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Investment Opportunities in Mexico’s Denationalized Energy Industry

 

In December 2013, Mexico passed Constitutional amendments to reopen its energy industry after decades of protectionism and stagnation. ((Tim R Samples, A New Era for Energy in Mexico? The 2013-14 Energy Reform, 50 Tex. Int’l L.J. 603, 605 (2016).)) Ernst & Young estimated in 2014 that total investments in Mexico with objectives to increase production, to improve the midstream network, and to promote energy sustainability would cost between US$35 billion and US$100 billion over a decade. ((Ernst & Young, Mexico’s Energy Reform: Key Issues from an Investor’s Perspective 2 (2014), http://www.ey.com/Publication/vwLUAssets/Reforma_energetica:_temas_clave_desde_la_perspectiva_del_inversionista_en_Ingles/$FILE/EY-reforma-energetica-ingles.pdf.)) It is estimated that there is a total of US$220 billion of potential investment opportunities in Mexico as a result of the energy reforms, including reforms in the electricity industry. ((Jules Gray, Mexico opens up its energy industry, World Finance (Nov. 2, 2015), http://www.worldfinance.com/strategy/mexico-opens-up-its-energy-industry.)) Additionally, the decrease in oil prices has sparked interest from Pemex to utilize partnerships to develop its fields. ((Michelle Casady, New Pemex CEO Says Mexico Is Open For Partnerships, Law360 (Feb. 23, 2016), http://www.law360.com/articles/762901/new-pemex-ceo-says-mexico-is-open-for-partnerships.))

 i. Bidding Rounds Thus Far

The bidding process for oil and gas leases was announced in 2013 to much fanfare; however, the results of the first auction fell short of expectations. ((Keith Goldberg, Mexico Oil Reformers Get Reality Check From Auction Results, Law360 (July 16, 2015), http://www.law360.com/articles/680024/mexico-oil-reformers-get-reality-check-from-auction-results.)) In the first round of bidding only two of the fourteen blocks auction were awarded and more than half of the auctioned blocks did not receive any bids, perhaps because the largest oil companies refrained from bidding. ((Id.)) A group consisting of Talos Energy LLC, Sierra Oil & Gas, and Premier Oil received the awarded blocks. ((Id.)) Carlos Sole, a Baker Botts LLP partner, commented that round one was a failure because “the Mexican government developed fiscal and contractual terms in a high oil price environment, failing to realize that capital is scarce and that scarcity is exacerbated in a low-price environment.” ((Id.)) Akin Gump Strauss Hauer & Feld LLP partner Steve Otillar commented that “Mexico is going to have to be more attractive from a legal and fiscal standpoint than other regimes to entice operators to enter a new country.” ((Id.))

Two additional auctions were held in 2015 where additional contracts were awarded. ((Anthony Harrup, Mexico Begins New Round of Oil Auctions With Shallow-Water Blocks, Wall St. J. (July 19, 2016), http://www.wsj.com/articles/mexico-begins-new-round-of-oil-auctions-with-shallow-water-blocks-1468953974.)) In July 2016, Mexico commenced round two of the auctions that include fifteen shallow water blocks of existing and undiscovered reserves in the Gulf of Mexico. ((Id.)) In December 2016, Mexico completed its first deepwater oil auction, awarding 8 out of 10 available blocks to major oil companies. ((Amy Stillman & Adam Williams, Mexico Oil Auction Succeeds in Drawing World’s Biggest Drillers, Bloomberg (Dec. 5, 2016), https://www.bloomberg.com/news/articles/2016-12-05/bhp-billiton-named-as-pemex-s-first-deep-water-oil-partner.)) The government awarded blocks to Total, a group with Statoil ASA and BP Plc, Exxon, CNOOC Ltd, Chevron Corp., Inpex Corp, and Sierra Oil & Gas. ((Id.))

ii. Upstream Investments

Perhaps the largest change with the Energy Reform is the ability for oil companies to directly invest in Mexico’s upstream oil and gas industry. The greatest attraction for private companies is the untapped reserve base which Pemex estimates could be up to one hundred and fifteen billion barrels of oil equivalent. ((Ernst & Young, supra note 2.)) The reforms target investment in the deepwater areas of the Gulf of Mexico. ((Adrian Lajous, Columbia Univ. Ctr. on Glob. Energy Pol’y, Mexican Energy Reform 16 (June 2014).)) However, opportunity also exists in shale plays in Northern Mexico as well as reserves in the Chicontepec region. ((Id.)) Further, additional opportunity exists for companies specializing in enhanced recovery techniques. ((Ernst & Young, supra note 2.))

However, the investments in upstream oil and gas are limited to the four types of contracts allowed under Mexican law, as well as the type of contracts being auctioned for the particular blocks. ((Diana Villiers Negroponte, Mexican Energy Reform: Opportunities for Historic Change, Brookings (Dec. 23, 2013), https://www.brookings.edu/opinions/mexican-energy-reform-opportunities-for-historic-change/.)) The contracts allowed for the deepwater blocks include production-sharing contracts, which allow the private company to gain title to the oil and gas once extracted from the ground. Production-sharing and license contracts are perhaps the most sought after contract types because the company gets title to the oil and gas. Currently title to the oil and gas reserves remains with the state until the oil and gas is extracted from the ground. Under the Securities and Exchange Commission’s (SEC) reporting standards, therefore, the companies cannot report the oil and gas as part of their reserves. ((Kyle Doherty, From “The Oil Is Ours!” to Liberalization: Resource Nationalism and the Mexican Energy Reform, 53 Hous. L. Rev. 245, 256 (2015).)) This could deter investment from large companies until the SEC creates a rule governing the reporting of the assets. ((Id.))

iii. Midstream Investments

As the upstream sector grows following the energy reform, the need for investment in the midstream sector also creates investment potential. ((Ernst & Young, supra note 2, at 3.)) Pipelines currently only transport ten percent of the crude oil produced by Pemex to refineries, creating a large opportunity for investment. ((Ernst & Young, Mexico Midstream: Opportunities for investors who move now (2015), http://www.ey.com/Publication/vwLUAssets/ey-mexico-midstream-opportunities-for-investors-who-move-now/$FILE/ey-mexico-midstream-opportunities-for-investors-who-move-now.pdf.)) Pipelines are also required to expand access to natural gas to areas not currently connected to the existing pipeline network. ((Jules Gray, Mexico opens up its energy industry, World Finance (Nov. 2, 2015), http://www.worldfinance.com/strategy/mexico-opens-up-its-energy-industry.)) International companies could be further interested in investing in Mexico’s midstream sector because of the impact it could have on trading arbitrage opportunities from its location between the Asian demand and production along the Gulf of Mexico. ((Ernst & Young, supra note 2, at 3.)) Many experts believe that companies with a presence in Mexico or with existing partnerships with Mexican companies are best situated to investment in the expected midstream growth. ((Ernst & Young, supra note 22.))

iv. Downstream Investments

The downstream oil and gas sector, which includes refineries, has not garnered as significant interest as the upstream and midstream sectors. Traditionally, Mexico exported a large percentage its oil and gas to the United States, which has large-scale, modern refineries, particularly clustered along the Texas and Louisiana Gulf Coast. The United States’ refining capacity which is capable of running Mexican crude, among other types of crude oil, has significant economies of scale over Mexican refining capacity. However, the downstream sector could be an investment opportunity if the international market created arbitrage opportunities through investing in Mexico. ((Ernst & Young, supra note 2, at 3.))