Efforts to boost crude oil production set to revive Mexico's energy sector

Since the nationalisation of the oil industry and the establishment of state-run Petróleos Mexicanos (Pemex) in 1938, hydrocarbons production has been a significant driver of growth, and the energy and utilities sector remains a key cornerstone of Mexico’s economy. The sector has evolved rapidly in recent years after a comprehensive energy reform was introduced in December 2013, which has helped to attract private investment in exploration, downstream distribution and renewable energies.

Despite the positive effects of the reform, the sector still faces some challenges. Annual oil and gas production has fallen since 2004 due to a lack of new discoveries and Pemex’s continued dependence on mature oilfields. In addition, the development of the manufacturing sector and the expansion of Mexico’s middle class has caused electricity demand to rise at a faster rate than GDP growth, resulting in pressure to develop new capacity. Higher demand has also caused a decline in oil exports and an increased reliance on imports, particularly from the US.

In an effort to revive the sector, President Andrés Manuel López Obrador, known colloquially as AMLO, announced plans in late 2018 to raise crude oil production from 1.6m barrels per day (bpd) to 2.4m bpd before 2025. The government is also planning to invest in refineries in order to raise output. However, changes to the political landscape have caused some uncertainty over the sector’s future. Despite the bold plans announced by AMLO since he began his term in office in December 2018, investors remain cautious due to a series of cancelled energy auctions and halted projects. Therefore, the challenge for Mexico in the coming years will be boosting Pemex’s productivity and ensuring it can keep up with rising demand while reserves continue to fall.

Structure & Oversight

The Ministry of Energy (Secretaría de Energía, SENER) is responsible for overseeing the sector and developing national energy policies. However, the two state-owned enterprises, Pemex and the Federal Electricity Commission (Comisión Federal de Electricidad, CFE), have long formed the backbone of the sector. As of 2018 there were 76 companies operating in Mexico’s oil and gas sector. Of this total, 39 were domestic firms – including Pemex – and 37 were foreign.

In 2013 a cross-party alliance known as the Pact for Mexico was signed, which saw changes made to energy policy, opening up the sector to involvement from foreign investors and private firms. The reform also ended the CFE’s monopoly on retail supply, thereby encouraging new entrants to the electricity market, and established targets for clean energy generation. It was hoped that exposing the two state-owned companies to additional competition would encourage them to operate more productively. However, the sector still suffers from a lack of investment and infrastructure. Although the reform remains in place, the new administration has shifted the focus away from attracting foreign investment and towards restoring confidence in Pemex. There is still some way to go in this regard; the company’s total revenue fell by $7.6bn in 2018 to $88.7bn, and it was $104bn in debt as of September 2019, making it the most indebted oil company in the world.

Performance

According to BP’s “Statistical Review of World Energy 2019”, Mexico’s proven reserves of oil totalled 7.7bn barrels at the end of 2018, down from 21.6bn barrels in 1998 and representing 0.4% of the world total. Proven natural gas reserves were recorded at 200bn cu metres, or approximately 0.1% of the world total in 2018, compared to 800bn cu metres in 1998.

Hydrocarbons production has gradually fallen in recent years, causing a reduction in exports and sector spending. Although the sector had faced difficulties prior to this, the collapse of international oil prices in 2014 caused a significant decline in investment in exploration and production. Oil production fell by 34.7% from 3.2m bpd in 2008 to 2.1m bpd in 2018, to represent a 2.2% share of the global market. In the same period natural gas production fell by 20.7% from 47.2bn cu metres to 37.4bn cu metres, to account for 1% of the world total in 2018. Pemex’s flagship Cantarell oil complex in Veracruz accounts for around 95% of the country’s annual production. Cantarell was once the world’s second-largest oilfield but production has declined rapidly in recent years. In 2004 the field produced a record 3.4m bpd, but output had decreased to approximately 1.7m bpd as of December 2018, according to international media.

One of the main challenges the sector currently faces is reviving crude oil exports. In 2012 oil exports accounted for 37% of total government revenue, compared to just 17% in 2017. The decline in exports can be attributed to the fall in production at maturing fields and the lack of exploration projects since 2014, meaning that older oilfields have not been replaced by new resources. As a result, oil rents have also fallen from 2.7% of GDP in 2012 to 1.1% of GDP in 2017, according to the most recent figures from the World Bank. The National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos, CNH) – the federal entity responsible for regulating the sector – predicts that, at current levels of extraction and without the discovery of any new sources, the country’s oil reserves will last until around mid-2027. This highlights the importance of new energy projects to increase capacity.

