Last year may be the most important one of the Mexican upstream sector since the absolute nationalization of 1938, performed by President Lazaro Cardenas that initiated the 75-year state monopoly of Pemex. Throughout 2015, the National Hydrocarbons Commission ("CNH") tendered 3 sets of hydrocarbons exploration and extraction contracts. The first two Calls for Bids awarded 5 offshore, shallow water blocks to private parties, but on December 15th, 2015, all of the 25 tendered onshore blocks were awarded to a diverse group of companies, both Mexican and foreign. Indeed, as of today one may justly say that a Mexican upstream industry formed by several players exists, but whether all of these players can explore and extract hydrocarbons in a profitable manner remains to be seen.

To put the results of this Third Call into perspective, one should remember that both the First and Second Calls for Bids of Round 1 involved the participation of 9 bidders, but resulted in only 14% and 60% of the tendered blocks being awarded, respectively. For the last Call for Bids, there was an unprecedented turnout of 40 participants and 100% of the blocks were granted. This may be partly explained by the fact that the tendered blocks corresponded to onshore fields with proven reserves that had been previously exploited by Pemex, but were abandoned during the 80s, as the Mexican national oil company concentrated its efforts and investments in extracting hydrocarbons at a lower cost from the shallow waters of the Southeast region of the country. Additionally, it is worth noting that both the technical and financial prequalification criteria for this last set of contracts were less severe than those featured in the first two Calls for Bids1.

The First and Second Calls for Bids were designed to attract major international players to Mexico, while the Third Call for Bids was tailored to allow a genesis of a national, private oil industry. This last objective was reasonably met, as 20 of the 25 blocks were awarded to Mexican companies with Mexican capital, and 2 more were won by consortiums that included Mexican capital.

It is worth mentioning that the 25 tendered contracts were divided in two: 4 "Type 2" Blocks, with a remaining volume of more than 100 million barrels of liquid hydrocarbons, and 21 "Type 1" Blocks, with a remaining volume of less than 100 million barrels of liquid hydrocarbons. Not only were all of the License Contracts corresponding to the 25 blocks awarded, but most of them faced extremely competitive proposals by the bidders that turned up to compete for them.

Now, unlike the previous Calls for Bids, which granted Production Sharing Contracts, the Third Call for Bids awarded License Contracts. The main difference between these two types of contracts lies in one of the hydrocarbon taxation instruments used by the government to capture economic value for the State, which also happens to be the main bidding variable used to determine the winner of the blocks. While for Production Sharing Contracts, the bidders offer a percentage of the operating profit to the State; in License Contracts, bidders offer a percentage of the gross revenues derived from the block's operations. This percentage of gross revenues is independent of the royalty that must be paid in accordance with the Hydrocarbons Revenue Law (Ley de Ingresos sobre Hidrocarburos), and that is why it is occasionally referred to as the "additional royalty."

Because royalties are paid over gross revenues, without considering the cost of extracting hydrocarbons, they are hydrocarbon taxation instruments that do not share risk between the State and the contractors, and are therefore usually seen as a less attractive tax instrument. Taking this into consideration, the minimum values for such bidding variable set forth by the Ministry of Treasury and Public Credit were considerably lower than those set out for the previous Calls for Bids2. Interestingly enough, the fact that the bidding variable was an additional royalty did not prevent the participants of the Third Call for Bids from making some very aggressive bids for some of the tendered Blocks that were well above the minimum values required by the authority.

The average percentage of additional royalty offered by the winning bidders for the Third Call for Bids of Round 1 was 55.27%, with bids as low as 10.56%, presented by Sarreal, S.A. de C.V. for the San Bernardo Block, and as high as 85.69%, presented by the consortium headed by Canamex Dutch B.V. for the Moloacan Block. Furthermore, for 17 of the awarded blocks, the contractors offered a percentage greater than 50% of the revenues to the State. This is great news for the Mexican government's finances, but puts some of the contractors in a difficult position to make their activities under such blocks profitable.

As an example, one can look at the highest bid presented by the Canamex Dutch B.V. consortium. Assuming a price scenario of 30 USD per barrel extracted from the Moloacan Block, which is congruent with the current situation on the international markets3, 7.5% of such revenues must be paid to the Mexican State as a royalty4. Such percentage added to the 85.69% corresponding to the additional royalty, which served as a bidding variable, means that the Mexican Government will receive 93.19% of the gross revenues from the Moloacan field, or roughly, 27.96 USD out of every barrel. This means the Canamex Dutch B.V. consortium needs to have a production cost of less than 2 USD per barrel to turn a profit, which quite frankly looks daunting. Furthermore, one should not forget that 30% of any such profit shall also be paid to the State as a result of the applicable income tax.

This not only applies to this highest bid. Taking the average percentage of additional royalty offered by the winning bidders and adding it to the normal 7.5% royalty yields a government take of 62.77% or around 18.83 USD per barrel under this scenario, without taking into account the income tax. This means a break even point of less than 12 USD per barrel, which is lower than the average production cost of 15 USD per barrel applicable to those fields according to statements by the CNH earlier this year5. It is great for both the Mexican State and the Mexican industry in general that the bidders were so enthusiastic in their proposals with the newest set of tendered blocks, but it is difficult to see how many of them plan on making any money from them.

The blocks of the Third Call of Round 1 were awarded to new players of the Mexican upstream industry who mostly presented very aggressive bids in order to obtain them. Either these new players are extremely confident in their ability to produce oil and gas well below the original cost of Pemex under such fields, they are extremely optimistic in their outlook of the price of oil in the near future, or they presented their bids without profitability as their main objective. Some of them may have just wanted to obtain certain contracts no matter the cost, in order to be one of the first private producers of hydrocarbons in Mexico, or have some other ulterior motive in mind, such as storing their production until the market price recovers. Only time will tell whether or not these bids were determined and presented in a foolhardy manner, but if their bets do not pay out and the contracts are not profitable enough, these contractors may want to try to renegotiate the economic terms of these contracts with the CNH. To allow such renegotiation would be a mistake by the authority, which will need to properly administer the already awarded contracts and concentrate on making the following Calls for Bids as successful as this one.


1.Regarding the financial prequalification criteria, the First and Second Calls for Bids required Assets of 10 billion USD, while the Third Call for Bids required only 5 million USD in owner's equity for each "Type 1" Block and 200 million USD for each "Type 2" Block. As for the technical criteria, the First and Second Calls required the bidders to evidence the company's experience in at least 3 exploration and extraction projects as well as 10 years' operational and management experience of the personnel in charge, while the Third Call for Bids only required this second criterion.

2.The Third Call for Bid featured a range of minimum additional royalty between 1-10% of the gross revenues, while the First and Second Calls featured a range of minimum operating profit of 25-40%.

3.As of December 30th, 2015, the price of a barrel of Mexican crude mix was 26.93. 

4.Pursuant to Article 24 of the Hydrocarbons Revenue Law, with a price of oil under 48 USD per barrel, the applicable royalty is 7.5% of the gross revenues.

5.Declarations made by the CNH on May 2015.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official opinion or position or institutional view of Rodríguez Dávalos Abogados.