This blog posting is the fourth of a series of five postings from the 2014 year-end energy briefing.
This article was first published in The Metropolitan Corporate Counsel, January 2015 issue.
Burdick: Now let's move onto Mexico and an update from Steve Otillar, a partner in the Energy and Global Transactions practice, and Dino Barajas, a partner in the Global Projects and Finance practice. Steve and Dino will discuss reforms and other developments in Mexico’s energy industry
Otillar: To give you a sense of what Mexico is going through, suffice it to say that almost everything you knew about Mexico’s energy industry has changed. I can’t say that clearly enough. Last year’s debate over a change in Mexico’s Constitution spurred extraordinary emotional responses, with one congressman even disrobing during the debate, saying “You're going to strip everything from the country,” and so forth. Today, life goes on in Mexico; business is moving, and the government has been trying to do a tremendous amount of work in a very short period of time. The secondary regulations were published in August. We've reviewed them, and while there are some conflicts or problematic scenarios here or there, a significant amount of work has been done, including a staggering number of new and amended laws.
The National Hydrocarbon Commission (CNH) has said publically what the bidding rounds are going to look like. They have identified the available assets and set forth the information that potential bidders must provide. I expect the tender documentation and model contract any day now, which essentially will be the first call for bids in Mexico.
Through the legislative process, Pemex was able to retain a number of properties, but it is no longer a monopoly in Mexico. It made an application to the Ministry of Energy (SENER), and Pemex received most of what it wanted – pretty much everything from a P1 and a P2 perspective. Pemex has been negotiating joint ventures with selected partners, but intricacies of the law require it to have those joint ventures be finally approved by a CNH tender. Thus, Round One includes a restricted tender for a number of properties that Pemex wants to joint venture, as well as the blocks that will be open for a variety of outside bidders.
Barajas: From my perspective working in the power sector for 20 years, the reforms have been transformational. The legislation not only went after the hydrocarbon sector, but it revamped the entire energy sector, top to bottom. In the last 12 months, they've been promoting private investment across the board in the energy sector, which already has been active over the last 15 years in terms of foreign investment. These new reforms have reinvigorated the power sector in particular, and we are seeing a lot of new activity from private equity firms, construction contractors and developers – especially in Mexico’s renewable sector, which is now a focal point for people looking for projects around the world.
Otillar: Now I’ll talk about what's at stake. In terms of unconventional resources, Pemex has already done some work in the Eagle Ford development, and while the oil-bearing portion gets deeper and more challenging south of the border, the unconventional revolution that we've seen in Texas, which is producing more than 3 million barrels a day, certainly appears to be continuing on into Mexico.
Some of the blocks are currently up for tender in 2015, and there are a lot more to be tendered in years to come. Of those blocks, 91 percent are exploration areas, and the remainder are producing fields that Pemex has allowed to be turned over to Mexico.
There are five main categories of properties that people are looking at for Round One: shallow waters, unconventional, heavy oil, onshore and deep water. The first tranche of blocks are in shallow waters, and the Round One bid date will be published soon.
What is Pemex expecting to get out of these rounds? The answer is about $50 billion over the next four years, which is what CNH and SENER assume will be the minimum levels of investment in the 169 available blocks. And this is just Round One. It is pretty impressive. The types of projects include exploration and extraction (or what we call exploration and production in the U.S.), and the P1 and the P2 analysis for proven reserves contained in each prospective block is the same as in the U.S. or other countries around the world.
As far is scheduling is concerned, the shallow water area is running a bit behind, but I am confident that Mexico will get there. For all of the planned stages in Round One – new areas, new fields and the PEMEX joint ventures – calls for tenders are going to start coming forward. Mexico will set forth a form of contract, meaning production-sharing contracts, profit-sharing agreements or service agreements, all of which are allowed. We’ll also see the rules for bidding basis and how bidders can qualify to bid. One important note, and this is published in the 28th regulation that CNH came out with last week, is that there will be a chance for the market to have input, which will be considered and used to modify the bid basis.
I have worked and continue to work closely with a number of companies in Mexico, and I can tell you that Mexico wants to get it right. There is tremendous pressure on the regulators and the country, with its somewhat limited resources. CNH – the agency created a few years ago as a watchdog for Pemex – is now is the regulator responsible for bidding, and it knows the stakes are high.
That covers the upstream side, so I’ll turn it over to Dino for news from the power side.
Barajas: Further to the point about transformative energy reforms in the electricity sector, the government has announced the creation of a new agency that will handle the national grid for Mexico; the creation of a wholesale energy market, which hadn’t been thought of before; and the creation of a Clean Energy Certificate System. The first guidelines for the latter were issued on October 31, 2014, and pertain to how renewable energy will be promoted within Mexico.
The president has announced that in the next 10 years, Mexico wants 35 percent of its electricity to be supplied by clean energy generators. One important distinction is that the clean energy system includes a subset of renewable energy: wind, solar and hydro, as well as cogeneration and highly efficient fossil-fuel generation. Clean energy certificates will be mandated for purchase by certain market participants, and the system will be announced by the government next year.
Renewable energy producers will be provided one certificate per megawatt-hour produced. The co-generators and the efficient fossil fuel generators will be provided a fraction of a certificate per megawatt-hour produced, under a formula that has yet to be defined. This system will be an important component of how renewable energy is promoted within the overall Mexican electricity sector.
Regulations that will be put into place next year in terms of purchase obligations don’t go into effect for another three years, which will be an important factor in determining the level of renewable energy generation that will take place over that time period. There will be a mechanism to defer obligations up to 25 percent for any given year into future years and an additional mechanism to increase obligations if you choose to defer.
In terms of who is going to be a customer for energy within Mexico on the electricity side, the government has set up a system where free customers will be those that have 3 megawatts or more of demand for next year. The following year that's reduced to 2 megawatts, and the third year it's reduced to 1 megawatt.
The next steps for the government are to further define the market benefits for renewable energy in order to promote additional development, and it will have to define how the wholesale energy market will work. Developers face challenges in that potential customers are taking a wait-and-see attitude. With the announcement of the wholesale energy market, their hope is that prices will fall and that it will be favorable to buy from the wholesale energy market as opposed to signing power purchase agreements. On the other side is the challenge of giving renewable energy developers confidence that the market will be restructured to ensure that their investments will pay off.