The Changing Role of O&G on Public Finances and the Impact of Mexico’s Unique Fiscal Regime on Licensing Rounds
The Fiscal Reform implemented by the Peña Nieto administration, including the mechanisms set in place to manage the income generated by the hydrocarbons industry, provide the Mexican government with flexibility to deal with any oil-price surprises that might arise, Salvador Ugalde, Director of the Income Unit of Hydrocarbons at the Ministry of Finance, told the 2017 Mexico Oil & Gas Summit on Tuesday at the Mexico City Hotel Sheraton María Isabel.
“From a governmental perspective, one of the most important advantages of the system is the flexibility of its mechanisms. This means the state can obtain a larger income from the generated hydrocarbons production when market prices increase,” said Ugalde in his keynote speech on the changing role of the oil and gas industry on public finances.
The referenced flexibility is provided by the model of incremental royalties imbedded in contracts. “Although it might seem very harsh to set an incremental model, it shields both the government and the companies from having to renegotiate the contracts in light of new discoveries or an increase in international prices,” said Ugalde. The renegotiation of contracts is a fairly common practice in countries such as Brazil, Africa or the Middle East. Ugalde told the summit that Mexico’s government wanted to avoid the practice by imposing the ex-ante conditions.
“In economic terms, flexibility is provided by the tax rate, which is the result of a competitive process, wherein free competition allows the government to award contracts to companies that offer the biggest contribution to the Mexican state in terms of income and investment commitment,” said Ugalde. “Free competition has led us to contractual fiscal mechanisms that allow the government to access over 75 percent of the hydrocarbons generated by the projects.” However, for this mechanism to function, Ugalde noted that contracts must offer an appropriate balance between risk and return. “We have to find ways to continue capturing resources in a manner that does not discourage private investment,” he said.
Ugalde suggested that the most important success of the 2013 Fiscal Reform is that it allowed the Mexican government to amortize the drop in oil prices. “In 2008, oil income represented around 6 percent of Mexican GDP. Today, it only represents around 2 percent.”
According to Ugalde, the participation of third parties will allow the country to reverse its downward production trend while diversifying investment risks and allowing for a better management of hydrocarbon-generated income. “Back in the 1970s, the country did not have any rules for managing oil-generated income. The creation of the Mexican Petroleum Fund now provides a framework on how to manage those resources.”
The Mexican Petroleum Fund was established in 2014 to manage Mexico’s hydrocarbons income. “If hydrocarbons income is above 4.7 percent of GDP, it will be stored and invested in sectorial improvement proportional to the amount,” Ugalde said. “Once the fund generates savings above 3 percent of the country’s GDP, the resources will be used to generate more human capital, infrastructure, pension funds or scholarships. Savings above 10 percent of the country’s GDP can be transferred directly to the Federation Expenditure Budget.”
In addition to the advantages, Ugalde said that one of the most important aspects of this new system is its transparency. “The Mexican Petroleum Fund has the responsibility of making all its investments public. This, combined with transparency of the bidding processes, will allow Mexico to take part in the global dynamic of accountability,” he said.
How to Measure the Success of Round One
Moderator: Juan Carlos Gay, Partner in the Global Energy Practice at Bain & Company
Panelist: Alberto de la Fuente, President of AMEXHI
Panelist: Ernesto Marcos Giacomán, Director General of Marcos & Asociados
Panelist: Rodrígo Hernández, Deputy Director General of Administration of Hydrocarbons at SENER
The transparency of the process, the rules and what the regulators learn should be the key determinants when gauging the success of the licensing rounds, Ernesto Marcos Giacomán, Director General of Marcos & Asociados, said at the Mexico Oil & Gas Summit 2017 in Mexico City on Tuesday.
“The number of blocks assigned is often used as a parameter of success but we should take into consideration the transparency of the process, the certainty brought by the rules and the learning attitude of the regulators as a major success,” Giacomán said during the panel discussing how to measure the success of Round One at the Hotel Sheraton María Isabel.
Juan Carlos Gay, Partner in the Global Energy Practice at Bain & Company, who moderated the panel, added that it was necessary to have a set of long-term measurement metrics for success in a country that is just opening its market.
The panel, which included Alberto de la Fuente, President of AMEXHI and Rodrígo Hernández, Deputy Director General of Administration of Hydrocarbons at SENER, agreed that creating a strong Mexican industry was a top metric. “Having Mexican companies in exploration and production will have the most important and positive effect over the long term because it will make the opening of the market brought by the Energy Reform irreversible,” de la Fuente said. He pointed out the commitment that AMEXHI members have to the country, adding that all AMEXHI members agree that having the value chain as close as possible is what makes the best economic sense.
Giacomán, pointed out that Mexico already has a strong and capable industry in place but he also said more needs to be done. “There is capacity; the Mexican industry is comprised of very capable national and international companies but what we need is an increase in demand as soon as possible,” he said.
But a number of hurdles must be overcome to drive the industry forward, Hernández told the audience. Among the top challenges was creating a proper level of trust, both from the general public and investors. “One of the main challenges of the reform was to create trust from the outside, to make both the Mexican public and investors trust that we would work with a transparent framework that provided certainty,” he said, while recognizing that the public is skeptical of political discourse.
Just like every other participant in the market, regulators are also undergoing a learning curve with every round that must be put to work to create better practices, Rodrigo said. “We as regulators are open to feedback, we want to have the best international practices in place,” the SENER official said.
Despite a low level of global activity, Mexico had been able to implement the licensing rounds in a short time, which must be seen as a major achievement, but simpler organization and regulation are required to ensure the country reaches its production goals, de la Fuente said. “The rounds need to keep coming at a quick and consecutive pace to achieve our reserves-replenishment goals. Trion is just one of the many discoveries that we need.”
