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Energy Reform in Mexico OPPORTUNITIES FOR CANADIAN OIL AND GAS SERVICES AND EQUIPMENT COMPANIES MARCELA SERRATO, AMERICOMPASS SC CONGRESO MEXICANO DEL PETRÓLEO GUADALAJARA, JAL. JUNE 11, 2015 Introduction Canadian and Mexican oil and gas industries have one thing in common: great challenges ahead. Your presence here today is a testimony of efforts to seek opportunities abroad using a worldwide recognized technological leverage. Mexico is a very good choice. The ER has ended close to 80 years of state monopoly in Mexico’s oil and gas sector. The ER has advanced at an amazing pace. In less than 12 months Mexico moved from a Constitutional reform to the passage of secondary legislation, the formation of regulators and the presentation of bidding and contract terms for Round One. ER opens a wide array of opportunities across the entire oil and gas value chain. Allow me to review them briefly. 1. Offshore The deep waters of the Gulf of Mexico hold the most important opportunity for foreign companies. Mexico is believed to hold considerable recoverable hydrocarbon resources of roughly 29.5 billion boe located in deep waters. Pemex exploratory campaign has rendered only 30 wells and only one major discovery near U.S. border. Best shot for IOCs because: a) profitable, b) infrastructure on other side of the Gulf already in place, and c) it allows to avoid social conflicts that may arise in works onshore. Likely that consortium requirements of contracts will be modified for deep waters. 2. Onshore Contracts in onshore mature fields have a lot of potential. As Pemex lost interest in some of them in the past, it abandoned the fields before many of them had reached maturity. Mexican private sector has already voiced publicly a significant interest in mature onshore fields. Financial requirements of tenders could be lowered to allow more participation of Mexican private sector. Many innovations in oil and gas exploration and drilling have allowed for new techniques to exploit existing conventional oil and gas assets. Deploying new technologies may help older fields to become more productive. Succesful partners for these plays will either have superior recovery technologies or the right operating margins to be profitable. 3. Shale One of the most meaningful opportunities for International players lies in the shale frontier. Mexico has the 6th largest shale gas and 8th shale oil reserves worldwide, and 2/3 of the most productive shale basins in the U.S. extend across the border. Despite vast shale reserves, Pemex has only drilled 6 shale exploration wells in the Eagle Ford play. In the short term, do not expect a wave of enthusiasm because of lack of infrastructure (pipelines), disfunctional municipal governments, property rights, insecurity, insufficient water resources for fracking. But shale will eventually take off. Technological innovations, derived from low oil prices, may become a detonator. 4. Midstream Rapid expansion of the oil and gas market can lead to infrastructure challenges. Mexico will need substantial infrastructure to produce the new resources. At the end of 2012, Mexican gas pipelines reached their capacity limit. Increasing demand and the very limited transport capacity provide a major opportunity for midstream companies to engage in developing the logistics and distribution requirements across the full supply chain. 5. Downstream and petrochemical In the past structure, the Mexican government burdened Pemex with funding retail price subsidies and, as such, Pemex did not have the funds to invest in expanding or properly maintaining refining capacity. The ER will unburden Pemex from funding the retail subsidy. Pemex will be able to reinvest in the downstream infrastructure. Making the retail subsidy scheme transparent and directly funded by the government will motivate Mexican and international companies to invest in reconfiguration of existing refining capacity. When shale production comes online, Mexican refineries will be able to process shale more efficiently. 6. Downstream retail With the ER there is a real opportunity for retailers to enter the Mexican retail market and brand their sites. There are 10,000 service stations trhoughout the country and no Mexican group owns more than 400 stations. The market remains fragmented and consolidations in the market are likely. Focused retailers with ready capital could enter the market, become aggressive in mergers and acquisitions, and position as leaders. Round One Through an independent body (CNH), Mexico is conducting 3 tenders for oil and gas E&P contracts for international bid. Shallow waters: 2 rounds, bids to be presented on July 15 and Sep 30. Onshore mature fields: 1 round, bids to be presented Dec 15. Rules and limitations intended to signal that Mexico is truly opening and to guarantee multiplicity of actors. Model contract in shallow