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Comisión

Nacional de Hidrocarburos (CNH) – Edgar Rangel German, Commissioner – Mexico

12.08.2014 / Energyboardroom

A leading commissioner from Mexico’s upstream hydrocarbon’s regulator outlines how the institution’s mandate has evolved and introduces the country’s new regulatory apparatus for the oil and gas sector. He also speaks in detail about Pemex’s Round Zero request and the different mechanisms in place to objectively determine a fair allocation of hydrocarbon assets for the national oil champion.

 

Can you please introduce your specific role as commissioner? And what has been keeping you busy over the past weeks and months?

The CNH was created during the first, relatively mild reform of the Calderon administration. My background is as a petroleum engineer and I was actually part of the original team within the Finance Ministry (SHCP) that helped draft that earlier reform. I have also worked for both Pemex and the Ministry of Energy (SENER) where I was advisor to the Undersecretary for Hydrocarbons and had a hand in drawing up proposals not unlike those currently being presented to Congress. I am therefore one of the few people to have a first-hand perspective inside each of the main actors that have been charged with enacting and overseeing today’s much more profound reform. On inception of the CNH in 2008, I was appointed Commissioner and therefore have also had the chance to witness the evolution of this institution.

The bulk of our time has been taken up with Round Zero commitments alongside our day-to-day functions such as working on the resolution of the 2P and 3P reserves. For Round Zero and Round 1 we have been called upon to advise SENER on Pemex’s request and to ascertain what proportion of hydrocarbon assets the NOC should be allowed to retain in view of its technical, financial and executional capacities. These are very difficult decisions so we have been careful to come up with numerical models to objectively and quantitatively determine the metrics using data that Pemex itself has been compiling and feeding to us. We will also be assisting SENER in the selection of lots for the various bidding rounds and advising on the appropriateness of model contract types for each category of field. SENER will announce Round 1 shortly and we are working hard on it.

How will CNH’s own mandate evolve? And where exactly does the CNH fit within the new constellation of regulatory and supervisory authorities being created?

Originally the CNH was little more than a technical advisory office to SENER, however the organization has matured a lot since then and now we have become the keystone in the reform process.  We continue to assist SENER in the definition of policy and also will be supporting SHCP from a technical and scientific standpoint as it defines the fiscal conditions for each field. The biggest change to our remit, however, is that we have been made responsible for overseeing the running of the bidding rounds and the administration, award and supervision of the contracts. In short, we have now assumed the full functions and attributes of a regulator. In the past, many people used to confuse us with thenational human rights commission because of our acronym. In the post-reform period everyone will surely know who we are.

Obviously we have to prepare ourselves to be ready to take on these additional functions and that means boosting our workforce by recruiting additional geoscientists and engineers such as geologists, sedimentologists and petro-physicists and reservoir engineers. We currently have 80 full time staff members and that should rise to 120 by the end of the year. Just to put that into perspective, Brazil’s regulator, theAgência Nacional do Petróleo (ANP), has over 1,500 full time personnel. Nevertheless we will be finding alternative ways to enhance our capacity such as outsourcing capabilities that we don’t require all the time such as the services of data room specialists. Meanwhile we enjoy good relations with other regulators around the world via the International Upstream Forum (IUF) and International Regulators Forum (IRF) and are continuing to share experiences and pool ideas about how to optimize what we do.

How will the regulatory apparatus work in practice? As you have mentioned, responsibility for the bidding for oil and gas contracts will be shared across a range of different Ministries and other entities including CNH. Is there not a risk of duplication, overlapping functions and ultimately bureaucratic gridlock?

Having worked at Pemex, SENER, the SHCP and the Commission, you could say that I am familiar with all sides of the dice. It is true that this looks all very bureaucratic and complicated from the outside, but it is actually based on international best practices. Certain features of the new process are actually derived from the example of the Norwegian Petroleum Directorate (NPD) which is renowned for being one of the most efficient and fair regulators worldwide. What’s more, the newly enacted Regulatory Entities Law actually mandates the setting up of a special council to coordinate how the different regulatory components work together to ensure that everything functions smoothly and that the lines of responsibility are clearly demarcated.

It is vitally important to have these sorts of checks and balances in place so as to send a clear message to international investor community that Mexico is a stable and reliable country where the rule of law is applied impartially and where bidding for hydrocarbon assets will be conducted in an open, transparent and fair manner.

The one area where I do foresee potential teething problems, however, is with the setting up of a brand new National Agency of Industrial Safety and Environmental Protection. My concern would be that this could become a bottleneck as has happened in other countries such as Canada where development of unconventional resources virtually stopped due to concerns on the part of an overly powerful environmental agency.

What’s your assessment of Pemex’s Round Zero request? Has the NOC requested too much? There is surely a precedent for this with Brazil’s Petrobras finding it had to relinquish 80 percent of what it originally asked for within 2 years.

My personal forecast is that Pemex will, in aggregate terms, be awarded a portion very similar to what they have requested – that is close to 30 percent of prospective resources and close to 80 percent of 2P reserves. Where there will likely be changes is in the composition of each category, because it seems to me that they have relinquished some very good producing fields that they should, in theory at least, be well equipped to operate.