When confronted with the question of what a change in administration would mean, with the presidential elections coming in 2018, the panelists agreed that Mexico’s open market and the resulting benefits have already been established. “We want to avoid a discussion of candidates or platforms. The way to go is to focus on long term goals, and from there lay the best action plan,” de la Fuente said.
Concluding the discussion, Rodrigo said that it would be dangerous to declare any round a final success. “We have to keep learning, never drop the towel and recognize that we are in an international battlefield, and that the objective is to bring investment to Mexico.”
The Road to First Oil for Mexico’s New Offshore Operators
Moderator: Jeroen Posma, Director General of Mexico Business Publishing
Panelist: Timothy Duncan, President and CEO of Talos Energy
Panelist: Gregory Hebertson, Vice President Western Hemisphere Exploration & New Ventures of Murphy Oil Corporation
Panelist: Andres Brugmann, Country Manager Mexico of Fieldwood Energy
Panelist: Carlos Morales Gil, CEO of PetroBAL
Boosting participation in the licensing rounds will help fill government coffers, panelists at the Mexico Oil & Gas Summit 2017 said on Tuesday in Mexico City. The panelists were addressing The Road to First Oil for Mexico’s Offshore Operators, a discussion that came on the heels of the historic oil strike on July 12 by the Talos Energy-Premier Oil-Sierra Oil & Gas consortium.
“Regulators should be focused on incentivizing participation because increased participation increases the government’s revenue,” Timothy Duncan, President and CEO of Talos Energy, told the audience at the Hotel Sheraton María Isabel. Talos and its partners became the first private drilling operation to strike oil since the launching of the Energy Reform. The Zama 1 site, located near the coast of Tabasco, is estimated to produce between 1,400 and 2,000 million boe.
The panel was stacked with industry heavyweights Duncan; Gregory Hebertson, Vice President Western Hemisphere Exploration and New Ventures of Murphy Oil Corporation; Carlos Morales Gil, CEO of PetroBAL; and Andrés Brugmann, Country Manager Mexico of Fieldwood Energy. Director General of Mexico Business Publishing Jeroen Posma moderated the discussion.
The Talos achievement suggests that the Rounds are solidly designed, and in themselves show the world Mexico’s potential, said Morales Gil. “The Rounds are a recognition of Mexico’s geological potential,” he said.
Opportunity often goes hand in hand with challenges. As Mexico’s market transitions from a PEMEX monopoly to a competitive playing field, the supply chain needs to adjust to this major shift. “Transporting and marketing oil is a complex process, with many different levels of negotiation,” Brugmann said. Local procurement service companies need to understand this and adapt their offer to the wide array of business models of the industry’s new players.” Added Duncan: “We have to design our supply chain in a way that it phases in different vendors.”
As part of Mexico’s energy-supply security, there is a clear desire to take oil production and the industry’s activity to a level that meets the country’s energy requirements. “If there is an intention of increasing the amount of activity in the industry, one way of doing so could be to reduce the size of the auctioned blocs to have more people committed with more activities,” said Morales Gil. But that objective also entails a high level of complexity. “Collaboration, commitment and transparency in the industry are key to stimulate activity and to ensure the service sector’s growth,” said Hebertson.
Encouraging onshore natural gas production for faster and cost-efficient power supply in Mexico
The liberalization of natural gas prices in Mexico will help develop the domestic production and eventually to more dynamism in the market, Marcelino Madrigal, Commissioner of CRE, told the 2017 Mexico Oil & Gas Summit on Tuesday at the Mexico City Hotel Sheraton María Isabel.
“Price liberalization will contribute to the local generation of natural gas. This will lead to the development of gas retailers other than PEMEX, which will lead to a more dynamic Mexican market,” said Madrigal during his presentation.
Liberalizing and incentivizing the generation of natural gas is an important part of CRE’s mandate, particularly considering that natural gas consumption has increased dramatically in the past few years. According to Madrigal, 51 percent of natural gas in Mexico is used for electric generation. However, more than 40 percent of the natural gas used in the country is imported. “Basically, all our natural gas-dependent electric generation relies on imported natural gas,” he said.
Although Madrigal accepts that the recent price liberalization of natural gas will not immediately shift these percentages, he said it is a first step in the right direction. “We need to ensure that the natural gas market develops alongside the needs of the electricity market.”
Madrigal added that CRE and other institutions are working to ensure development of a more competitive market that incentivizes production and commercialization of natural gas. For this to happen, the CRE Commissioner said that they had been working around three specific pillars: infrastructure, nondiscriminatory access to the national pipeline system and liberalizing the market. “As of today, we have US$12 billion committed for network expansion and we have commitments for the construction of around 7,500km of pipelines,” Madrigal said.
Infrastructure combined with access to the pipeline is key for the development of the market, Madrigal said. “The first bids for incoming pipelines from the US represents a landmark. For the first time in history, private companies can access this type of infrastructure.” More infrastructure and broader access to it will inevitably lead to more supply. “To increase our offering of natural gas we need to provide private companies more production possibilities,” he added.
After infrastructure and access, Madrigal said only one element was missing to boost the market: price liberalization. He acknowledged, however, that there was no perfect moment to liberalize the price of natural gas. “When analyzing international experience, particularly the cases of the US and Canada, they opted to first liberalize prices and then to provide access to infrastructure. However, we decided it would be best to first advance our infrastructure for gas transportation and afterward focus on price liberalization.”
Madrigal concluded with an estimate of the impact of the impact from the current licensing rounds on the production of natural gas, “Domestic production is expected to rise 18 percent increase in relation to current demand,” he said.
