Neighbouring opportunities

Mexico

Andy Fisher, director-general of Tonalli Energía, talks to TOGY about the development of the Tecolutla onshore field, the company’s desire to concentrate more on onshore activities and the need for Mexico to develop alternative marketing strategies for its oil and gas industry. Tonalli Energía was formed in 2015 as a joint venture between International Frontier Resources (IFR) and Grupo Idesa.

The company was established to participate in Mexico’s Round 1.3, a tender for mature oil and gasfields. In the May 2016 round, Tonalli bid on four blocks, winning Contract Area 24 (Tecolutla) after the first-place bidder was unable to meet financial obligations. In August 2016, Tonalli signed the 35-year PSC with the National Hydrocarbons Commission for this 7.2-square-kilometre block, which holds 100,000 boe in 3P reserves in the Tecolutla field.

• On the energy reform: “The energy reform is a good thing for Mexico because it allows companies to participate that have the aptitudes and ambitions to chase opportunities that Pemex couldn’t or didn’t want to do because of its large size.”

• On Mexico’s attractiveness: “Mexico is a very developed country with a strong legal system that also has a transparent, world-class regulatory system in place for oil and gas. Moreover, there is good infrastructure here. Although security can be a problem, you simply need to adjust your operations and put the right procedures in place to try to minimise security risks. Certain areas are worse than others.”

Fisher also discussed other items, such as its successful bidding round, comparisons between working in Mexico and Canada, and infrastructure needs in Mexico. Most TOGY interviews are published exclusively on our business intelligence platform TOGYiN, but you can find the full interview with Andy Fisher below.

How did Tonalli fare in Round 1.3?
We were happy with the results of Round 1.3. We built a comprehensive economic model and conducted a very thorough analysis before we submitted our bids. Part of our strategy was to start small.
Tonalli bid on four blocks in Round 1.3. We ended up with second place bids on two of these blocks. Eventually, in May of 2016, we were advised by the CNH [National Hydrocarbons Commission] that the first place bidder on the Tecolutla Block did not complete the terms and conditions required, and in accordance with the bidding guidelines, we were offered the block. In August of 2016 Tonalli signed a license agreement with the CNH for the Tecolutla block.
After our analysis, we were confident the oil in place at Tecolutla was potentially much higher than the number that was published by CNH. Also, we believe we are going to have a very high recovery factor because of the active aquifer that underlies the oil reservoir, provided the depletion strategy is effectively managed. Having Tecolutla, which is small but has incredible potential, gives us a good opportunity to learn the regulatory environment and grow together with the CNH and National Agency for Safety, Energy and Environment of Mexico, which are learning to apply the regulations at the same time.

What are Tonalli’s prospects in Tecolutla?
We are very excited about drilling our first well, which will be conventional and vertical. It will be drilled into a previously untapped part of the reservoir, which we identified by looking at the 3D-seismic data provided through the bid round. We think it will yield exceptional results and perform better economically than most fields in western Canada. We expect that Tecolutla will be profitable in the current commodity environment, and with Tecolutla’s fair and reasonable royalty structure shared with the Mexican government. All required services are available and there is a well-educated labour pool that we will be able to hire from as we grow.
There is a large amount of drilling and other equipment that was brought to the area during the drilling that occurred under previous service contracts. The challenge will be to re-activate this equipment and the associated crews in an efficient manner, but we are confident this won’t be a problem.

Will production from the planned well be more than the field’s previously recorded peak production?
Peak production from Tecolutla’s four producing wells was 900 bopd and IP [initial production] rates from one of those wells were as high as 500 bopd. With our first well, we plan on intersecting a part of the reservoir that is significantly higher and has never been accessed. We expect to have an IP rate that exceeds the original IP rates that were obtained at those four wells. Also, we believe that the downhole pressure is still the same as it was in the 1950’s because of the underlying aquifer support, which means there is great potential to recover more oil. It’s very exciting.

What have you learned about the bidding process and the private oil and gas industry in Mexico?
We have learned many things. Part of our goal was to make sure all processes are managed internally so Tonalli can learn and build up a knowledge base of the regulatory environment in Mexico.
The upfront regulatory process prior to drilling is intensive, but we feel that the CNH is supporting us to help the process move along.

