Save for later Print Download Share LinkedIn Twitter July 2015 Jason Fargo The prospects for Mexico's historic upstream auction — the first since a 2013 constitutional reform ended state producer Pemex's 76-year monopoly — have recently looked questionable, with low oil prices and wonky draft contracts raising doubts about whether companies would bid. Yet the relative stability of crude prices since April, along with Mexico's revisions to the contract terms, have led many observers to predict the auction — dubbed Round 1 — will in fact be successful. Perhaps surprisingly, given the current price environment, company sources suggest the most attractive acreage in the auction will be highly prospective — and costly — deepwater blocks in the Gulf of Mexico. The recent uptick in oil prices is without doubt a major reason for the renewed optimism. Yet Mexico's government also deserves much credit. Officials were apparently surprised when the draft production-sharing contract for the auction's first tender, comprising 14 shallow-water exploration blocks, came out in December and met with resounding disapproval by oil companies. However, as part of a consultation process, the energy ministry and upstream regulator CNH worked over the following months to simplify the contracts and make them more attractive. By the time the CNH approved the final terms on June 9, the consensus in the industry was that the government had addressed most of the outstanding concerns. Awards for this first tender are scheduled for July 15. Mexico: Tentative Round One Blocks and PEMEX Farm-out Offerings The changes include a reduction in what companies had called onerous pre-approval requirements, an extension of the exploration period from three years to four, and a reduction in the number of reasons for which rescission may occur. Furthermore, to give companies greater upside potential, the government increased the pretax internal rate of return that a project can earn before a so-called "adjustment factor" kicks in and boosts the government take. The government also made the bidding process more flexible. The final terms eliminated a rule barring companies from bidding individually on some blocks and as part of a consortium for others, and the deadline for changing a consortium's structure was extended. In addition, the operator in a consortium no longer must hold the largest economic stake in the project. The government also did away with a restriction preventing a given bidder from making offers on more than five blocks. And companies will now be able to keep the information they acquire from the data room after the tender, although selling the data remains forbidden. The government has said it will make similar changes to the draft contracts for the second tender, comprised of nine nearby shallow-water areas with certified proven and probable (2P) reserves. Those blocks have a Sep. 30 bidding deadline (EIF Mar.4'15). Looking farther ahead, company sources expect the first contracts to serve as a template for the round's remaining tenders. Those include an offering for 26 small onshore fields, with a bidding deadline of Dec. 15 (EIF May13'15), as well as planned tenders of extra-heavy crude fields, shale and other unconventional acreage, and deepwater Gulf of Mexico blocks. Indeed, from the majors' perspective, it is the deepwater exploratory blocks that hold the most appeal in Mexico's auction, due to their high potential for significant discoveries. Under Pemex's monopoly, drilling in Mexico's deepwater Gulf acreage was minimal, although the state company did have some exploratory success with a few wells in the Perdido Fold Belt, near the US maritime border. Given the huge resource base already in production on the US side of the water boundary, Mexico's largely virgin waters south of that line are tantalizing — particularly for companies already developing deepwater projects in the US Gulf. It's true that oil companies are slashing their capital budgets these days due to low oil prices, and deepwater projects around the world have been among the casualties due to their rising costs (EIF May20'15). Yet there are reasons to think that Mexican deepwater projects may make the cut. In the first place, the estimated cost of such projects is low; Pemex claims the break-even cost in Mexico's deep waters is $50/bbl or even less (EIF Jan.21'15). Furthermore, at least initially, Mexican officials suggest that output from Mexico's deepwater Gulf could be transported north to the US via existing infrastructure — a strategy that should help hold down expenses. What's more, sources at the majors point out that there is basically nowhere else in the world where such a high resource potential is up for grabs via a competitive auction. They also note that Mexico, despite its problems with rule of law, is a far more stable, pleasant place to do business than, say, the Mideast. Somewhat paradoxically, the recent fall-off in drilling activity in Texas may actually prove a boon for Mexican projects, as idled rigs and workers can easily move south. With the energy ministry and CNH expected to announce details of the deepwater tender by the end of July, interest in Mexico's auction will almost certainly heat up. Jason Fargo is the team leader for Latin American coverage at Energy Intelligence.