Goals and Challenges of the Special Economic Zones for the Oil and Gas Industry
Mexico is one of the most important investment destinations in the world but it also has vast intra-country disparities that must be addressed, Max Mergenthaler, Head of the Investment Promotion Unit for the Special Economic Zones, told the Mexico Oil & Gas Summit 2017 on Tuesday in Mexico City.
“The Special Economic Zones [ZEEs] were born from the strong differences between the northern and southern regions in the country, where the north is highly industrialized, the center is gradually taking advantage of the economic development and the south is lagging behind,” said Mergenthaler. “Northern Mexico can be compared to developed economies like those in Chile and Brazil, the center is comparable to Croatia and Malaysia and finally the south and southeast to Angola and Mongolia.”
The economic differences have widened in the last few years due mainly to structural barriers, including a lack of human capital and infrastructure, small markets and companies with small productivity, as well as limited access to credit, Mergenthaler told the summit’s audience of industry stakeholders and decision-makers, regarding the implementation of the ZEEs in Mexico.
In his presentation, Mergenthaler discussed the benefits that companies can derive from establishing in ZEEs. Among them, the most significant are: A discount on income taxes totaling 100 percent for the first 10 years and 50 percent for the next five years, as well as exceptions on value-added taxes. The discount of 25 percent in training costs ensures better-prepared human capital in the region, he said. Finally, a 50 percent discount on social security costs for the first 10 years, followed by a 25 percent discount for the next five years, allows for an increase in social security.
Mergenthaler also pointed out the importance of infrastructure. “Logistics infrastructure is vital for the project and we have made a preliminary identification of 172 crucial projects that require an investment of approximately US$5 billion.” Mergenthaler said that 36 percent of that amount is expected to come from public finance and 64 percent from the private sector. “Strong logistics will not only allow for the movement of goods and people in these areas but also to increase imports and exports, ultimately creating a positive economic flow.”
The government is also aware of concerns that ZEEs could drain investment from other regions and has implemented measures to address that possibility. “To ensure that investment and infrastructure is not just transferred from one part of the country to another we make sure that all the investments are new. This makes it impossible for a company to just transfer its facilities, for example, from Monterrey to Coatzacoalcos.”
Priorities of Mexico’s Onshore Operators
Moderator: David Enríquez, Partner at Goodrich, Riquelme & Asociados
Panelist: Rogelio Montemayor, CEO of Strata BPS
Panelist: Jaime Martínez, Business Development Director of ERM
Panelist: Javier Zambrano, Executive Director of Jaguar E&P
As private onshore operators take a foothold in Mexico’s liberalized oil and gas market, panelists at the Mexico Oil and Gas Summit 2017 reflected on Rounds One and 2.3 to evaluate the different stages of the Energy Reform, the steps that have been taken and the path that lies ahead. Several issues arose during the discussion surrounding the priorities of Mexico’s Onshore Operators.
“The Energy Reform brought about a singular scenario where PEMEX can be your partner, your client and your competitor all at once,” said David Enríquez, Partner at Goodrich, Riquelme & Asociados, to open the discussion at the Hotel Sheraton María Isabel on Tuesday. This transition means companies that before dealt with a monolithic entity are now dealing with a multivariable scenario involving the several new facets of the productive company of the state.
The panel included Rogelio Montemayor, CEO of Strata BPS; Jaime Martínez, Business Development Director of ERM; and Javier Zambrano, Executive Director of Jaguar E&P. Enríquez moderated the discussion between the industry experts.
The former hydrocarbons monopoly was at the forefront of the talks. “The Reform needs to ensure PEMEX’s institutional and market capacity in absorbing such a complex and multifaceted business venture like farmouts,” Montemayor said, as the productive enterprise of the state suffered from making decisions that more often than not had heavy political undertones, to the detriment of economically sound and strategic measures. Adding context to the farmouts, Martínez reminded the audience that PEMEX was immersed in and operating under monopolistic conditions since 1938, crystallizing processes that weighed heavily in its transition in the form of a certain inertia to the detriment of decisive decision-making.
“Under the new regulatory framework, PEMEX is regulated simultaneously by the Energy Regulatory Comission (CRE), the Ministry of Energy and the National Hydrocarbon Commission (CNH),” Montemayor added. This further complicates the interactions of private players with the sector’s regulators under this tripartite scheme.
Regulating authorities were also part of the state of the industry discussed during the panel. A particular focus was placed on the oil Rounds, as well as the social and environmental impact issues facing the industry. In the previous auctions, particularly 1.3, “some companies found themselves with a negative ROI once all was said and done,” Enriquez said. Consequent Rounds learned from past mistakes, as “the imposition of a royalty cap is a positive message for the market,” according to Montemayor.
The design of the Energy Reform left the private sphere practically on its own in terms of the required social and environmental impact assessments. The cost of an exhaustive and holistic assessment is considerably more expensive than the cost of fixing environmental issues found on-site prior to launching the project, said Montemayor. To address the issue, Enriquez suggested the design of a trusteeship financed by private funds, managed and distributed by the government, based on the required studies conducted by government agencies. “If left unaddressed, social and environmental impact assessments will become a time bomb,” he added.
At present, the available guidelines and incentives are not adequate to allow private players to abide by the regulatory framework and reach an agreement with local communities and land owners without hindering the development of the targeted project, Montemayor said, while Martínez added that in some cases, social and environmental issues are reason enough to definitely bring down onshore projects. “The authorities need to revamp their institutional capacity in addressing the novelties of indigenous consultations and social impact and integrate them with environmental impact assessments, while the law treats them separately at the moment,” he said.
Regulatory authorities, however, have significantly improved the design of oil-round contracts, the panel agreed, while adding that this technical advance must be mirrored in the design of a regulatory framework tackling social and environmental impact issues.