Investment

The new administration’s aim of reaching 2.4bn bpd by 2025 presents notable opportunities for investment. According to the CNH, around $24bn per year will be needed between 2019 and 2032 in order for the sector to make a recovery. Currently, spending is still lagging behind this target, with oil companies in Mexico collectively planning to spend just over $16.5bn in 2019: approximately $13.6bn of this total will come from Pemex and the remaining $2.9bn from private firms. In 2019 Deloitte México predicted that Pemex’s investment would range between $15bn and $30bn per annum over the years to 2024. This will be dependent on how the firm divides its capital between hydrocarbons production and refinery upgrades.

Pemex

The state-owned company has held a monopoly on oil and gas production since it was formed in 1938. Following the 2013 energy reform, Pemex maintained its control of most reserves and was granted a first option on exploration acreage before private companies could bid for involvement. According to the CNH, Pemex holds around 83% of Mexico’s proven and provable reserves.

However, Pemex is the world’s most indebted oil company, which is a considerable factor deterring investors from working with the state-run firm. In June 2019 Fitch Ratings became the first credit rating agency to downgrade Pemex’s debt to junk status. As a result, investors seeking to work with Pemex are requiring a larger cut of profits to cover the risk of making a deal with the company. According to Ricardo Solís Hernández, head of oil and gas for the UK Department of International Trade, companies could reduce this risk by partnering with a Mexican firm that already has an established relationship with Pemex. It will be important for potential investors looking to work with the staterun firm to understand local content regulations.

Sector players have argued that Pemex is efficient in shallow-water exploration but lacks expertise in deepwater offshore ventures. It is therefore difficult to find Mexican companies to participate in such projects. As a result, Pemex is expected to remain the largest firm, with the CNH predicting that approximately 15% of oil production will come from private companies by 2024. “The current administration aims to give Pemex back its dominance in the oil market, and drive it away from private territory,” Ricardo Arce, CEO of oil services firm Compañía Perforadora de México, told OBG. “In some cases, the government has given contracts to companies that do not have the required capabilities. As a result, Pemex and local firms will need to work alongside foreign players to successfully fulfil technical requirements to a high standard,” he said.

In the long term it will be essential that the government improves investor confidence in Pemex. “The oil and gas industry needs a strong, reliable and efficient Pemex,” Alejandro Villarreal, executive president of offshore exploration and production oil services company Cotemar, told OBG. “Although this is a unique challenge for the country, the new administration is making progress in this regard.”

However, other stakeholders place greater importance on the private sector in driving the sector’s growth. “Mexico’s hydrocarbon reserves hold great potential to attract the world’s largest companies,” Rustem Mansurov, CEO of Lukoil Mexico, told OBG. “However, the industry needs to function as a private-led sector, and the country has to open its doors to foreign investors through farm-outs and partnerships. Alongside this, the government should seek alliances with banks to finance Pemex’s debt.”

Foreign Participation

There are 37 foreign companies operating in Mexico’s energy market. The majority of their investment is directed at exploring fields in the Gulf of Mexico and maintaining production at Cantarell. However, the environment is changing for foreign companies operating in Mexico. In February 2019 President López Obrador cancelled future farm-out agreements, where private oil companies have the opportunity to buy into Pemex’s acreage. Existing farm-out contracts, however, remain valid. As of September 2019 the outlook for this type of agreement was unclear, but some sector players expect that competitive bidding rounds for upstream developments will restart in around 2021, and contracts will be awarded by 2022, with the hope that production will begin in 2023.

Several large-scale projects led by foreign operators were announced in 2019. In January 2019 the CNH approved plans from US firm Fieldwood and Mexico’s Petrobal for a $7.5bn shallow-water project in the Ichalkil and Pokoch fields, which have estimated total resources of 1.7bn barrels. Production is set to commence in 2020 with initial output of 20,000 bpd, which is set to increase to 40,000 bpd by 2021. According to the CNH, the field could become the second-largest in Mexico if it is able to reach its projected peak output of 110,000 bpd in 2026.

In June 2019 the CNH also announced that Italian firm ENI had commenced production at the Amoca-Mizton-Tecoalli shallow-water complex, but initial output will be limited to 8000 bpd due to capacity limitations at Pemex’s onshore facilities. Nevertheless, ENI is the first private operator to begin offshore production of crude oil in Mexico. The company also plans to build a floating, production, storage and offloading unit at the site by 2021, subject to approval from the federal government.

Meanwhile, several oil and gas majors have committed to investing in Mexico. In June 2019 the CNH approved Shell’s exploration plans for between four and eight deepwater areas in the Gulf of Mexico, with a minimum investment of $397m between 2019 and 2023. According to the CNH, if drilling is successful, investment could total around $1.3bn. Drilling is scheduled to commence at the end of 2019 and extend until the end of 2022.

