Mexico: The failed auction, the oil reform, and US shale

Last week the WSJ wrote about Mexico’s Petro Flop
A failed auction shows the need to reform the Pemex monopoly.

What if you held an auction and there were no bidders for half of the assets? That’s what happened to Mexico’s state-owned oil monopoly—Pemex—last week when it opened the bidding for production at six exploration sites in the Chicontepec basin.

This is bad news for Mexico’s oil and gas industry, which suffers from declining production. Pemex crude output in 2012 was 2.5 million barrels a day, down from three million in 2007 and 3.4 million in 2003. Mexico needs private investors with the incentive to get oil out of the ground. President Enrique Peña Nieto couldn’t have asked for a better demonstration of the need for Pemex reform.

Pemex may think it scored big in the three blocks that were sold. The long-time monopoly was offering to pay “all the costs of production in the first ten years plus a fee-per-barrel to the [winning bidders], providing oil is produced in sufficient quantities to cover those costs,” according to Houston-based oil analyst George Baker. Pemex was ready to pay bidders $6-$7 per barrel. But the winning bids ranged from one cent to 98 cents a barrel, making Pemex officials look like geniuses—but only at first glance.

What if the companies bid so low because they aim to make their money by what they charge the Mexican monopoly for supplies, service and technology? In that case their profit depends only on producing enough oil to meet the costs as required by Pemex in the contract. They won’t focus on producing more because they will be paid very little for the effort. As Mr. Baker wrote in the Mexico Energy Intelligence newsletter, “There is little incentive for the contractor to increase production beyond the level at which profit margins are met through intra-firm commerce.”

Which is hardly surprising, considering that the PRI, which is now back in power, had been telling the Mexican people that oil is their birthright; now the Mexican Leftist Party Urges Energy Referendum
Move Likely Will Add Uncertainty to President’s Proposal to Let Private Firms Participate

The proposal by the Party of the Democratic Revolution, or PRD, comes as a reaction to an energy overhaul presented last week by Mr. Peña Nieto that seeks to increase private sector involvement in the state-run oil sector. Mr. Peña Nieto seeks to let private firms participate in the oil and gas sectors by sharing the risk and profit from exploration and production.

“The government’s initiative is a privatization, no doubt about it,” said Cuauhtémoc Cárdenas, the founder of the PRD and son of former President Lázaro Cárdenas, who nationalized the oil industry in 1938 by expropriating the private oil firms. Mr. Cárdenas said the government’s proposal opens the door to the selling of state-oil firm Petróleos Mexicanos, or Pemex.
…
Chances of Mr. Peña Nieto’s bill seem good in Congress. It is expected to have the support of the ruling Institutional Revolutionary Party, or PRI, and the right-wing National Action Party, or PAN, which between them can muster the two-thirds majority in both houses to change the Constitution. But the PRD, along with nationalist leader and former presidential candidate Andrés Manuel López Obrador, hope to stop the changes by mobilizing the Mexican people.

The leftist opposition seems to have most Mexicans on its side. In a survey published in July by the lower house, 54% of Mexicans disagreed with the idea of opening the state-oil monopoly to private investment. Other surveys show even bigger numbers against the overhaul.

In all, while Peña Nieto has certainly worked on getting his party’s support, reform in Mexico, from the foreign investor’s point of view, remains a roll of the dice.

Pemex still needs revenues, though, so now Mexico’s Pemex Looks to Tap U.S. Shale
Rookie CEO Lozoya Seeks to Reverse Production Slump at State-Run Firm

Petroleos Mexicanos, Mexico’s state oil monopoly, will set up a new company to explore and produce shale gas and deep-water oil in the U.S. as part of an ambitious plan by its rookie CEO to turn around years of falling production.

The proposal, outlined by Chief Executive Emilio Lozoya in an interview, would push Pemex into complicated drilling techniques where it has no experience. It is a bold move abroad for the inward-looking company, which is the world’s fifth-largest crude producer but has never faced competition nor ventured far beyond its borders.

They’ll need a foreign partner,

especially in deep-water exploration and production where Pemex has no experience,

the CEO has no oil industry experience, and their unions are famous for featherbedding.

Any takers?