The panel concluded by stating that the success of the reform will manifest itself when Mexico’s competitive hydrocarbons industry, incentivizing private participation across the value chain, is consolidated. To give it the means to succeed, solid regulation in financing mechanisms and easily accessible liquidity are required, the panelists agreed. Another capital condition, according to Enríquez, is a solid asymmetric legislation that levels the playing field between private onshore operators and PEMEX.
ASEA’s Transformation from Preparation to Regulation
Mexico’s Agency of Security, Energy and the Environment (ASEA) wants to be a triggering factor for the oil and gas industry and not a restraining agent, Alejandro Carabias, Head of Regulatory Unit of ASEA, told the 2017 Mexico Oil & Gas Summit on Tuesday at the Mexico City Hotel Sheraton María Isabel.
“Our regulatory focus is based on performance targets for safety and environmental protection. This allows us to generate more efficient regulatory models that incentivize participation in the sector,” Carabias said in his presentation on the agency’s transformation from preparation to regulation.
ASEA plays a key role in the implementation of the reform, ensuring its long-term sustainability beyond economic aspects, Carabias said. “CRE and CNH work as the economic regulators. ASEA, which is one of the products of the Energy Reform, works as an environmental regulator, which is necessary to ensure the reforms sustainability regarding social and environmental elements,” he said.
“Our job is to regulate the entire value chain of the hydrocarbon industry. No other regulator in the world has the same capacities in terms of environmental safety as ASEA,” said Carabias. However, the agency’s work goes well beyond regulations. “To achieve our mission, we must be able to help companies generate a culture and capacity for risk management.”
Carabias noted that in only 29 months, the agency is well on its way to achieving its mandate. “We have developed a number of regulations that range from accident investigations, requirements for updating information, norms for refueling stations and maintenance terminals for transportation of liquid hydrocarbons, as well as the revision and updating of existing regulations.”
The technical regulation the agency works on includes the development of official norms, administrative dispositions, agreements and guides to regulate performance in terms of safety and environmental protection, all following best practices and international standards. “If an operator does not have the capacity to work in a complex system such as the one we are establishing in the country, it cannot operate in Mexico. It is not an act of ill will, it is a matter of complying with international standards,” Carabias said.
Carabias acknowledged that the agency’s agenda is quite ambitious and substantial and that the development and the parallel development of regulations has an important degree of complexity, that is why it relies on other players. “We do not set regulations in an arbitrary manner; the industry, academia, research centers and other regulators accompany us constantly.” Carabias also said that the agency relies heavily on independent third parties, which have become similar in some ways to a branch of the agency.
ASEA’s performance has not fallen short of its responsibilitie but Carabias said that it continues to evolve and introduce new ways to operate more efficiently. “We want to implement a digital platform that would allow companies to carry out online procedures, instead of doing them physically. This would also allow us to interact with other regulators.”
However, it is not the only improvement to be made. Carabias said that both the OECD and the International Energy Agency have already provided recommendations to improve ASEA.
Still, Carabias said that the best way for the agency to improve its operations is to transition to a simplified regulatory environment. “ASEA is regulated by a number of laws and regulations that were published in different moments and that have different approaches, which complicates the functioning of the agency, unlike CRE, which is only regulated by two different laws and two regulations.”
Farmouts Are the Future of PEMEX
PEMEX will focus on developing alliances that make it stronger and that increase its portfolio of assets, Gustavo Hernández García, Director of Operation for PEMEX E&P (PEP), told the Mexico Oil & Gas Summit 2017 in Mexico City as he presented the company’s vision for its future.
Hernández reminded the audience that before the Energy Reform, PEMEX worked as a parastatal entity focused solely on production and increasing the volume of oil barrels no matter the economic costs. The Ministry of Economy fixed prices and the company was part of federal budgeting. “Now, with the Reform, we are a productive state enterprise focused solely on rentability, we have a budget based on rentability and adhere to prices fixed by the market with financing options open for external investment,” he said.
One of the main challenges of the Mexican oil and gas reality is to substitute declining production, particularly at Cantarell. PEP is working intensively to replace these declining resources, Hernández said. Alliances will be, without a doubt, a key factor of this work. “First, we will focus on replenishing and keeping production levels, and after that we will increase it. Identifying the best partners and actives for our work will be vital for this.”
Clusters, he said, will be a key proponent of the company’s strategy. “Our strategy to bring investment and financial and operational partners is to create assignation clusters that properly integrate assets in the most attractive way.” Hernández said. Some of the strategies are to combine high and low operational cost areas, as well as keeping geographical and operational aligned assets together. Once the clusters are created, the market will decide how much to bet on them, he added.
In this regard, Hernández said that PEMEX E&P already has 74 clusters. All of which will be assigned according to the company’s vision. Deepwater assignations will be segmented in three phases according to its strategy, mainly due to CAPEX capabilities and oil-price expectations. “PEP will be cautions on the assignation of deepwater fields,” Hernández assured. “Assignations onshore will also be rolled out in three phases through bid rounds,” he said. As for farm-outs, PEP will migrate them during 2017 and 2018. The company wants to fully restore the country’s depleted reserves through production and expects to do so by 2018 through alliances as both operator and non-operator.
The signing of the contract with BHP Billiton, and its cash payment, is evidence that the work is being properly done, that alliances are attractive not only for PEMEX but also for international companies. “PEMEX used to be a unique operator but now we are looking for and working with international partners. We are in the global major leagues,” Hernández concluded.
The Saga of Zama
Sierra Oil & Gas expects to begin producing first oil at its Zama-1 well in about four years, Iván Sandrea, the company’s CEO told the Mexico Oil & Gas Summit 2017. Presenting the opening keynote presentation, The Saga of Zama, in Mexico on Wednesday, the head of the first private player to strike oil in Mexico also outlined the importance of the Energy Reform, Mexico’s privileged position in the hydrocarbon industry and provided an outlook for the future.