Natural Gas

The natural gas segment has experienced a similar decline to oil production in recent years, though the new government is looking to boost supply and reduce dependence on foreign exports. According to BP, natural gas output reached 38.3bn cu metres at the end of 2017, and decreased by 2.4% to 37.4bn cu metres the following year.

Demand has long outpaced domestic production in Mexico. In 2008 the country produced 47.2bn cu metres of natural gas and consumed 60bn cu metres. While there has been a natural gas deficit for a long time, production levels have continued to fall as demand for electricity has soared, which has made the gap more difficult to manage in recent years. In 2018 natural gas consumption reached 89.5bn cu metres, up 49.2% compared to 2008.

Consumption has also increased as a result of the country’s growing manufacturing sector and expanding middle class. Consequently, Mexico has depended more and more on imports, which covered around 41.8% of the country’s total supply in 2018, compared to 60.1% in 2014. According to BP, Mexico received approximately 68% of US natural gas exports in 2018. AMLO’s main objective is to expand natural gas infrastructure in the southern states of Oaxaca and Chiapas, and in the Yucatán peninsula, where infrastructure is typically weaker. Progress has already been made in recent years – according to SENER, Mexico expanded its natural gas pipeline network by 31% between 2013 and 2018.

Liquefied Natural Gas 

Despite working to promote the use of renewable energies, Mexico continues to depend on natural gas-fired thermal generation for around 62% of its electricity matrix, the majority of which is imported from the US. Mexico’s liquefied natural gas (LNG) imports totalled 6.9bn cu metres in 2018, an 81.6% increase compared to the 3.8bn cu metres imported in 2008. Mexico’s LNG import scheme is made up of two terminals, one at Manzanillo on the west coast and one at Altamira on the east coast, which each have a capacity of 160,000 cu metres per day. A third LNG facility at Ensenada in Baja California is designed exclusively for US re-export to Asian markets. The terminals operate at between 50% and 70% capacity, meaning that Mexico has a buffer in the event that it needs to import LNG from a supplier other than the US. However, some players are concerned that the country is not prepared for every eventuality. “We do not have a strategy in place if there is a disruption to supply from the US,” Arturo García Bello, energy and natural resources partner at Deloitte México, told OBG. In recent years the country has taken steps to increase the capacity of its pipeline network. In mid-2019 TransCanada and the Mexican company IE nova started operating the 73.6m-cu-metre Texas-Tuxpan marine natural gas line, which delivers gas from Houston. The pipeline is expected to increase US LNG exports to Mexico by 40% and aims to boost supply in the centre and south-east of the country.

Downstream

Mexico’s downstream sector is set to expand in response to rising demand for petrol, which is expected to grow by around 2% each year between 2019 and 2028, from an average of 843.9m bpd to around 1.1bn bpd. The rate of demand reflects the country’s expanding middle class and the growing number of households that are purchasing cars as average incomes steadily rise.

Mexico has become increasingly dependent on US fuel imports, which supply around 60% of total consumption. Of the country’s total petrol consumption in 2019, 335.5m bpd was sourced from domestic refiners and the remaining 508.4m bpd was imported. However, the government has announced plans to upgrade the country’s six existing refineries and construct a new downstream facility at Dos Bocas, in the southern state of Tabasco.

The Dos Bocas project was launched in response to growing reliance on US gas imports. In September 2019 Mexico’s natural gas pipeline imports from the US reached a record high of 5.8bn cu feet per day, highlighting the need for new capacity to come on-line. According to local media, construction of the 340,000-bpd refinery commenced in mid 2019 and is expected to cost MXN150bn ($7.8bn). However, in May 2019 the government failed to award a project management contract, as none of the interested companies could commit to building the facility before 2022 and for less than $8bn. As a result, construction will be undertaken by Pemex under the supervision of SENER. When completed, the refinery would be able to supply central Mexico and the Pacific coast via a new 35-km pipeline. However, financing the new refinery and the planned upgrades to existing infrastructure is likely to be challenging for Pemex due to the company’s rising debt loads and falling production levels. As a result, the government has promised to pay for the upgrade programme using fiscal revenues.

Electricity 

Mexico’s utilities sector has also evolved alongside the country’s structural reforms. According to SENER, in 2018 Mexico produced 317 GWh of power, up by 2.5% compared to the previous year. Demand for electricity is projected to grow by between 2.8% and 3.6% per year in the medium term. According to the Mexican Association of Solar Energy (Asociación Mexicana de Energía Solar, ASOLMEX), demand grew by around 3% per year between 2013 and 2018, as a result of economic growth and population growth. The manufacturing sector is also a significant driver of demand. The electricity industry grew by 1.2% year-on-year in the second quarter of 2019 and 1.6% on the previous quarter. In order for the government to reach its targeted annual growth of 4.5%, outdated infrastructure needs to be modernised and expanded to support the rising demand. President López Obrador has also placed increased emphasis on the use of renewables such as solar and hydroelectric power.

