Ernesto Marco, Founding Senior Partner, Marcos y Asociados, Mexico
“Regulation is the principle challenge. I am not principally concerned with the original laws governing the oil and gas sector, as everything has been laid out in the constitutional reform decree and that is clear. The challenge is executing the first steps of reform,” states Ernesto Marco, Founding Senior Partner of Marcos y Asociados, Mexico.
How will the on-going energy reforms alter Mexico’s geopolitical standing, both in the region and around the world?
Mexico has the opportunity to be the party that extracts the largest benefit from the North American energy revolution. The country shares the an abundance of resources, both conventional and non-conventional, and has an industrial base, which means the country is the largest exporter of manufactured products in Latin America; more than all the Latin American countries combined. There is no previous case in history of a country opening its energy sector as Mexico has, whilst having such a large industrial capacity. The opportunities to attract foreign direct investment at this moment are substantial.
This adds to Mexico’s competitiveness and contributes to the further industrialization of the country. Should the country be able to play the same role as we have with the US and Canada, in terms of the division of labor with regard to exports for the oil and gas industry, then Mexico can benefit substantially.
The price of oil and gas in North America is far different to the rest of the world. New opportunities for private investment are particularly valuable here. Post reform, in exploration and production with the new contractual forms, Pemex and new comers will be able to develop many new openings. Seismic in particular, is now no longer exclusively the responsibility of Pemex, translating into significant opportunities for seismic companies. The investments in this sector are especially mouth-watering.
Given your experience in business development, where do you think initial investments will be placed?
Investment has to target the downstream market early on. Historically, it has almost been considered heresy to refine in Mexico. Pemex’s refineries have not as yet had a feedstock that suits the technology installed in them, which is one reason they are so inefficient. These refineries have had to deal with whatever Pemex’s E&P services procure that was not exported straight away. In terms of imports, distribution and marketing of petroleum products, the investment required will be significant, and the opportunities available are enormous.
Simultaneously, licenses and development in the upstream sector will speed the transformative process of liberalization across the industry. In the long term, the most notable transformations will occur in the upstream sector. There will also be a great deal of investments in pipelines and terminals. Whilst there are many numbers thrown around, Marcos y Asociados have made some approximations. With regard to deepwater fields, we expect to see four projects take shape with an average cost of 6.5 billion dollars by the end of the decade. Mature fields too, will receive investment. I hope that some of these fields will be allocated to independent Mexican companies, allowing them to learn key E&P skills and expand their portfolio in that respect.
This is exactly the kind of initiative that Mexican Association of Oil Service Companies A.C. (AMESPAC) is promoting. Currently, I am president of this organization.
The average sum of private investment we estimate to enter Mexico each year on average in the upcoming years is around US $30 billion. This will add an estimated two percent to Mexico’s GDP by the end of the decade.
Given that the Mexican market is only recently liberalizing, there is limited experience in financing and capitalizing energy projects in Mexico. As one of the first movers in the country, how do you deal with this, and how long will it take Mexico to catch up and gain experience in this field?
This is a key challenge indeed and this situation is completely new for our firm. Private equity companies have gained valuable experience in financing oil and gas projects internationally, and can contribute significantly in this regard. To demonstrate the extent to which the environment will change, whilst I was at Pemex some twenty years ago, I undertook a project working with foreign investors such as the World Bank and the Export-Import Bank of the United States (Ex-Im Bank). I was accused of treason by some within Pemex because I had shown details of Mexican reserves to foreign engineers!
Due to this, there is limited experience in putting together finance packages for oil and gas exploration. Particularly in Mexican commercial banks, and indigenous private equity funds, there is scarce understanding of this issue. Marcos y Asociados has received around a dozen private equity funds looking to partner and advise in this field.
Given that new financial instruments are required to push forward this development, our business is working to persuade the Ministry of Finance to develop a public market instrument similar to FIBRAS, or as in the US, a Master Limited Partnership (MLP). This is an interesting financial tool that the US developed to invest in infrastructure supporting the extraction, production transportation and distribution of raw materials and other natural resources.
MLPs have the right structure that allows investors to have a direct interest in the infrastructure projects, as they are direct investors as limited partners. On a yearly basis the MLP also obligates around 95 percent of the income to be distributed to the shareholders of the asset, to ensure steady returns. MLPs are fiscally transparent, which means they are not taxed until the investors receive their return, a practice not currently extant in Mexico.
Public markets need vehicles that can invest in these large infrastructure projects.
With regard to financial markets, would a partial listing of Pemex help increase transparency and efficiency across the company’s operations, and therefore overall investor confidence?
This has been discussed, but has not been pursued as yet. At this phase, it would be difficult to undertake an IPO for Pemex as their finances are currently none marketable. They have a negative equity structure. At the moment, Pemex cannot account for the reserves they have discovered, as the owner is the Mexican state. The solution that has been adapted to this in the reform is that Mexico’s oil companies will be able to report the ‘economic interest’ from these reserves, though they are still owned by the Mexican nation. This means that Pemex will be able to include the economic interests in their balance sheets.
This means that Pemex will be able to capitalize on the reserves it has, to the tune of approximately 130 billion barrels of oil equivalent (boe). The economic interest in Pemex could be valued at over US $100 billion dollars. Ultimately, this will take five or six years, but at the end of this process Pemex ought to be ready for an IPO.
Considering all the changes in the industry at the moment, what is keeping your company anxiously on its toes, and what happens next for Mexico?
Regulation is the principle challenge. I am not principally concerned with the original laws governing the oil and gas sector, as everything has been laid out in the constitutional reform decree and that is clear. The challenge is executing the first steps of reform. For instance, with regard to the bidding process for exploration and production, the attractiveness of blocks auctioned will depend on three variables. Firstly, these include the terms and conditions of the contracts detailing the bids; international norms should be followed, and risk should not onerously weigh on the operator. The legal approach to conflict resolution and mediation between parties, should disagreement arise, needs to be clear.
Secondly, is the issue of the fiscal package, and how attractive it is to international investors. An initial draft, a proposal of how to finance these schemes was sent together with a piece of legislation named the Ley de ingresos sobre hydrocarburos (or hydrocarbons revenues law). This was written with the intention of revising Pemex’ tax arrangements, but could be applied more widely. However, this was rolled back.
Thirdly, are material considerations and whether there are hydrocarbons actually present in the blocks that are auctioned. There are many areas that are yet to be explored. These have the potential to be materially important, and there is a general confidence that further resources are present in unexplored areas. Given that Pemex has so far been the only company allowed to explore these areas, further exploration will provide a clearer impression of the prospectivity that can be derived from these areas.
These are the key factors influencing whether the contracts will properly promote exploration and production opportunities. To be clear, companies will not own reserves, or book them, but have exclusive economic access to reserves. The Mexican people will still own the resources.
In light of these exciting developments, what is your priority today, and how are you positioning yourself in the market?
Marcos y Asociados will have to prioritize in terms of business development, and work for clients who have the potential to engage with larger projects. There will be a renewal of activity in our financial practices, as at the moment we are strategizing on the most effective manner in which to structure financial plans for large projects. Given our expertise in the energy sector, we are determined to establish an early lead in this field.
Similarly, our firm is made up of seven partners that currently provide common services, but independently from one another. For us to take our organization to the next level, institutionalization is required. This should allow us to engage with project financing and investment banking.
What is needed to succeed in Mexico?
You have to bring your strengths, and international experience. Identifying opportunities that best fit your key competencies is the next step and will allow a speedy transition to success.