“As the major discovery that it is, we think we will reach first oil in around four years,” said Sandrea, answering a question from the audience, while also pointing out that the oil industry has characteristically long processes.The company is still doing appraisals, getting plans approved and obtaining the necessary permits, he said, adding that every step of the process has to be carefully evaluated and designed. Sandrea that Sierra is the only company to have acquired three of the four bid permits necessary to meet its legal obligations, calling that a testament to the company’s engagement with Mexico’s regulatory authorities and its desire to move ahead swiftly with its timeline for developing its block.
Shortly after Sandrea’s presentation, hydrocarbons regulatory CHN announced it would delay Round 2.4, scheduled for December, until Jan. 31, 2018. It said it wanted to give companies time to analyze the recent discoveries at Zama-1, Amoca-2 and Amoca-3. Thirty blocks will be bid during Round 2.4. The regulatory also said a new rule would apply to the rounds: if both maximum added investment and royalty are offered, an economic offer must be included in the same envelope.
Although the industry has fixated on Sierra’s Zama find, Sandrea said that the other blocs won by the company will be managed with the same level of commitment and passion they have consistently showcased in the industry. “We are focused on drilling Block 2, as our contract with CNH outlines. The same applies for blocs 4, 5 and 11. It is only a matter of establishing the order of priority in drilling the blocks,” he said. These decisions will be taken by the operator, in unison with its partners.
Sandrea also shared his vision for the future of the oil industry in general and Sierra Oil & Gas in particular. “I don’t think there is a better place to be doing what we are doing. The quality of the hydrocarbons, the opportunities in place, the scale of the basins are too great to be overlooked,” he said. Considering what has happened in the last three years, there is not much more shallow water and offshore activity left for the taking in the southeastern basin. “Finding another Zama will be difficult,” he warned. Still, Sierra’s CEO insisted that there is much work left to be done. Particularly, developing and marketing the awarded blocks, IOR and the energy infrastructure requirements necessary to meet the demand, among others.
To meet the coming challenges, Sandrea said companies need to adapt. “Oil companies need to metamorphose. You will see Sierra continue to evolve. Our vision is to be a major independent player as an energy provider. Our journey will involve allocating capital to disruptive technologies, rejuvenation and thinking outside the box,” he said.
Lower for Longer: Supply-chain Cost Strategies for Surviving Depressed Prices
Moderator: Héctor Rocha, Partner, Segment Energy at EY
Panelist: James Buis, District Manager Mexico of Nalco Champion
Panelist: Esau Sasso, Country Director Mexico & Central America for Baker Hughes
Panelist: Alfredo Carvallo, Director General of McDermott Mexico
Low oil prices have forced companies to reinvent themselves and their capabilities, while trying to capitalize on every long and short-term opportunity the country offers, agreed panelists at the Mexico Oil and Gas Summit 2017 as they reflected on their supply-chain cost strategies for surviving depressed prices.
“In the past few years, the industry has experienced massive changes and companies have had to reinvent themselves and their supply chains to face this market shock,” said Héctor Rocha, Partner, Energy Sector at EY, during the panel discussion at the Hotel Sheraton María Isabel in Mexico City on Wednesday.
Rocha was accompanied by Alfredo Carvallo, Director General of McDermott Mexico; Esau Sasso, Country Director Mexico and Central America for Baker Hughes; and James Buis, District Manager Mexico of Nalco Champion.
“Low prices are not unique to Mexico, so every company has had to adapt their business strategy to a new environment. The industry has been adapting by itself,” said Carvallo. Sasso added that part of the strategy Baker Hughes has undergone in Mexico in this process is understanding what the customer wants and not only what they as a service company think the client needs. “It is not a matter of the prices you are offering them, it is rather a matter of how much in costs you are helping them save.”
Buis added that even though pressure to reduce costs has affected everybody, companies still must maintain the same quality standards that characterized them. “The products and services we offer our clients must be the same wherever we are. Service requirements might be different from one place or another but the quality has to be the same.” However, for Sasso the responsibility for quality does not end with supplying the same standard everywhere. “We have to show new operators that in Mexico we have local suppliers that have been our local partners for years and that have absorbed our level of quality and our corporate culture. For us, it is critical to pass our standards to our suppliers; in the end, suppliers are critical for moving to the next phase.”
Rocha added that in most cases, local suppliers tended to be passed over for international suppliers, an issue that Carvallo attributed partly to the fact that new operators are not aware of the capabilities that exist in Mexico. “If I were an operator I would be looking for people who have been operating in Mexico and can provide technical support in the country.” Buis added that having local suppliers can help with availability of products and cost-efficiency of services.
Local suppliers not only help companies in terms of cost-efficiencies but also in complying with local content requirements. Buis recognized that, although calculations for local content are complicated, they focus on having a very localized force, a strategy that the other panelists also acknowledged. “There was a time when we needed to bring personnel from other countries to increase the efficiency of our operations in Mexico. That is not the case anymore. The efficiency of Mexico’s labor force has increased,” Carvallo said. Sasso added that having a qualified workforce used to be a challenge but the situation has been reversed: “Keeping our people focused and engaged in what we are doing is the challenge. Retaining our talent is going to be quite critical.”
The panelists agreed that although the past few years have involved a series of changes that none could have imagined, the industry in the country is moving forward and that is a positive sign. Sasso said that his company knows the market and can bring value to new operators entering the country, a sentiment that Buis echoed: “We have to show them local expertise that has been built over the years. We have to show them how capable we are in Mexico.”