How does IFR’s previous drilling experience translate into the Mexican operational environment?
Our team has significant experience in operations. In the previous company, our team was operating in the Swan Hills area of Alberta developing a tight carbonate platform. We were innovators in the implementation of multi-stage acid fracks in tight carbonate reservoirs there. We drilled more than 100 wells and simultaneously established waterflood patterns and built infrastructure: pipelines, batteries and so on.
Through that process, we began continuous improvement initiatives, such as performance drilling. We got to a point where we were analysing every minute of the drilling of our wells. We were then able to drill wells in nine days that previously would have taken more than 30 days to drill. These wells had a measured depth of about 3,800-4,000 metres and a vertical depth of about 2,500 metres. We had multiple evolutions of completion strategies and we got to the point where we drilled some wells with the highest 12-month cumulative production rates in Alberta.
The thing we find interesting about Mexico is that most people are talking about unconventional and shale, but there are also many onshore conventional opportunities left because Pemex has been more focused offshore. If you took the reservoirs that are here and put them in Alberta, people would be salivating over them. It’s much better.

Why have attractive prospects in Mexico been left underdeveloped?
Pemex had to prioritise its investments, which has resulted in many opportunities being left underdeveloped. The energy reform is a good thing for Mexico because it allows companies to participate that have the aptitudes and ambitions to chase opportunities that Pemex couldn’t or didn’t want to do because of its large size.
A smaller group can focus all of its attention on a specific reservoir, learn how to efficiently exploit it and create value. If we are creating value for a company, that means we are creating value for Mexico through the royalties, job creation and advances in technology. There are many smart people at Pemex, but they didn’t have the resources to focus like this.
It is like this with many large companies. For example, ExxonMobil will not chase smaller plays in Alberta because it doesn’t make sense for them. They need a certain reservoir size or play type before going after it because of their general and administrative expense structure and their reserve replacement requirements.
Though there are many opportunities in conventional reservoirs, there are also portions of conventional reservoirs that are tight that can be chased as well. We believe that as the drilling density increases, there will be more hydrocarbons discovered than what is currently expected.

Are there significant opportunities for foreign companies to participate in the development of Mexico’s major fields?
I think so, but for Pemex and the rest of the country, that comes down to the amount of money that needs to go into getting extra recovery and technology and the economics of this. It also depends on whether it makes sense within the current financial and corporate structure of Pemex to try to implement those technologies in the Cantarell field, for example; or whether it makes more sense to have a third party come in and put up the capital and let Pemex get the benefit of it.
Pemex will high-grade its development opportunities and this will result in numerous opportunities for foreign companies. However, it still has to make sense from a business and strategic perspective for the foreign company.

How has the CNH performed in Mexico’s bidding processes?
The CNH has done an great job. They have been open-minded, listened to people and made adjustments to the process that have improved it, and they continue to do that. Also, the processes could not be much more transparent. It is a big job to figure all this out and do the right thing, but the CNH seems to be doing it.
Different companies and stakeholders each have their own point of view, which is usually based on their particular needs and wants, and that means they push their own agenda. The CNH has been able to filter through all of that and decide what is best for the country and the industry as a whole.

Where in the domestic hydrocarbons value chain is there room to develop more infrastructure?
The country needs to create alternative marketing structures because relying solely on PMI [Petróleos Mexicanos International] as a marketer is not good enough. Competition needs to be created in that sector. A market-driven differential structure needs to be created to ensure that the prices operators are receiving for their respective crude types are fair. That will be good for everyone.
Furthermore, if midstream services are strategically located in different places throughout the country, that could start to build up the volumes that are required to create the benefits of the marketing strategies as far as blending the right APIs and sulphur content of crude in different areas is concerned. From our focus as a smaller upstream operator, we can see midstream service opportunities, such as construction of facilities where oil can be trucked for treatment and where it can be aggregated to create export opportunities.
For the investment in new midstream facilities to take place, investors need to have the vision that there is going to be a high production volume coming on stream as a result of the reform and agree to risk putting capital into these types of facilities. Midstream is a big business and we want to see more of that coming into the country.
Even if existing facilities are used, investment will have to be made in these facilities to upgrade tanks and other equipment and add measurement equipment. Pemex didn’t really require strict measurement requirements and it didn’t continue to invest in a lot of its facilities because it was finished developing a lot of the existing fields that fed into them.

Will Pemex be able to bring in new partners and investors to attract capital to its downstream assets?
At this time, the negotiations seem very complicated as far as they pertain to agreeing on risk allocation and getting companies to come in to make investments in downstream assets such as refineries. I think it will happen, though, because many of the final decisions will come down to common sense. If the production volumes start ramping up from the reform, there will be a big incentive for the investments to be made. It will happen naturally, but I believe closing those deals will take some time.

