In December 2013, Mexico introduced a constitutional reform that allowed companies other than state-owned oil firm Petroleos Mexicanos to own Mexican production blocks for the first time since the nationalization of the country's oil sector in 1938. Since then, Mexico City has been organizing its Round One bidding process to award oil production and exploration blocks to private companies. The Mexican government has chosen to split up the blocks into separate tenders for shallow exploration blocks, shallow blocks with proven reserves, onshore conventional blocks, deep-water exploration blocks and unconventional blocks. All of the bids are set to take place by the end of 2016.
The first tender, which was held in July and offered 14 exploration blocks in the Gulf of Mexico's shallow waters, garnered little interest from foreign companies. As a result, Mexico awarded only two of the 14 blocks, both to a consortium led by Mexico's Sierra Oil & Gas. The bids, already disappointing to a government that had hoped to award at least five blocks, also barely exceeded Mexico City's minimum bid requirement. Companies' lack of interest stemmed from not only the blocks' poor geology and low oil prices, but also the unattractive fiscal and legal terms offered in the contracts. Since then, Mexico has increased the flexibility of its minimum work commitment requirements and changed its security credit guarantee. In the Sept. 30 round, the government also announced its minimum bid requirements two weeks before the bidding began, as opposed to right before opening the bids, as it did during July's auction.
Refining the Bidding Process
Mexico's willingness to compromise with foreign participants has been a consistent theme of the Round One bidding. There has been an ongoing dialogue between Mexico City and international oil companies, meant to ensure that the government can work out the kinks in its offerings. Even before the first tender began in July, Mexico made several key changes to the process aimed at attracting greater participation, including a stipulation that the "adjustment mechanism" — a feature created to give Mexico City a greater share of revenue in the event that a project yields extraordinary profits — would not kick in until oil companies gained a higher rate of return on their investment in the blocks. The Mexican government raised the threshold of the adjustment mechanism, originally triggered at a rate of return of 15 percent, to 20 percent before the first tender and again to 25 percent for the Sept. 30 bid.
Based on the outcome of the Sept. 30 round of bidding, Mexico's changes worked. The second tender of blocks were shallow-water blocks with proven reserves. The bid for the first block alone signaled that the entire round would be a success; on its own, it attracted more interest than all of the blocks in the July tender combined. The first block received nine bids, all well above Mexico's minimum bid requirements, and in the end it was awarded to Italy's Eni, which offered the Mexican government an 83.75 percent share in the production-sharing contract. (Mexico's minimum requirement is just 34.8 percent.) Meanwhile, Mexico City awarded two of the remaining blocks to consortiums led by Argentina's Pan American Energy (60 percent of which is owned by BP) and by the United States' Fieldwood Energy (the largest U.S. operator in the United States' shallow waters). Each of the consortiums offered the Mexican government shares of at least 70 percent in their production-sharing contracts.
Though Mexico failed to award the remaining two blocks, the significant interest in the other three indicates that geology was likely the deciding factor in the lackluster performance of the last blocks — not Mexico City's contractual terms. The fact that the three awarded blocks all went to proven exploration and production companies also represents a victory for Mexico, whose previous energy reforms failed to attract such companies. In addition, major exploration and production companies like Norway's Statoil, Russia's Lukoil, China's CNOOC and Malaysia's Petronas submitted competitive bids on at least one block.
A Promising Future
Mexico will offer its next group of blocks, this time containing onshore resources in mature basins, in December. However, the third tranche is not expected to attract much interest from major international exploration and production companies; instead, it is designed to facilitate the development of Mexico's private oil companies. Already, 60 companies — nearly all of which are small Mexican firms — have begun the process of prequalifying for December's bid. Despite the expected lack of international participation, the round is notable because it will be Mexico's first time offering more flexible and potentially more attractive licensing contracts, as opposed to the production-sharing contract model seen in the first two tenders.
The main event of Round One — the auctioning off of Mexico's deep-water resources — will not take place until the fourth tender, expected to be held in the first half of 2016. Although Mexico City has yet to unveil the contract model it will use for this round, it will likely be a licensing contract. The government will probably announce its initial call for bids, which typically predates the actual bid by six months, by the end of 2015. Mexico City has been holding off on doing so until the Sept. 30 round was complete to give itself time to incorporate any lessons learned from the second tranche process.
For both Mexico and the major oil companies that view it as a potentially lucrative market, the first three rounds of oil block bidding serve as a trial-and-error process. By working informally together toward a model that balances the needs of all parties involved, the government and the oil companies are aiming to ensure the success of the critical deep-water bidding round and, in the long term, the revival of Mexico's oil industry. The results of the first two tenders indicate that Mexico City now has both the legal architecture and fiscal regime needed to solidify and sustain the country's energy reforms. Now, the only question that remains is whether factors that are largely outside of Mexico's control, like global oil prices, will enable the country's energy sector to realize its full potential.