The Expected Impact of Local Content Requirements on Supply Chain Development
How does local content factor into the making of a national flag? “Where does the material, the labor force and the infrastructure investment behind its production come from?” asked Hector Rocha, Partner Energy Sector at EY, holding aloft a Mexican flag to start his presentation at the Mexico Oil & Gas Summit 2017 on Wednesday in Mexico City. “Local content is not an easy theme. What does local content even mean? Answering this question can be even scary because of its complexity.”
Rocha pointed to the significant fees that could be applied if operators fail to meet their minimum local-content requirements, fees that could reach millions of Mexican pesos in some cases. “If a company has to pay that amount because the local-content requirement is not met, the whole operation could be put in jeopardy,” Rocha warned.
The logic behind stating a minimum local content with which companies must comply is clear: provide for competition that ensures the growth of the Mexican local industry. “As a main measurement, the government fixed the minimum local content to 35 percent for operators,” Rocha said. “To know the percentage of local content operators are using, the Ministry of Economy published a methodology that, in the fewest words, divides all the expenditures made on local content by the total expenditures. Unfortunately, getting the local content expenditures is the hardest part.”
To help operators, the Ministry of Economy made providers responsible for stating the complete local-content percentage of their activities. “Mexican providers need to be aware of all the requirements and paper work that operators need to offer when stating their local-content percentages,” said Rocha.
Héctor Landeros, also from EY, highlighted the importance of operators relying on their providers’ local-content statements. “If an operator fully relies on what his provider says, he will be able to focus on hidden value-adding operations, therefore creating a better industrial ecosystem,” Landeros said. Local content should not only be a requirement but a facilitation that ensures a competitive industrial market. “If providers fight to become the preferred selection of operators, they will fight to include lean administration and activities, ultimately creating a better market,” said Rocha.
He also worries about the implications of creating an institution that certifies local content requirements. “The industry is not ready yet; there are plenty of administrative actions that can be carried out if we want to go that way and many providers may be left behind. For now, Mexico should focus on learning and improving the processes it already has.”
The Rise of Digital Oil Fields in an Increasingly Complex Industry
Moderator: Leonardo Cuneo, Energy Director Of Capgemini
Panelist: Bruno Lima, Country Manager Mexico and Central America of Halliburton
Panelist: Victor Oliveros, Business Development Director Mexico for WorleyParsons Group
Panelist: David Vizcarrondo, Commercial Director Mexico of Emerson Automation Solutions
Imagine you are an operator and one of your valve suppliers notifies you they detected an issue with one of your oil rig valves. How much time and resources would it take to determine: how many valves did you purchase in a certain period, where are they exactly located, which ones are under-performing and how long will it take to change them?
This example from Victor Oliveros, Business Development Director Mexico for WorleyParsons Group, illustrates well the challenges and opportunities that digitalization and automatization bring to the table for the oil and gas industry, the point of discussion for the panel, The Rise of Digital Oil Fields in an Increasingly Complex Industry, at the Mexico Oil and Gas Summit 2017 at Mexico City’s Hotel Sheraton María Isabel on Wednesday.
“We would like to highlight the contribution of digital oil fields to efficiency, productivity and security in oil-field production and exploration,” said Leonardo Cuneo, Energy Director of Capgemini and moderator of the discussion. The panel illustrated the valuable insights of major players in the industry: Bruno Lima, Country Manager Mexico and Central America of Halliburton, David Vizcarrondo, Commercial Director Mexico of Emerson Automation Solutions and Oliveros.
“The oil and gas industry is lagging behind industries like defense and automotive,” said Oliveros. “Part of the difficulty of progressing in digital enterprise is showcasing the value of an investment in this segment,” he added. He advised companies to undertake the necessary studies and assessments to determine which digital maturation phase their services and processes are located in.
Industry workforce was at the core of the discussion. Lima was adamant on the issue: “If you integrate your workforce to these automation and digitalization technologies and processes, you get the operational efficiency to simplify decision-making.” “Data horizontalization,” he called it. This strategy also provides companies with diversely qualified professionals, generating workflows that facilitate major decision-making processes. For it to work, Lima asserted that the workforce must be exposed to competence maps to become familiarized with these improvements before they are deployed. In this way, companies can shorten the learning curve for their employees.
A constant objection that translates into a challenge for digitalization and automation service providers comes in obtaining quality data able to generate effective insights for problem solving. Lima asserted that any and every digitalization process needs not just an input, but the correct input. “If your input is wrong, the data generated will reflect those mistakes and lead to the wrong conclusions,” he said. “The process of Artifical Intelligence is driving this process. We have today the capability to offset and benchmark data in such a way that we can analyze whether the scanned input makes sense or not,” he added. Oliveros explained that digital enterprise is built in different stages: “First, you launch a digitalization process for your available information. Then, you collect the data, analyze it and make sure it is sound, reflecting reality.”
Another dominant issue was security. It is well known that the oil and gas industry, particularly in oil rigs. Digital Oil Fields could benefit tremendously in reducing risk factors. “We adapted drones with automatic risk detection systems, interconnected to the drill to warn it from imminent risk”, showcased Lima. What about the personnel? Internet of things can be used as a tool mitigate their risks as well. “Digitalization and automation has an inherent security element as it brings terrain data to the analyst, instead of going for it on site”, Vizcarrondo reminded us.
From the government’s side, the panelists agreed that government must be increasingly involved in this process, drafting regulation in favor of mainstream digitalization and automation, so Mexico’s oil and gas sector can reap the benefits of these technologies, and the companies providing them can have further and deeper outreach, for an efficient, digitalized and secure industry.
