Commentary: Mexico’s third-round of lease auctions gives domestic energy industry a jump-start

By Alfredo Alvarez and Deborah Byers

By all measures, the Mexican Government’s third round of oil and gas lease auctions was a major success.

The 25 onshore leases — including four medium-size blocks and 21 small fields — attracted significant interest from energy companies. In fact, all 25 were awarded during the 15 December auction. Many of them went to emerging Mexican companies that were founded following the privatization of the energy industry in 2013.

That’s a big plus for the Government and its National Hydrocarbons Commission (CNH), which are hoping to develop a strong private energy sector to increase competition and drive domestic production. Among Mexican companies, the winners included Compañia Petrolera Perseus, Servicios de Extracción Petrolera Lifting de Mexico, Diavaz Offshore, Geo Estratos Mxoil Exploración y Producción, Geo Estratos, Strata Campos Maduros and Grupo R Exploración y Producción.

Roma Energy Holdings, headquartered in The Woodlands, also won rights to a lease in Tabasco in partnership with Mexican companies Gx Geoscience Corporation and Tubular Technology.

“The primary objective of this round was to sow the seeds to create new Mexico oil enterprises,” said Lourdes Melgar, Mexico’s Deputy Energy Minister. “That goal was achieved.”

Many of the country’s start-up E&P companies are led by former Pemex (Petróleos Mexicanos) managers or are affiliated with existing oilfield services firms doing business in Mexico. By winning these bids, the companies can focus their efforts on manageable mid- and small-sized blocks — 19 of which are already producing oil and/or natural gas — and give themselves a jump-start on a successful future.

The CNH was especially pleased the first oil to be produced under Mexico’s energy reform will come from the third-round auction. The blocks awarded are expected to yield 77,000 barrels per day when they hit peak production in 2018, generating more than US$600 million in revenues for the Mexican Government over the first five years of the contracts.

Interestingly, Mexico’s major conglomerates, many of which created energy businesses after 2013, were not as successful as the smaller stand-alone firms in the 15 December auction. But they will have plenty of opportunities in future auctions of bigger and more complex blocks, either alone or as joint venture partners with international firms.

A total of 51 bidders qualified to submit final offers in the third round and 40 actually participated, including companies from the US, the Netherlands and Canada. Those numbers were significantly higher than the number of participants in the first two auctions, which were aimed at larger companies and consortiums.

The first two auctions generated only five qualifying bids — perhaps understandable given current crude prices and the more stringent financial requirements in place for bidders.

Industry experts watching this third round expected the four medium-size blocks to draw interest. But many were surprised when the smaller blocks also received a great deal of attention. In more good news for the CNH, all 25 leases received at least two bids, which ensures a contract can be finalized even if the winner decides not to move forward.

Another surprise for the Government was the fact that many bidders offered extremely high royalty rates in their offers. Most of the over-royalties offered — the level above the required royalty, taxes and fees — were between 30% and 60% of gross revenues. One participant even offered 85% plus a 7.5% royalty on gross.

Those offers were far higher than the 0% to 10% minimum over-royalty established by the CNH, which purposely kept requirements lower than in the past two auctions to help smaller domestic companies that will be facing a difficult low-cost commodities market.

Given the generous terms they submitted to the Government, however, it remains to be seen whether the winning bidders can actually make a profit once they begin producing. That uncertainty should temper some of the industry’s enthusiasm going forward.

The CNH followed up the successful third round with an announcement on 16 December that 10 offshore blocks will be auctioned off in the next round of bidding, including deepwater fields in the Perdido and Salina del Istmo areas of the Gulf of Mexico. That auction is expected to attract significant interest from U.S. companies and international majors.

Mexico’s energy reform, which was heralded by the industry, is unfortunately being implemented in very difficult times for many companies. But the success of this third round of auctions is proof that the Government is learning valuable lessons as it moves forward, and that industry still sees great opportunity in the country’s vast resources.

Alfredo Alvarez is the Mexico oil and gas leader for Ernst & Young Mancera, and Deborah Byers is the U.S. oil and gas leader for Ernst & Young LLP. The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global EY organization or its member firms.