However, in March 2019 electricity sales to the CFE were cancelled as part of AMLO’s plans to reduce the involvement of private firms in the power generation segment and give more power to the CFE. Nevertheless, sector players seem confident that opportunities remain in the wholesale market, particularly as demand for electricity continues to rise, driving companies to develop more competitive technology. “As customers demand more efficient equipment, power generators have become more sophisticated in recent years,” Bulmaro Rojas, CEO of power generator supplier Generac, told OBG. “While there is still a focus on gas, both the US and Mexico are moving towards using biofuels in the long term.”

Although the government’s decision to cease future power auctions was intended to reduce the share of private operators, some industry stakeholders have noted that investment remains concentrated in the private segment. “Investment funds are seeking to invest in the development of private power generation projects, with the ultimate goal to operate under a power purchase agreement framework in order to supply energy to big companies,” Nicolás Méndez, CEO of solar generation company Solar AE, told OBG. “The focus has shifted from public auctions to the private segment, and this is expected to bring more stability to the sector during the government’s six-year term.”

Renewables

Mexico has invested heavily in clean energy in recent years. In 2017 renewables made up around 21% of Mexico’s power generation matrix, and the government aims to increase this to 35% by 2024 and 40% by 2035. Between 2017 and 2031, 63% of the proposed 55.8-GW capacity to be added to Mexico’s grid is expected to come from clean energy sources. Of this total, wind is expected to account for 24%, solar for 14%, geothermal and biothermal for a combined 5%, and hydropower for 3%.

Mexico has a geographic advantage for solar and wind energy, making it an attractive location for investment in renewables. Funding for solar projects is projected to reach $8.5bn in 2019, up 34% compared to $6.3bn in the previous year. However, the change in government has caused some uncertainty among investors. In 2019 AMLO cancelled future clean energy auctions until further notice, meaning that there are no planned projects in the tender stage. Nevertheless, the new government has promised to respect pre-existing contracts, as well as upgrade the country’s hydroelectric park. According to ASOLMEX, investment will most likely continue to flow into the renewables segment despite the cancellation of future auctions, as private buyers continue to negotiate directly with private solar and wind developers on the country’s wholesale market.

Transmission 

Transmission lines are overburdened and in need of renovation in order to develop a comprehensive transmission network. Tenders for two large-scale projects were cancelled in 2019, but the government has not shelved all plans to establish clean transmission lines. Although investors should be wary of infrastructure limitations when investing in renewables. However, it is possible that the infrastructure problem will push the development of renewables, particularly solar power.

“There are some issues of saturation in transmission,” Israel Hurtado, president of ASOLMEX, told OBG. “This can cause power outages, particularly in the south of the country where infrastructure is the most limited. This is compounded by a deficit in natural gas supply, but it creates an opportunity for the development of solar energy.” According to Deloitte México, as of 2019 there were 18 ongoing projects to build new transmission lines and six programmes in place to upgrade the existing network.

Outlook

Mexico’s energy and utilities sector has benefitted from increased openness and competition brought about by the 2013 energy reform. Although recent policy changes have sought to limit the involvement of foreign and private firms, there are still significant opportunities for investment, particularly as Pemex struggles to reduce its debt. Although political risk and uncertainty about working with the state-owned company are likely to deter investors, private firms are still expected to play an important role in assisting smaller local providers.

As demand continues to rise, investment in upstream projects is aiming to solve the problem of dwindling crude oil and natural gas resources and ensure the country possesses enough resources for the future. In addition, despite the new government cancelling clean energy auctions, private developments and deals in the renewables segment are still moving forward, with projects to expand the production of solar energy under way. Meanwhile, foreign investors continue to express interest in offshore projects in the Gulf of Mexico, as well as the government’s plans to modernise its six existing oil refineries and improve outdated infrastructure. If these plans are successful, Mexico will be able to boost its energy connectivity, which will support efforts to reduce its reliance on US imports.

Nevertheless, following the change of government in 2018, multiple cancellations of tenders and auctions have caused uncertainty among investors. Despite this, the new administration has not cancelled any existing contracts and has pledged to review policy before deciding whether to hold upstream auctions or tender new clean energy projects. In the meantime, the stable regulatory framework continues to provide security for investors.

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The Report: Mexico 2019

Energy & Utilities chapter from The Report: Mexico 2019

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