waters replicates the Chicontepec integrated services contract with a production sharing agreement and fiscal formula. Factors driving interest are: a) size of resources and b) the fact that everybody is doing it. The Mexican government wants experienced companies, to receive a fiscal flow of revenue sooner rather than later, and to allow Mexican companies to be part of the process. Foreign investors are enthusiastic about how rapid things move forward. Role of the Mexican oil & gas companies There are more than 10,000 Mexican companies in the oil and gas sector that generate over 1 million jobs. Around 500 of them are mid-sized companies. Many lack the scale and expertise for E&P but can participate in distribution, storage, logistics, services and petrochemicals. They understand the political and regulatory landscape and have established relationships with the government and community leaders. There will be a preference for bids that include Mexican companies and/or create jobs for Mexicans (25% requirement of national content). Foreign investors should take heed in developing their business models and should consider engaging Mexican partners where it makes sense. Role of independent oil and gas producers They have the skills and focus required for efficient horizontal drilling and fracking. They are well suited to establish profitable partnerships and JVs with other Mexican oil companies. They will bring their technical know-how, as well as quick turn manufacturing style drilling that allows shale gas production. If Pemex is not aggressive in its pursuit of shale, there will be a proliferation of new JVs between smaller Mexican firms and foreign independents. Service and equipment companies Many oil service companies had extensive operations in Mexico prior to the regulatory changes. Service companies have been in Mexico for a while and have a wealth of seismic and geological information that will make an important difference in an environment where data will be uncertain. Mexican service companies like Petrofac have already successfully won contracts that give them first mover advantage. Going forward, the service companies will be able to seek partners for more than what their current cash service contracts allow. A likely scenario would imply service companies partnering with local companies to form new Mexican independent - a marriage of technical expertise and local content. Areas of opportunity for service and equipment companies (1) Seismic Seismic, micro-seismic imaging Seismic data processing and analysis Tubing Production tubing and casing Service to wells Oil and gas software (data management) Oil and gas processing and well testing equipment Drilling Hydraulic fracking and horizontal drilling Rig manufacturing and rig site products Progressive cavity pump systems Production optimization equipment Flow control products Offshore drilling Areas of opportunity for service and equipment companies(2) Logistics Proppants providing and transportation (sand and ceramics) Helicopters Technologies for inspection, monitoring and management of physical infrastructure Platform supply vessels and other marine services Other Shale services Deepwater services Capital equipment Market entry strategies Establish a joint venture or partnership with an existing Mexican technology or service sector company (or an international providing services to PEMEX). Develop a relationship with bidders through Canadian equity investment or through EDC. Create a Canadian consortium of technical expertise that offers a wide range of services to prospective clients. Provide services through a larger service sector company that already has existing client relationships (e.g. Halliburton, Schlumberger). Start a brand new Canadian-Mexican service sector company (e.g. Petrofrontera). Challenges ahead The ER will take a long time to be fully in place and there will be delays along the way (other 4 sets of tenders and then multiple rounds). Important challenges: → Understanding the new rules of the game (national content requirements). → Overregulation and micromanagement. Material question about capacity of CNH to oversee work programs and of Hacienda to audits costs. → Questions over property rights, rule of law, due process of justice system. Monitor the commitment of the Government that it is working to make things better. → Pemex budget cutbacks derived from the fall in oil prices and their impact on the cancelation or postponement of projects. Conclusion Canadian companies will need to strike a balance between being bold and prudent. Whether you are an independent, an oil field service company or a provider of equipment, there are opportunities for all. You just need to understand what your competitive advantage is, find the play (and partner), plan and organize, and then execute. The new Mexico should be a rewarding and interesting place to do business. Thank you.