Project Economics Firm in Mexico, Brazil -- For Now

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Plunging oil prices have engendered a sense of bullish optimism among two of Latin America's top producers, Mexico and Brazil, who have been strong to defend the robustness of their upstream project economics no matter how many dollars are shaved from the price of crude. At least for now they appear to be right. The attractive size and historic opportunities to invest in the region's largest plays has near-term development plans in the clear. But further out, the upstream landscape may look markedly different than the picture originally mapped out during periods of stronger oil prices. Mexico's historic energy reforms and inaugural post-liberalization bid round now under way could hardly have come at a worse time. Indeed, Round 1 was delayed before it even began. The country's upstream regulator, the CNH, missed its original November deadline to release contract details and other key terms for shallow-water blocks, presumably -- although never confirmed -- to let the government rethink its bid round strategy amid free-falling oil prices. The 14 blocks eventually offered were themselves scaled back from CNH's original plan to auction 11 exploration blocks and another seven fields with proven and probable (2P) reserves. Yet auspiciously for interested investors, those shallow-water blocks carry relatively low development costs. CNH commissioners maintain that prospective light crude in those blocks remains "very attractive" for companies contemplating submitting bids by July, with projected finding and development costs no greater than $20 per barrel. Roughly the same price can be pinned to majority of state-led Pemex's existing portfolio of acreage. Last year's Round Zero process assigned Pemex control of acreage holding approximately 83% of Mexico's 2P reserves and 21% of the country's prospective hydrocarbon resources. Most of that portfolio is heavily weighted toward shallow-water crude developments and other projects with low production costs. Chief Executive Emilio Lozoya has previously disclosed the company's "all-in" cost to find and lift hydrocarbons at around $22/bbl, comfortably below today's depressed price levels (EIF Nov.12'14). Additionally, Pemex officials have said that even deepwater oil developments should break even at around $50/bbl, or roughly the price of benchmark Brent today. Ultimately, Mexican industry officials are relying on the opening's once-in-a-generation opportunity to motivate investors to overlook short-term price fluctuations in favor of establishing a first-mover advantage in a promising oil market. However, the expected costs on some of the riskier acreage in the bid round -- namely unconventional shale and extra-heavy crude blocks -- will be higher, and there is a growing sense among companies that current prices cannot support those projects. Shale blocks in particular will likely be the first casualty of the low oil price. Energy Minister Pedro Joaquin Coldwell has been saying for a while that plans to auction shale blocks later this year could be changed. More recently, Finance Minister Luis Videgaray has made more explicit statements that shale and unconventional blocks could be postponed to another round altogether because oil prices are too low. But a change to Mexico's shale offerings should come as neither a surprise nor a disappointment. Analysts point out that unconventionals were never billed as the core attraction of Mexico's opening, having first to compete with the plethora of projects further along in development in the US. Additionally, they say, the intent has always been to initially source most of the gas that underpins the country's electricity output from the US, allowing for an immediate low-cost source of supply. Further south, in Brazil, low oil prices are having little immediate impact on the country's presalt upstream bonanza. State-controlled Petrobras has gone on the offensive, issuing statements that its current presalt projects are robust and profitable at a $45 break-even price. Indeed, in many respects the dazzling future once envisaged for the Brazilian presalt when first unearthed in 2007 is now here. Petrobras posted its highest-ever output figure in 2014, reversing two straight years of production decline, mainly on the back of rising presalt output which is breaking records virtually every month with little regard for plunging oil prices. December production from presalt alone was 666,000 barrels per day, compared to the 2.03 million b/d average for the year. Having commissioned over a dozen new offshore production units since the start of 2013, mainly for presalt fields, the focus for 2015 will be on ramping them up to full capacity, making 700,000 b/d from presalt alone an easily attainable target. The problem, however, is that current success is masking a very cloudy future for presalt projects. A corporate bribery scandal engulfing Petrobras threatens to derail investment in those very same presalt riches (EIF Dec.10'14). Officially shut out from international debt markets to finance investments, Petrobras is planning to significantly rein in capital spending in its next budget to conserve cash, cope with lower revenues from oil sales, and pay for hefty legal fees for the host of lawsuits it is facing related to the scandal. While most cuts will likely be absorbed by its downstream business, future presalt projects can also be jeopardized by Brazil's stringent local content laws. Petrobras has already blacklisted some of Brazil's largest construction companies from bidding on future projects because of their alleged involvement in the bribery scandal. That naturally shrinks the pool of companies that can fulfill local content regulations. Analysts say this can lead to painful delays in project execution. The effects might not be felt until 2017-18, but would be enough to seriously derail Petrobras' plans to boost domestic output by 2020 to 4.2 million b/d.

Offshore Oil and Gas, Shale
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