The Brazilian case is actually quite unique because, when Petrobras underwent their equivalent of Pemex’s Round Zero, the Brazilian NOC was able to factor in loans and potential credit lines into their financial capabilities when submitting their request. In the end, much of that financing was not forthcoming and they had to relinquish 80 percent of the assets that had originally been awarded. Making comparisons with other Latin American case studies is useful to a point, but also has its limitations because each context is unique.

When Brazil reformed its energy sector, the country had comparatively little proven reserves, but huge prospective resources. It therefore made sense that Petrobras should be allowed to keep the vast majority of the reserves because the government could be fairly certain that there was a much larger quantity of hydrocarbons out there that the private sector could discover and put into production.Colombia, in contrast, does not enjoy a very prolific geological basin and possesses comparatively few reserves and prospective resources. In that case it made sense to award their NOC, Ecopetrol, what it could practically produce and to open the rest to outside technology and investment. This was a complete success and they reached the one million barrels per day mark.

How about Mexico’s context then?

Mexico’s context is different in that we possess both a large quantity of existing reserves and also substantial prospective resources albeit not as large as Brazil’s. Some of our potential hasn’t even been evaluated yet. Given our geology, it is highly likely we have considerable potential in the pre-salt and methane domains and none of this has yet been properly analyzed and explored. My point is that, given the sheer amount of real and potential hydrocarbons to be divided up, we have to be careful not to overstretch the Pemex share.Let’s be clear that this is not about taking away assets from Pemex. The assets have always belonged to the state. What has to be determined is the allocation and type of hydrocarbon assets that Pemex can reasonably put into production given its expertise and capabilities.

Pemex may be a major league player, but we still have to objectively determine where its key skill sets lie and devise an allocation of hydrocarbon assets that plays to the company’s strengths while at the same time permitting enough of a varied portfolio to enable future diversifications. Petrobras, for example is a recognized leader in deep-water and pre-salts, whereas Pemex has historically been second to none in the shallow water plays. This would suggest that Pemex should automatically be granted the vast majority of shallow water fields.

These are major decisions that, in many aspects, have political implications. IOCs, for example, will say that Pemex should stick to shallow water and vacate the more complex plays where they hold the real expertise. The NOC would, no doubt, disagree. In its recommendation tom SENER, how will CNH go about forming these decisions in an objective way?

We have established a systematic process for Round Zero involving several stages and this has been approved by SENER. First we deploy a technical filter based on qualitative metrics that calculatecapabilities based on how many geologists and rigs a company has at its disposal. Pemex might desire to explore the moon but it certainly doesn’t possess the capital, equipment, human resources and expertise to do that and this is revealed through the calculations. This gives us a quantitative grade indicator for technical capabilities.

The next filter is based on execution capability which is essentiallyhow long it takes a company to drill a well, to fracture it, and then to bring it to production. Again we evaluate this quantitatively using baselines and benchmarking against global norms. We are also performing the necessary economic analysis to identify the development and production cost for each type of field and are benchmarking that with equivalent fields across the world and assigning a grade. Sometimes it takes Pemex more than a year to drill a well and bring it to first oil and, when this scenario is compared against global norms, this falls well outside what could be considered best practice.

To give a real example, Pemex requested 50 percent of the Perdido fold which accounts for a large amount of resources. When we analyzed their capabilities, we calculated that they possess four drilling equipment semi-submersible platforms each of which on average drill 1.5 wells per year. That equates todrilling a maximum 6 wells per year. For an area of the size of Perdido that means it would take Pemex over a century to properly develop. Pemex may well have the technical capabilitiesto set a well, to complete the design and go down to the formation and also the requisite in-house expertise, but it is in the interest of the nation that those resources are developed much faster than that. Another example is Chicontepec which representsthe country’s single largest deposit. Pemex requested 60% of that asset but so far has only managed to develop under three percent of the reserves in place. Such sluggishness of production would again clearly not be in the interest of the nation. Pemex’s response, however, will be that they aim to acquire expertise in the more complex plays through farm-outs.

What is the process for Pemex farm-outs?

There will be a ‘vertical split’ which divides up the assets awarded to Pemex from those that will go into the bidding rounds. Then there will be a further ‘horizontal split’ applied to the Pemex assets which differentiates those areas that will be kept under exclusively for them from those that will be farmed-out. CNH will be responsible for establishing the rules to complete that migration from lease to farm-out, one Pemex decides which areas it wants to turn over to a partner.

What makes it so difficult to assign areas such as tight oils like Chicontepec or unconventionals is precisely this farm-out dimension. Is it ultimately better for the nation to place unconventional plays in the bidding rounds and have multiple players compete to make a success out of these difficult fields? Or is it more preferable to award such assets to Pemex and hope that they can identify a great partner so that the fields will be productive at the same time as the national champion acquires new expertise? These are tough questions and ultimately it falls to SENER to make an intelligent decision from a strategic policy perspective, rather than to CNH which is, after all, only the technical assessor.

What message would you like to send out to the international investor community on behalf of CNH?

The new chapter in Mexican oil and gas has just opened. We now have a wonderful opportunity to put Mexico as on the map as the fifth largest economy and to also place Pemex among the Statoils and Petrobrases in terms of market capital, reserves and hydrocarbon production. Join us and make this happen. It will be a great ride witnessing the transformation of our country.

 

To read more articles and interviews from Mexico, and to download the latest free report on the country, click here.

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