Governments have to understand what they are promoting and be flexible enough to put in place the most appropriate terms to develop a specific area.

Carlos CANALES Partner CANALES AUTY

Pillars of sustainable development

August 7, 2017

Carlos Canales, partner at Canales Auty, talks to TOGY about risks faced by E&P companies in Mexico and how the country’s regulators have attempted to put forward workable contract models to attract companies and investors to develop the domestic oil and gas industry. Specialising in energy and natural resources, Canales Auty is a law firm working throughout Latin America.

With offices in Mexico, Peru and Bolivia, the firm has worked with a wide range of clients in including IOCs, NOCs, oilfield services providers, midstream companies, fuel traders, independent power producers, governmental agencies and investors. Canales Auty has been involved in Mexico’s Round 1 and Round 2 E&P auctions, for which it participated in the negotiation and drafting of consortium and joint operating agreements, as well as the review of bidding guidelines, exploration contracts and PSCs.

• On handling risks: “Mexico has a very low geological risk compared to other Latin American countries, but that does not mean that you do not have to put in place different specific frameworks to attract investors. The size of the blocks, access to information and the design of the applicable contract and framework is crucial. Other countries may have very high geological risks, but very attractive fiscal and legal terms.”

• On contract models: “Governments have to understand what they are promoting and be flexible enough to put in place the most appropriate terms to develop a specific area. Mexico’s approach to different contracts and frameworks for different areas is good industry practice.”

Canales also discussed how the energy reform has increased the flexibility and security of the domestic oil and gas industry, and how the industry will continue to evolve in the years to come. Most TOGY interviews are published exclusively on our business intelligence platform TOGYiN, but you can find the full interview with Carlos Canales below.

How has the implementation of the energy reform been rolled out?
In our opinion, the Mexican government has done exceptional work with the energy reform. The speed in which the reform has been implemented is truly remarkable. The government has put in place a significant amount of legislation in such a short period of time. It is outstanding how fast the regulatory design has happened. We have no doubt that Mexico is on the right track.

What are the main risks and challenges E&P companies face when entering Mexico?
As to main risks, whether you are a mid-cap, IOC or even NOC, everyone first looks at three fundamental factors: geological risk, fiscal regime and regulatory framework. You can have a very good framework, but if there is not enough geological information available, the geological risk is high, and then it does not really help much. The same is true if there is a lack of fiscal stability. It is advisable that government concerns such as fair revenue share, prompt exploration, environmental protection, training, activity controls and incorporation of local goods and services be aligned with investors’ rights to stability and enforceability, and to monetise [resources], particularly to avoid unnecessary tensions once hydrocarbons production occurs.

How should contract terms take into account Mexico’s geological risk?
Mexico has a very low geological risk compared to other Latin American countries, but that does not mean that you do not have to put in place different specific frameworks to attract investors. The size of the blocks, access to information and the design of the applicable contract and framework is crucial. Other countries may have very high geological risks, but very attractive fiscal and legal terms.
Mexico is also blessed with the whole hydrocarbons spectrum. The country has ultra-deepwater and deepwater, shallow-water, conventional and unconventional areas, yet this full spectrum also brings complexities in attracting investors. It is impossible to effectively develop all of these different areas under a single model contract and framework. Governments have to understand what they are promoting and be flexible enough to put in place the most appropriate terms to develop a specific area. Mexico’s approach to different contracts and frameworks for different areas is good industry practice.
Finally, we praise the recent amendments to the rules for participating in upcoming rounds. Having a five-year licence to access the whole data room and participate in upcoming rounds reduces geological risk and transactional costs of participating. This full access to available data increases options for looking at the full picture of what is there and is a great insight of the geological risk.

 

What main advantages does Mexico have over other countries when it comes to attracting capital?
The more we standardise and implement upstream practices under international industry standards, the more attractive Mexico becomes. It is remarkable how fast this has happened. From December 2013 to today, 49 new operators from 14 different countries have entered Mexico. That has translated into billions of dollars in investment commitments to Mexico in such a short period.
Mexico must continue to take advantage of its low geological risk, its vast hydrocarbons spectrum of diverse basins and plays and its proximity and integration potential to the US market. That is something other Latin American countries do not have.
This is a technology-driven industry. Technology, for the first time, has opened opportunities for regions and countries that have never had access to hydrocarbons. Recent discoveries in the Caribbean region is a clear example. Competition in the following years will be significant. After all, Mexico has to compete in a global market. Technology will continue to help mitigate geological risk, which is a primary factor in the decision-making process.

