Geothermal. These permits authorize their holders to spend three years exploring geothermal resources located in three zones, each measuring 150km, in Sangangüey (Nayarit state) and in Cerro Pinto and Las Derrumbadas (Puebla state).
As the number of new players and the diversification of the energy mix increase, the Mexican government is on track to meet its requirements.