What unique risks do international companies face when investing in Mexico?
It seems that people who are not knowledgeable about Mexico have some false preconceived notions. Mexico is a very developed country with a strong legal system that also has a transparent, world-class regulatory system in place for oil and gas. Moreover, there is good infrastructure here. Although security can be a problem, you simply need to adjust your operations and put the right procedures in place to try to minimise security risks. Certain areas are worse than others.
We will try to be smart about that, be proactive and engage the communities we are in to establish good relationships, and to support them. We will try to be a good operator and neighbour to the people we are near. If you start with that foundation and develop good relationships, that will help you through the whole process.

How important is local content and what other countries provide models for the successful implementation of these policies?
Colombia has implemented successful local content measures that Mexico could emulate. Local content is a good thing. Mexico is well developed in the oil industry with people, equipment and exports.
Complying with the local content rules that we have in our contracts is not a problem here whatsoever. In fact, we want to keep increasing local content as we grow. When we start, it will be a bit smaller because we are a small company, but as we grow, the amount of local content we employ will keep increasing.

What is IFR’s energy industry background and how will that benefit operations in Mexico?
IFR is a public company that has been around for 17 years and that has had some limited operations. The previous management team of IFR was involved in bid rounds in the North Sea and drilling some wells there, as well as making a significant gas discovery in the Northwest Territories of Canada that was shut in and not developed, despite a significant accumulation of gas, because of a lack of pipeline infrastructure.
IFR also has some smaller operations in the sedimentary basin of western Canada, as well as some land holdings in Montana. We came in as a new management team about two years ago, at which point we were essentially using IFR as a public vehicle to finance operations in Mexico.
If you look back at the history of the TSX [Toronto Stock Exchange], you see many companies that started small and grew to be massive based on the capital that was raised through the TSX market, especially in the mining sector, once mining reform happened in Mexico. You will also see that about 75% of the money that went into the Mexican mining industry came out of the Canadian markets.
We therefore see Canada as a great potential source for capital to fund companies and energy reform in Mexico.

How has the company’s financing model affected what areas it concentrates on?
We are focused on onshore projects. Some of the people on our team have worked offshore, but that will not be our focus because it is outside of our capital range and expertise. The way we grow with our TSX model is to start small, but continue to do financings at increasing stock prices. That is how we create value.
This is different from the private equity model that some of the other players have taken up, in which they will accept millions of dollars in funds up front from a private equity firm, which then owns a large percentage of the company. Our model is to have more ownership and control and to grow value through the public market structure because we have experience with that. It is a model that has worked repeatedly for Canadian companies operating across the world.

What are the benefits of partnering with Grupo Idesa?
The first thing IFR did when we came down here was to find a good local partner. We believe that when you come to Mexico, regardless of your previous experience, you need a partner who understands the country and its business environment. We’re extremely fortunate to be able to partner with Idesa. We formed Tonalli Energía, 50% of which is owned by IFR and the other 50% of which is owned by Idesa. It’s been a great partnership. We have worked closely together and taught each other many things.
IFR brings much of the technical and operational experience, as well as the experience in actually running an oil and gas company because we understand all the components you need to be successful in doing so. It’s not just knowing how to drill wells and other operations. You have to actually know how to run the business as well. People from Canada have experience with that because there are many situations in which start-up companies grow and learn all aspects of the business.
Idesa covers the regulation background, human resources and legal aspects. They understand the infrastructure and many other things about Mexico that we don’t. Idesa and IFR have a good and complementary relationship and we plan on moving forward together with Tonalli as the entity for our growth in Mexico.

What are your objectives for 2017?
Our objectives for 2017 are to drill at Tecolutla, analyse Round 2, and perhaps to get involved with Pemex joint ventures. Though 2017 might be slower, those joint ventures are going to be ramping up with Pemex starting to do many of them, if not in 2017, then in the following years. Pemex will also start joint ventures with existing contract holders and service contract holders because it is part of the contract migration process. We are open-minded, opportunistic and looking at opportunities as they come.
We can also analyse opportunities quickly. Even though Idesa is a big company, it is quick at making decisions because its strategic planning group and board of directors are actively involved. Proposals that Tonalli puts forward can be approved and funded as required.

What is Tonalli’s growth strategy?
We believe that Mexico, as of today, is one of the most attractive markets. If we concentrate ourselves at this time within Mexico, it will be good. We think there is a big opportunity for growth here and, though you have to have some patience, it will all be worth it. We will manage our risk and expenditures and the company will take on more risk as we can accept it.
We will also bring in more employees throughout the year as Tecolutla comes on stream, and if we acquire another block or do another deal on an existing block, we will be staffing up quite a bit.
Our guess is that the core team will comprise 15-25 people with the support of both parties, but that does not include part-time people. Part of our model is to utilise and adapt some of Idesa’s resources and try to use them part-time to start with, to limit general and administrative expenditures.

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