How will Mexico’s regulatory and legal framework evolve in the coming years?
It is unquestionable that many legal frameworks and petroleum laws around the world are heading towards efficiency and achieving sustainable development goals. The three basic pillars of sustainable development – economic stability, environmental protection and social sustainability – are currently the cornerstone of much legislation around the world.
Mexico has very aggressive sustainable development goals, including its commitment to the Paris Agreement. The standard of sustainable development is not negotiable for Mexico any more. Now it is all about sustainability and efficiency, avoiding resource and economic waste, unnecessary environmental degradation, and increasing social welfare. The three basic pillars are equally important.
As Mexico aligns with international principles of sustainable development, including the recommendations provided by the ILA [International Law Association] New Delhi Declaration, the more sustainable and attractive its oil and gas sector becomes. Mexico has a historic opportunity to put in place a culture of efficiency in a sector historically driven by waste.

Is Mexico laying the groundwork to attract more foreign companies?
Mexico is unique because of its low geological risk, proximity to the US market and its historically strong NOC, Pemex. This is where the enforceability factor comes into play.
The regulatory design of Mexico is very good, but that in itself is not enough. Strong regulators to implement secondary legislation and oversee that best industry practices are followed is crucial. The head of policy, SENER [Secretariat of Energy], and the hydrocarbons regulator, the CNH [National Hydrocarbons Commission], are working hard towards this culture of efficiency.
Legislation on unitisation, secondary recovery, use of information and control of activities is expected soon. To continue to attract foreign investment, these rules need to be clear and consistent with best industry standards and be applied to everyone without exception, and to every type of contract, including Pemex’s farm-outs.

How can unitisation be a challenge to successful bidding rounds?
Let’s imagine you have a common reservoir that lies across two different blocks: a Pemex block and a vacant block pending to be incorporated in a licensing round. There are four potential title holders in total. What do you do? Good practice is always to avoid unnecessary tension. Do you appoint a single operator? Should there be mandatory or voluntary unitisation,? Field-wide unitisation? Redetermination?
Going forward, unitisation will become a big technical and legal challenge for Mexico. Many technical and legal issues will come up. The role of the regulator to first provide legal certainty and then to implement and enforce efficiency is key, especially if the overall objective is to create a culture of efficiency and avoid resource waste.

What is the outlook for third-party access to natural gas transportation capacity and the liberalisation of the power sector?
For a competitive market environment, Article 73 of the Hydrocarbons Law is key. The implementation of secondary markets is crucial for developing a robust midstream sector. Full implementation of Article 73 will provide a tremendous benefit to the gas sector and indirectly benefit the power sector. Availability of information regarding transportation and storage capacity, and firm and interruptible agreements will trigger creative gas and power trading products.
Mexico’s market is big enough for all sorts of players: LNG players, gas transportation companies, storage companies and gas and power traders. Secondary markets provide more equilibrium and trading products provide efficiency; a must for a full liberalisation of the gas and power sector.

What should Mexico concentrate on to further develop its midstream sector?
Along with expanding its current energy infrastructure and implementing secondary markets as discussed, Mexico should also emphasise the importance of US-Mexico energy integration to increase energy supplies and improve energy security for both countries. It is not only about alleviating infrastructure constraints and bringing efficiency to the market, but also looking at mechanisms to integrate cross-border markets. In our opinion, that is the next big thing that Mexico has to focus on.
An aligned regulatory framework with common standards on both sides of the border creates a predictable energy environment favourable for attracting investment for both countries.

What is the outlook for the LNG market in Mexico?
To obtain energy security, Mexico has to have a balanced portfolio. There are always going to be infrastructure constraints and problems with access to gas. LNG for Mexico costs more, but pipeline constraints in the country make it necessary.
Mexico has traditionally received its LNG from Nigeria, Qatar and Peru. Although Mexico took nearly half of the more than 70 tankers Peru loaded in 2016, due to prices linked to the US Henry Hub, Mexico and Peru have been in a price dispute, forcing Mexico to issue tenders from other suppliers and understandably taking in loads from the US’ Sabine Pass LNG. As of the end of March 2017, Mexico accounted for 18 of the 90 cargoes that left Sabine Pass LNG since operations commenced in February 2016.
Mexico now imports about 55-60% of its current gas needs, and this could reach 75% by 2020. With dry gas production already down 15-20% this year, harnessing natural gas is slightly problematic for a country that uses gas for nearly 60% of its electricity.
Until pipeline constraints are settled, the reality is that we have to continue relying on LNG. The refreshing news is that the impact of the Panama Canal expansion for bringing LNG to Mexico is significant, as far as shortening transportation time is concerned. The expansion of the Panama Canal slashed the one-way voyage from Sabine Pass LNG to the Manzanillo terminal to just 10 days, down from the 27 days the old route took around Cape Horn.

For more information on Canales Auty in Mexico, or the various industry changes the country’s energy reform has brought about, see our business intelligence platform, TOGYiN.
TOGYiN features profiles on companies and institutions active in Mexico’s oil and gas industry, and provides access to all our coverage and content, including our interviews with key players and industry leaders.
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