On April 30 the Mexican government published a series of proposed laws that will govern how the newly opened oil industry will work. It was an important step for Mexican President Enrique Pena Nieto, and the proposals add a lot of details to his much-heralded energy reform. More importantly, the proposed rules bring the country closer to realizing its goal of kicking off a new era of energy production.
The Mexican state has held an iron grip on the oil sector ever since President Lazaro Cardenas nationalized the industry in 1938. Keeping oil reserves and production in state hands has been a source of pride for the country. To this day, there is a lot of controversy about allowing any private company to compete in the oil sector, with a recent poll finding 42 percent opposed to the idea.
For years public opinion prevented any reform of the energy sector. But Mexico's oil production has significantly fallen over the last decade, dropping by a quarter between 2004 and 2013. Corruption and mismanagement at Petroleos Mexicanos (Pemex), the state-owned oil monopoly, has been blamed as a big factor in the nation's deteriorating oil position.
But Mexico remains the world's ninth largest oil producer and has potential to regain lost ground. President Pena Nieto made energy reform a centerpiece of his six-year term. He successfully pushed through a constitutional amendment last year that will open up the oil industry for private investment.
And all indications…
On April 30 the Mexican government published a series of proposed laws that will govern how the newly opened oil industry will work. It was an important step for Mexican President Enrique Pena Nieto, and the proposals add a lot of details to his much-heralded energy reform. More importantly, the proposed rules bring the country closer to realizing its goal of kicking off a new era of energy production.
The Mexican state has held an iron grip on the oil sector ever since President Lazaro Cardenas nationalized the industry in 1938. Keeping oil reserves and production in state hands has been a source of pride for the country. To this day, there is a lot of controversy about allowing any private company to compete in the oil sector, with a recent poll finding 42 percent opposed to the idea.
For years public opinion prevented any reform of the energy sector. But Mexico's oil production has significantly fallen over the last decade, dropping by a quarter between 2004 and 2013. Corruption and mismanagement at Petroleos Mexicanos (Pemex), the state-owned oil monopoly, has been blamed as a big factor in the nation's deteriorating oil position.
But Mexico remains the world's ninth largest oil producer and has potential to regain lost ground. President Pena Nieto made energy reform a centerpiece of his six-year term. He successfully pushed through a constitutional amendment last year that will open up the oil industry for private investment.
And all indications point to the fact that Mexico is serious about lifting its oil production from its current level of 2.9 million barrels per day. The framework consists of a flexible tax regime, allowing for a sliding scale in which royalty rates rise with the price of oil.
The proposed laws would also include a local content rule of only 25 percent. This is much lower than Brazil's 40 percent local content requirements, which has been ridiculed for raising costs and slowing projects. Perhaps more importantly, Mexico may allow oil companies to meet that requirement over the course of a decade, potentially allowing operators to move in quickly.
So who will move in first? And where are the most promising opportunities?
The first stage of development comes in the so-called "Round Zero" phase, in which Pemex gets to choose which assets it wants to keep. The government has until September 17 to wrap this up, and the remaining assets will go to a first round of competitive bidding in January 2015.
At a recent offshore oil conference in Houston, Gustavo Hernandez-Garcia, the Acting Director of exploration and production at Pemex indicated that the company would want to hold onto its shallow water and conventional onshore assets. He went on to say that Pemex would then want to enter into joint ventures to work on deep water and shale plays.
Presumably Pemex is following this strategy because it can handle shallow water and conventional onshore by itself, but would need the sophisticated technology and deep pockets of the biggest international oil companies for more technically difficult projects.
For this reason, Pemex will hold onto its biggest producing assets, which includes its once massive Cantarell field in the Bay of Campeche. Cantarell used to be one of the world's most prolific oil fields, producing 2.1 million barrels of oil per day as recently as 2004. But as well pressure dropped, so did production. And it dropped fast. Last year, Cantarell only produced 440,000 bpd, an 80% drop off in only a decade. The Ku-Maloob-Zaap (KMZ) field nearby is now Mexico's largest producing field, churning out an average of 864,000 bpd in 2013. Pemex will hold onto these shallow water fields, and try to boost well pressure to lift production.
Therefore, investors should be watching what is left over after the Round Zero.
First, this means deep water. And one of the biggest spots to keep an eye on is the Perdido Fold Belt, which lies in the Gulf of Mexico along the maritime border with the United States. On the American side, big oil companies are already operating - BP, Chevron, Shell, and Statoil have large investments right up along the border.
The Mexican side of the border is much quieter, but that's not because Mexico's waters lack oil - oil reserves don't magically stop at the border. It is because Pemex has lacked the expertise to exploit the resources thus far. Pemex estimates that the Mexican side of the Gulf of Mexico holds an estimated 26.5 billion barrels of untapped oil.
And Pemex made big discoveries in 2012, proving that these fields are just as abundant as their American counterparts.
The Trion-1 field holds an estimated 250 to 500 million barrels of oil. The Surpemus-1 field holds 125 million barrels. These two fields account for Pemex's largest discoveries since Cantarell in 1979. All together, the Perdido Fold Belt could hold 10 billion barrels of oil, an enormous opportunity that is amazingly undeveloped. The companies that would be there to pick up the best of the leftovers will be the oil majors, specifically the ones operating in nearby waters in the U.S. They could theoretically move in next year if they can get their hands on some blocks put up in auction.
One word of caution. Pemex did submit a request with the Mexican government to hold onto some of the assets in the Perdido Fold Belt during Round Zero. But it confirmed that it will relinquish some of the assets as well.
Even more promising for investors is the prospect of an entirely new shale industry is Mexico. Without much presence by Pemex, shale presents a chance for new companies to start at the ground floor. The first shale well was only drilled in Mexico in 2010, and there are only around five operating shale wells today.
Mexico has one of the world's largest reserves of shale gas - just like the Gulf of Mexico, it is no accident that the geology in Mexico is also fertile since abundant shale reserves lie just across the border in Texas. Mexico holds an estimated 545 trillion cubic feet of technically recoverable shale gas. And most of it is clustered in the northeast near the border with the U.S. and acts essentially as an extension of the Eagle Ford shale in Texas. Known as the Burgos Basin, this area of Mexico offers drillers a huge opportunity. And the ones that are positioned the best to take advantage of the play are the ones already operating in Texas.