Shaping Mexico’s Fast-Growing Pipeline Network: Challenges and Opportunities
Moderator: Lorena Patterson, President of AMGN
Panelist: David Madero, Director General of CENAGAS
Panelist: Jan Frowijn, Director General of The ROSEN Group Mexico
Panelist: Alejandro Lupiañez, Vice President of Mexico Operations for Wood Group
The classic demand and supply dynamic will determine how quickly Mexico develops its natural gas pipeline, panelists said at the Mexico Oil & Gas Summit 2017 as they reflected on the challenges and opportunities that Mexico’s fast-growing pipeline network entails.
“We are experiencing a transformation. From having a government controlled industry, we are now going to a market-controlled dynamic. This means that transformation incentives such as price differentials will have to come from the market,” said David Madero, Director General of CENAGAS, during the panel discussion at the Hotel Sheraton María Isabel in Mexico City on Wednesday.
Madero was joined by Lorena Patterson, President of AMGN; Jan Frowijn, Director General of the ROSEN Group Mexico; and Alejandro Lupiañez, Vice President of Mexico Operations for Wood Group.
Patterson said that attending infrastructure needs such as the creation of pipelines was key for the development of the natural gas market. “Natural gas is a fairly convenient energy source for Mexico; it is the most economical, cleanest and efficient fuel.” Madero agreed that characteristics inherent to natural gas, alongside its multiple uses, are driving a rise in demand. “Natural gas will continue being very important not only for the energy industry — the manufacturing industry will also benefit and even residential areas.”
Frowijn added that even though market development is important, clear regulations are needed to further its growth. “Setting a regulatory framework and its subsequent implementation are crucial.” For Lupiañez, even though natural gas can be a catalyst for the development of a pipeline network, the rules of the game must be clear before planning even starts for more infrastructure construction. “We need transparency regarding the regulatory framework and its interpretation.”
Madero echoed that sentiment, adding that in Mexico, of all hydrocarbons, natural gas has the most up-to-date and stable regulation. However, he also acknowledged that for it to continue growing, it needs to have a more developed and strong regulatory framework. “Regulations need to be modernized alongside the industry.”
While a clear set of rules is necessary, Frowijn said that will only go so far. “The future of the industry is not technology or laws and regulations. At the heart of the development are people. It is important to transfer knowledge and to support the creation of a new generation of professionals.” Lupiañez said that in a country as diverse and big as Mexico, the transfer of knowledge and experience is crucial: “The problems associated with building the needed network change depending on which part of the country you are. Although we have the required technology to do it, we encounter several problems related to local communities. We need people with experience to deal with this.”
Still, Lupiañez is confident and believes that the missing pieces of the puzzle are trust and communication among all the players. “Technology companies need to be involved in the decision-making process from day one and not just at the end,” he said.
Although demand will continue growing, it will be volatile, which is why investors want transparency, Madero said. “Investors need clarity and certainty regarding their investments, knowing that there will be volatility associated with the appearance of renewable energies. Providing good and competitive services will help companies to obtain profit and contribute to the development of the market.”
PEMEX’s Exploration Achievements and Ambitions
The Energy Reform has expanded PEMEX’s horizons and will permit it to look for participation opportunities outside Mexico, José Antonio Escalera Alcocer, Director of Exploration at PEMEX E&P, told the Mexico Oil & Gas Summit 2017 on Wednesday at the Mexico City Hotel Sheraton María Isabel.
“As a company, PEMEX had been invited to participate in projects abroad but the law did not allow it. However, we now have the possibility to participate abroad and we are working on a project that will permit us to invest outside Mexico, particularly in North and South America,” said Escalera, although he did not name the project or its location.
Participation in international rounds is one of the initiatives PEMEX E&P will implement as part of its 2017-2021 Five-Year Plan to boost reserves. “In light of the complex environment we are facing, we need to find new ways to cement our competitiveness,” Escalera said. The business plan also includes prioritizing value areas for PEMEX E&P, increasing the efficiency of operations and investments, accelerating the implementation of the Energy Reform mechanisms and participating strategically in the next bidding processes.
Escalera said the new competitive environment allowed PEMEX E&P to become more efficient in its processes. “We come from a closed ecosystem where, for 75 years, we had the responsibility of capturing the potential of the oil industry on our own. However, we are now learning in an ordered and methodological manner, following international standards, how to participate in this new market.”
Though there have been accusations regarding PEMEX’ lack of investment in the sector, Escalera says that the company has the knowledge and the technology to continue being an active participant. “Due to low oil prices, investments in the sector all around the world fell approximately 62 percent. PEMEX’s investments in comparison only fell 37 percent.” Though reduced investment is not necessarily good news, Escalera says that it is a trend that will likely continue until companies can obtain better prices and operate more efficiently.
Regardless of the challenges, Escalera said the company has enjoyed significant participation in the discoveries in shallow waters but that there are still opportunities in different fields. “Due to price constraints, we have not ventured into exploring fields of dry gas,” he said. Deepwater is another untapped opportunity. “We have developed a program for deepwater. Currently we lack the capacities to carry out a project of such magnitude on our own. However, the reform allows us now to share both the risks and the results.”
Escalera noted that despite it monopolistic history, PEMEX has increased its capacities and can compete in the current licensing rounds. “We participated in both Round 1.4 and 2.1, winning blocks in both. We want to show the industry that we are competitive and that we can be a preferred partner for the upcoming rounds.”
Optimizing the competitiveness of Mexico’s future licensing rounds
The Exploration and Production Bidding Rounds have been a success for CNH and Mexico, Héctor Moreira, Commissioner of CNH, told the Mexico Oil & Gas Summit 2017. “The results of Round 2.3 have without a doubt showed the great interest that international investors have in Mexican soil,” he told the audience in his closing presentation at the Mexico City Hotel Sheraton María Isabel on Wednesday.
