Extraction protraction: Despite major hurdles, shale still holds great potential

At first glance, the story of Mexican shale oil and gas sounds frustrating. Like its northern neighbours Canada and the US, Mexico has some of the world’s largest shale deposits. The government’s deep energy reforms of 2013-14 created an environment attractive to international oil companies (IOCs) willing to invest the tens of billions of dollars needed to develop shale. But in 2014-15, just as the country seemed poised to unleash a shale revolution of its own, with the sale of exploration and production (E&P) licences for some of its prospective basins, international oil prices collapsed. The revolution may have been postponed.

While development will be slower than first hoped, shale’s potential remains critically important for Mexico. Its shale reserves are huge, particularly in gas: according to the US Energy Information Administration (EIA), Mexico has 545trn cu feet of shale gas reserves and an estimated 13bn barrels of shale oil reserves. These are concentrated in the Sabinas, Burgos, Tampico-Misantla and Veracruz basins in the north and east. Some, like Burgos, are geologically connected to shale formations on the US side of the border, such as the prolific Eagle Ford play in the state of Texas.

A second key factor is that because of the depletion of some of its conventional shallow water offshore fields, to reverse the gradual fall in oil and gas production of the past decade, Mexico needs to develop more technically challenging non-conventional deposits: that drive pushes it to develop deepwater E&P. In the long term shale also has to be part of the equation.

A third factor is that while developing shale production poses complex environmental, technical and logistical challenges, the benefits are significant. A joint study by US and Mexican research centres notes that, “The harnessing of hydrocarbons wealth in the sub-soil, combined with the development of the services sector and major infrastructure projects, will mean the creation of more than 196,000 jobs per year and the generation of more than $137bn for the state of Texas by 2023.” The Mexican states of Coahuila, Nuevo León, Tamaulipas and Veracruz, all of which have shale resources, aspire to reap similar benefits.

Competitive Edge

Finally, it is also worth noting that shale gas is already playing a key role in Mexico’s core manufacturing exports-based “economic model”. A recent study by Boston Consulting Group (BCG) describes Mexico and the US as the “emerging stars” of global manufacturing. Because of the shale gas revolution, BCG says, in the 10 years to 2014 the price of natural gas fell by 25% in the US and by some 37% in Mexico, which currently imports gas from its northern neighbour. This was in contrast to average gas price increases in the world’s top 25 exporters, which over the same period rose by 98%. Shale gas can help boost the competitiveness of the increasingly interconnected Mexico-US manufacturing value chain.

Round One

However, it is clear that the collapse in international oil prices in 2014-15 has had a negative impact on the pace of shale oil development in Mexico. In December 2014 the authorities announced that they would auction a total of 169 exploration and production blocks in 2015. This process – known as round one – was to be divided into five phases, offering a combination of different hydrocarbons assets designed to attract the IOCs, and test levels of interest, starting with shallow water exploration blocks, but also offering on- and offshore production blocks, higher-cost deepwater plays, the Chicontepec basin (a particularly complex geological formation) and shale oil and gas.

The timing was unfortunate as it coincided almost exactly with the collapse in oil prices. As a result, from an early stage officials admitted round one would bring in less than the initially hoped-for $12.5bn worth of investment commitments. In the first phase only two of 14 shallow water exploration blocks were awarded. As round one progressed, contractual terms were altered to make the blocks more attractive to oil companies. Officials suggested that some auction phases might be altered or postponed. At the end of August the energy minister, Pedro Joaquín Coldwell, said that the fourth, deepwater phase would be postponed to give more time to perfect the contractual terms, while the fifth, shale oil and gas phase was being shelved.

However, the results of the second phase of round one, announced in September 2015, were better. Nine companies bid for a block thought to hold more than 700m barrels of oil, and another attracted five bidders. They were among three blocks awarded production-sharing contracts, all of them in the Gulf of Mexico’s Southeast Basin. The National Hydrocarbons Commission had said that it would consider the phase a success if two or more of the blocks were awarded.

Profitability

Mexican officials say that shallow-water oilfields have a production cost as low as $20 a barrel, which makes them profitable whether international oil prices are at $100 or $50 a barrel. However, unconventional oil – whether deepwater or shale – can cost $60 per barrel or more to extract, making it an unattractive proposition when the price is $50. The exact calculation of profitability in shale production in Mexico is complex. Companies need to factor in the cost of the infrastructure that needs to be put in place, from roads to pipelines. Yet developing shale is a long-term business, so this or next year’s price is less important than the long-term average. One option for the government is to help shale producers by offering larger licensing blocks, which spreads risks and reduces costs.

Challenges

Developing shale remains a major challenge for Mexico’s northern states. Each Eagle Ford shale well requires 100 train wagons of sand and 4m-5m gallons of water as part of the hydraulic fracturing (fracking) extraction process. Fresh water availability in Mexico’s northern states could be an issue, and local opposition to fracking on environmental grounds may develop. Mexico has no federal regulations governing fracking, but Semarnat, the federal environmental agency, has issued guidelines governing shale exploration and production. It will also be necessary to build a dense network of pipelines. In addition, concern has been expressed over security issues, as some of Mexico’s drug cartels operate across the northern states. But perhaps overriding this is the technical and financial challenge: to fully develop shale, it is estimated that Mexico will need to drill more than 40,000 new wells, at a cost of $10m-20m each.

While the government and IOCs are cautious, some investors see a moment of opportunity. In September a joint venture was formed between US-based American Energy Partners and equity fund EIM Capital. The joint venture will “explore and develop Mexico’s unconventional oil and gas resources”.

As one market tracking media group has pointed out, “Investors who are willing to take risk during the current cyclical trough may gain access to a wide set of opportunities on reasonable terms and with relatively little competition.” In other words, this may be a very good time to gain a foothold in the Mexican shale industry ahead of the next hydrocarbons recovery.

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The Report: Mexico 2015

Energy chapter from The Report: Mexico 2015

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