Second unitization process in Mexican shallow waters sparks concern

Mexico City — A second unitization process in the Mexican shallow-water Gulf of Mexico between a private company and state Pemex is sparking concerns that Mexican federal regulators could use a gray area in the law to grant control of upstream resources to Pemex, potentially delaying first oil, as the company lacks the resources to take on new projects.

Mexico has instructed Hokchi Energy, a Mexico-based company controlled by BP and Argentina's Grupo Bridas, to begin the process of unitizing its Hokchi shallow-water block with Pemex's Itta Block, according to a document sent by the Energy Secretariat and seen by S&P Global Platts.

Designed under the open market principles of the previous administration of President Enrique Pena, the unitization process requires parties to select an operator and come up with a development plan.Sources say that if Pemex and Hokchi come to an agreement on how to exploit the reservoir, then regulators will simply approve the agreement and instruct the companies to start operations.

In an ideal world, Pemex and Hokchi would reach an agreement, designating an operator, and submit their plan to the National Hydrocarbons Commission, the Energy Secretariat and the Treasury for approval, said Fausto Alvarez, a Mexico-based consultant who headed the technical unit for E&P contracts and leases at the commission, or CNH, in the Pena administration.

Hokchi is a 25 square-mile block located inside a 691-mile area operated by Pemex. Hokchi Energy has so far drilled six wells. In 2016, it drilled the exploration well Hokchi-2 and in 2017 it drilled five more delimiting wells, CNH data shows. The company started production in May 2020. In July, Hokchi Energy produced 1,559 b/d.

Itta is an oil discovery made by Pemex in July 2019 located less than a mile away from Hokchi. Itta has roughly 29 million barrels of oil equivalent in prospective resources, while Hokchi has over 150 million boe and 46 MMcf of natural gas, according to CNH data.

SENER could choose operator

If Pemex and Hokchi fail to reach an agreement on any of the terms, the Energy Secretariat, or SENER, could select Pemex as the operator, and does not have to support its decision under technical or financial merits, sources said.

According to the guidelines that rule the unitization process, when the parties fail to reach an agreement, SENER has one year to select the operator. However, the law does not set the criteria to choose the operator, making it subject to interpretation.

SENER can also determine the many terms and conditions under which the unitization process will take place, Alvarez said.

The announcement for the unitization comes at a time when criticism is mounting that Pemex might have too many areas to operate and too little resources to do it efficiently.

In 2013, Pemex was allowed to keep 80% of the country´s reserves and 20% of the prospective resources during the so-called Round Zero. In 2017, SENER found PEMEX had not complied with the minimum works required by law to exploit those reserves, but granted the company a two-year extension period, to the dismay of many participants. In 2019 Pemex received a second extension.

So far this year, a divided CNH has approved exploration plans from Pemex for those blocks that show the company is only doing the minimum amount of work allowed by law, as the company lacks financial resources. Two of the five commissioners have voted against the approvals, expressing concern that Pemex has too much on its plate and that those resources would be better exploited by another company.

According to the law, if SENER choses Pemex as the operator of the unitized resources, Pemex would be allowed one year to prepare a development plan.

Hokchi's $2.5 billion development plan for its block was approved in April 2018, CNH data shows. Hokchi Energy was the first private company to submit its development plan for approval. Hokchi started production in May, and in July, the company produced 1,559 b/d.

Zama

Regardless of who is the operator, each company will get the barrels of crude that are in its block, no more no less, said Marco Cota, CEO of Mexico-based consultancy Talanza Energy, who headed the exploration and extraction unit at SENER during the Pena administration.

But granting Pemex control of Hokchi could delay the extraction of the resources. The issue in the unitization process is that the decision to name the operator should consider who has the biggest operating and financial advantage; whoever can extract more barrels, Cota said.

"Crude extraction has an economic limit, defined by a company´s costs; whoever has the smallest costs will be more successful at getting more barrels," he said, adding that Pemex technical capabilities are not in question, but the company's finances are. Pemex held a total financial debt of over $100 billion at the end of 2019 and has reported losses of over $24 billion in the first semester of 2020.

Pemex and Hokchi did not respond to requests for comment. SENER declined to comment.

The speculation will continue, as the process is lengthy, Cota said, adding that the same process is happening at Zama.

Zama is a 1 billion-barrel well discovered by Houston-based Talos Energy, which borders a Pemex field and which has started the unitization process with another Pemex block under SENER's instruction. Both Talos and Pemex have expressed interests in operating the field.

These and other moves by the Lopez Obrador administration have dampened the interest in the Mexican energy sector among international investors, which is not helpful considering the state oil company is in deep financial trouble, said Omotunde Lawal, head of emerging markets corporate debt at Barings in London.

Lawal said international investors are aware that Pemex is "chronically broke," but said there is money available if the government decides to use its "sovereign wallet" to save it. She added that if the government decided to bring in foreign capital to the sector again there is also appetite, but for that the country would need to create the framework for people to participate.

"You can bring capital or do it all on your own, but you can´t have both," she said.

In the second quarter, Pemex reported a net financial debt of over $100 billion.