Success does not come from one day to the other, he said, adding that a learning process was necessary. Round Zero started everything. In that round, PEMEX was awarded 489 assignations of which it would decide whether to keep producing or migrate into shared production contracts with partners, as it did with Trion, or without partner, such as with Ek-Balam.
Rounds One and Two were also economic successes, Moreira said. “Round One is expected to bring around MX$49 billion, or almost US$2.7 billion, while Rounds 2.1, 2.2 and 2.3 are expected to bring MX$11 billion.” Moreira also pointed to the creation of Mexican operating companies. “We went from having only one operating company, three years ago, to now having 33 Mexican operating companies in the environment,” he said.
CNH also recognized the challenges that have arisen, not necessarily as a direct result of the Energy Reform, admitting that having Mexican operating companies is only one part of the equation. To make sure that a healthy Mexican oil and gas value chain is created, Mexican service companies are needed. “The problem of having few Mexican service companies comes from before the Energy Reform, but it is a problem that we are working to tackle. To solve this, Mexican associations that look to the needs of Mexican companies, CNH and the Ministry of Economy must allow for a healthy discussion to create a plan that tackles this problem,” he said.
Moreira is expecting more success to come as the basis for Round 2.4, comprised by 30 blocks, was announced during a live transmission earlier in the day. The basis will be formerly published in the DOF on July 20 for the general public to consult.
Moreira also took the opportunity to announce an important new rule to be used on Jan. 31, 2018, when the economic offers for Round 2.4 are received. “In case they bid with the maximum added royalty and investment, interested companies must include an economic offer. This economic offer will only be given to the government if there is a tie,” he said.
He also highlighted CNH’s willingness to improve the rounds. One main area in which he sees improvement is the number of blocks to be included in the rounds. “CNH has the areas included in the Five-Year E&P Bidding Plan only, but if the market asks for it we are open to include more blocks.” CNH’s objective with the rounds is to incentivize the Mexican industry, he added, “We want companies to be profitable, that is the only way they will get capital to invest more in the country.”
Revitalizing Mexico’s Refining and Petrochemical Industries
Moderator: Ixchel Castro, Manager of Oil and Refining Markets for Latin America of Wood Mackenzie
Panelist: Carlos Murrieta, Director General of PEMEX Industrial Transformation
Panelist: Stefan Lepecki, CEO of Braskem IDESA
Panelist: Daniel Zuluaga, Country Manager Mexico of Tiger Engineering
Panelist: José María Bermúdez, President & Director General of the Northern Region of Latin America at DOW Chemical
Panelist: David Eduardo Rosales, Director General of Natural Gas & Petrochemicals at the Ministry of Energy
Mexico’s licensing rounds, spearhead of the country’s Energy Reform, provided new life for the oil and gas industries’ upstream and midstream sectors. What of the downstream sector? PEMEX’s role remains preponderant, yet there is confusion about its involvement with this segment in the coming years, as the reform crystallizes and a wide array of private players find their footing in the refining and petrochemical industries, according to the panelists debating the issue at the Mexcio Oil & Gas Summit 2017 in Mexico City on Wednesday.
Ixchel Castro, Manager of Oil and Refining Markets for Latin America of Wood Mackenzie, and moderator of the Day 2 panel, set the stage for the discussion: “Is the key to answering the challenges for Mexico’s refining and petrochemical industries more related to infrastructure or public policy design?” she asked.
The panel set out to offer a clear picture of those challenges and those on the panel drafting a roadmap toward the best solutions available were Carlos Murrieta, Director General of PEMEX Industrial Transformation, José María Bermúdez, President & Director General of the Northern Region of Latin America at Dow Chemical, Stefan Lepecki, CEO of Braskem IDESA, Daniel Zuluaga, Country Manager of Tiger Engineering, and David Eduardo Rosales, Director General of Natural Gas & Petrochemicals at the Ministry of Energy.
The exchanges reflected the importance of Public and Private Partnerships (PPP) to ensure a bright future for Mexico’s refining and petrochemical industries. Murrieta insisted on alliances being a fundamental element for the productive enterprise of the state’s growth. “PEMEX identified a major shift in the signs and behavior of the market, particularly in terms of prices, additional to the offer and demand of the sector,” he said. PEMEX’s Industrial Transformation DG insisted on the necessity of creative and concise projects from the private sector, designed under a win-win scheme. Echoing Murrieta, Bermúdez highlighted the importance of this partnership. “The public and private sectors need to become co-participants to raise industrial policies to new heights, develop advanced manufacturing and guarantee a space for permanent and constant dialogue,” he said.
PEMEX opened the door to collaboration through farmout agreements. But is this the only instrument available? Quite the contrary, according to Rosales, who added direct asset sales, joint operation of natural gas processing centers, petrochemical facilities or refineries, and processes managed by a third party. Parallel to this wide array of possibilities, Lepecki mentioned a vital element the success and economic viability for both parties: clear rules and conditions. “Clear legislation, with precise rules and regulations, can send the positive message investors need to generate the adequate trust and give the go ahead,” he said.
Lepecki added that many other industries depend on the added value PPPs to the chemical and petrochemical industries. “Agro, automotive, packaging and pharmaceutical industries, to name a few, are directly impacted by the impulse they receive from our line of business,” he warned. To that end, Zuluaga suggested PEMEX should focus on the segments of the industry where its past monopoly confers a comparative advantage and leave to the private sector those which do not represent a profitable business. “In this way, we will be able to invigorate both the projects and decisions, by their steadfast and economically coherent distribution between PEMEX and private players,” he said.
Looking ahead, Murrieta emphasized the importance of discarding completely more of the same policies that were previously in place and were harmful for the sector’s development. “Innovation. Flexibility. New ideas. Those are the elements we need to materialize PEMEX’s clear vision of what we want to set in motion for the long haul.”
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