December 22, 2014 / 10:42 AM / in 5 years

Oil shock to tilt Mexico energy opening in private sector's favor

MEXICO CITY (Reuters) - The allure of investing in Mexico’s historic oil sector opening has been dimmed by the plummeting price of crude, putting pressure on the government to offer bigger incentives to private investors in the first major round of contracts up for grabs.

Refinery workers walk at one of the facility's catalytic plants, used to convert heavy hydrocarbon crude oil fractions into lighter gasoline and diesel in Tula November 21, 2013. REUTERS/Henry Romero

Since Congress in August approved the laws governing the dissolution of Mexico’s 75-year-old state oil monopoly, crude prices have plunged more than 40 percent, reducing the appeal of investing in Mexican deposits.

Mexico, the world’s 10th biggest crude producer, last week announced bidding terms for the first set of production-sharing contracts, unveiling 14 shallow-water exploration blocks that will pay winning firms a share of each project’s output.

The overhaul aims to reverse a decline in crude output of 30 percent since 2004, but the slumping prices have cut potential returns, putting the onus on Mexico to make it more attractive for firms to invest - at the government’s expense.

By law, what companies must pay the government include a range of taxes and a basic royalty which will vary depending on the price of oil.

The most important consideration in determining who wins the contracts will be what share of operating profits bidders offer the government above a minimum level.

The finance ministry won’t set the floor on that share until just before the contracts are awarded next summer, and it is here that lawmakers say Mexico must be flexible.

“What will the government do? Well, if it planned on a certain percentage for a given (project), it’s just going to have to reduce the percentage,” said German Pacheco, a congressman from the opposition National Action Party who helped craft the energy reform.

Government officials admit privately that adjustments will likely be needed to maintain strong interest, though in public they are more circumspect, mindful that oil prices could still rally before winning bids are revealed.

“The market will determine how much it’s willing to offer,” said deputy finance minister Miguel Messmacher.

Companies will know what the floor for the government’s share of profits is “just before” companies must submit their offers on the first contracts by mid-July, Messmacher added.

Some experts are pessimistic, suggesting that low oil prices over a prolonged period could put off oil majors like Chevron Corp and Exxon Mobil Corp, which tend to seek only the biggest and most profitable projects.

“I suspect most of them will buy the bid packages, but when it comes to submitting a bid, those big companies won’t bid anything,” said George Baker, a Houston-based oil analyst and publisher of industry newsletter Mexico Energy Intelligence. “This is a great, unacknowledgeable setback for the government.”

‘WHATEVER’S NECESSARY’

The oil slump is a blow to President Enrique Pena Nieto, who is grappling with outrage at the apparent massacre of 43 trainee teachers and a conflict of interest scandal. He has built his presidency on reviving Mexico’s struggling economy, and energy reform is the cornerstone.

International benchmark Brent crude for February delivery traded at about $60 a barrel on Friday, down by nearly half since June. Mexico’s oil mix is worth even less, dipping beneath $50 a barrel for the first time since 2009 this week.

Revenue from Mexican state oil giant Pemex has for years funded about one-third of the federal budget, and the government hopes opening up the industry to private companies will generate thousands of jobs and additional tax returns.

“Even in the current price environment, all of those blocks that are being auctioned offer a high degree of profitability,” Emilio Lozoya, CEO of Mexico’s state oil giant Pemex, said in an interview.       

With oil down, Senate energy committee head David Penchyna of the ruling Institutional Revolutionary Party said Mexico had to do “whatever’s necessary to avoid scaring off investment” when asked about the government take for the first contracts.

Oil industry officials say Mexico should make it easier for companies to recover production costs - the first round foresees up to 60 percent - as well as temper rigid requirements to front load 80 percent of investment in the first three to five years.

“Imposing rapid schedules in this low oil price environment is not helpful because we’re all struggling with less revenues,” said a senior oil executive, speaking on condition of anonymity.

However, Messmacher at the finance ministry insisted the government is not yet contemplating additional sweeteners.

“We believe that the contracts already have significant flexibility,” he said.

Mexican officials say the relatively low production costs expected for the first shallow water blocks should provide enough upside for would-be investors. These could be below $20 a barrel, Credit Suisse said in a recent report.

But if prices stay low, the energy ministry has already hinted it may trim the costliest blocks from subsequent rounds given higher development costs in more complex deposits such as shale, deep waters and the tight oil of the Chicontepec basin.

Additional reporting by Adriana Barrera; Editing by Simon Gardner and John Pickering

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