Mexico: The Execution Of The Agreements Of The Third Call of Round 1: Face Of The New Mexican Hydrocarbons Industry.

Round 1 has finally shown, through the results of the Third Call for bids, the promising direction outlined by the Energy Reform on 2013. For the last 3 years, it has been evidenced that the opening of the national hydrocarbons sector is calling the attention of investors, both Mexican and foreign. The three calls for bids carried out so far have resulted in the execution of 24 hydrocarbons exploration and extraction Agreements. These Agreements are the legal acts by which Mexico, acting through the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos,"CNH"), grants a contractor the right to conduct hydrocarbons exploration and extraction activities in a contractual area for a specific period of time; something that was impossible before the Energy Reform.

To summarize the success of this last bidding round, one must take into account that out of 51 prequalified bidding competitors for the Third Call, 40 were successfully registered (14 in consortium and 26 individually). Furthermore, out of a total of 25 blocks, 25 received bids were awarded, and even though only 76% of the agreements corresponding to the assigned blocks were signed, -as will be later explained- these results are historical. These results represent the highest percentage of the current Round, compared to the previous 14% and 60% of the First and Second Calls, respectively.

The blocks' awarding is made through a bidding process, during which qualified competitors make closed bids to the CNH for each block they are interested in. Then, the CNH chooses the one with the highest government take. Specifically for Licence Contracts, two bidding variables are taken in consideration: an additional royalty and a % increase to the minimum work program. Bidders freely offer the additional royalties, which are taking from gross revenues, while the increase in the minimum work program is limited to 100%, or double to the original minimum work program.

After the results' disclosure, winners have to sign the Agreement to materialize the achievement of the Bidding Process. This time, 6 Contracts were not executed (Tecolutla, Paso de Oro, Ponton, La Laja, Ricos and San Bernardo). For these unexecuted Agreements, the seriousness guarantees will be made effective. Equivalent to an amount of US$65,000 per block, seriousness guarantees will be affected to the Mexican Oil Fund for Stabilisation and Development (Fondo Mexicano del Petróleo para la Estabilización y el Desarollo).

An awarding process will begin to grant these blocks to the second place bidders, in accordance to the Bidding Guidelines. GeoEstratos, S.A. de C.V., in consortium with Geo Estratos Mxoil Exploration and Production, S.A.P.I. de C.V., is the national company that won more Licences Agreements in Third Call. However, it is noteworthy that this company did not sign any of the four Agreements awarded to it, affecting its credibility toward the CNH and the new Mexican oil and gas industry.

It is important to think about the reasons that led some winners to retract. In comparison with the second place bidders proposals' for the unsigned blocks (excepting San Bernardo), the enthusiasm of the additional royalties proposed by the winners may look disappointing. Some of them were too aggressive. The fact that royalties are paid without deducting the cost of extracting hydrocarbons is a major issue that probably affected the original winners' profitability projections for the blocks.

In this sense, extracting hydrocarbons in a profitable manner seems to be difficult to achieve today, taking in consideration the present hydrocarbons taxations conditions. The oil market price fluctuation takes a prime importance for companies in their investment decision process. It is perhaps the most important factor, as forecast attempts to predict its evolution in order to determine if it is convenient or not to invest in a certain block.

It is likely some winners considered the break-event point was not reachable under the current price scenario. One may suspect that the desire to take away a block, forgetting profit value and offering more than reasonable for it, got bidders carried away. Then, at the results publishing date by the CNH, some winners may have become aware of the audacity of their proposals, and considering the profit line doubtful, decided not to sign the Agreements. It is not new that the international oil climate rules the sector's investments, and with the low oil market price recently observed, one can explain why some winners finally did not carry out their aspirations and altogether preferred to sacrifice their seriousness guarantees.

A significant point is that the winning companies who did not sign their Agreements surely lost face before the hydrocarbons industry, the Mexican authorities, and their peers. Stained with an unreliable image, its engagements may be no longer considered trustworthy. A lesson to take away from this Third Call is that Companies should measure the consequences before bidding, instead of wanting to win an economically unviable block no matter what.

It is interesting to notice the positive attitude of the relevant authorities, taking in consideration the feedback experience of the past Bids to learn and correct the procedure problems, such as previously revealing the minimum values for the bidding variables to avoid what happened in the First Call1. Moreover, the CNH has removed its prohibition for two or more companies that produce more than 1.6 mmboepd to participate jointly as a consortium in a bidding process. This is especially relevant for the Fourth Call of Round 1, as companies, considering the costs of exploring and extracting in deep and ultra deep waters, usually form consortiums to distribute and share the risks of those activities.

Actually, to look at the very near future, new challenging methods of exploration and extraction are being integrated to the Mexican Hydrocarbons agenda. The Fourth Call for Bids is considered to be the most critical of Round 1. The 10 deepwater Blocks tendered are located in the attractive areas of Cuenca Salina and Cinturon de Plegado Perdido. The stakes are real, and main super-majors will enter the competition.

There is no doubt that the upstream hydrocarbons sector in Mexico is going through a major transformation, and will continue to do so in the near future.

Footnotes

1. In the First Call for Bids of Round 1, 4 Blocks were not awarded because the bids did not meet the minimum values, which were not disclosed by the Ministry of Treasury.

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