Jorge Castilla, Partner, Deloitte Mexico
Jorge Castilla, a Deloitte Mexico partner, gives his insight into the many economic and social issues that make operating Mexico’s downstream industry so complex and difficult, and what Deloitte Mexico must do to stay atop of the ever-growing industry competition.
Over the past decade, Pemex has struggled with decreasing reserves and crude oil production levels—down from a peak of 3.5 mbpd in 2005 to 2.6 mbpd at the end of 2012. Given your expertise in the field, how have you seen the E&P landscape evolve in Mexico?
Going beyond the declining oil output figures, it is often overlooked that Pemex was traditionally accustomed to having a fantastic situation from a production point of view. In terms of cumulative production to date, the Cantarell field is by far the largest oil field in Mexico, and one of the largest in the world that enjoyed great access and stellar productivity. In the past, a vast majority of invested capital was channeled into additional production in order to increase overall output, whereas few resources were dedicated to exploration activities. This is understandable considering Pemex’s role as a state-owned company, helping to generate in excess of 30 percent of the government’s revenues.
However, when Cantarell’s output began to decline more rapidly than anticipated, Pemex in turn needed to grow into a more typical oil and gas operator. Pemex had to mold itself into an oil company that maintains exploration activities in more challenging geologies and incurs generally higher extraction costs: an unfamiliar territory for one of the world’s largest oil companies. This accelerated decline in production and the general change in business and operational practices saw Pemex undergo some turbulent times over the past few years. Nevertheless, I genuinely believe that the company has finally begun to stabilize and make the right investments in exploration and production. In fact, when former President Felipe Calderón served in office, exploration based investments were so good that they actually achieved a one-to-one rate of production to reserves. Although this was often overlooked, this was a superb initiative.
On the other hand, expanding Pemex’s overall production will certainly remain a key challenge as they attempt to arrest the output decline. In any case, I believe Pemex have done an outstanding job of addressing a highly complex problem and I am optimistic about their future.
With respect to gas, although there have undoubtedly been a number of good discoveries, how have investment shortfalls affected their full exploitation?
Concurrently, the shale gas revolution that began in the US also lead to some significant discoveries of the unconventional resource and industry leaders in Mexico are currently debating how best to proceed. Considering that the imminent energy reforms in Mexico are intended to tackle these challenges and the envelopment of so many stakeholders in the matter makes for a highly complex issue. Few people truly appreciate the vast amounts of investments needed to overcome these challenges and the risks that accompany them. Fundamentally, the issues facing Mexico’s oil and gas industry are technical in nature. Instead of being treated as such, these issues are quickly treated as political instead.
Adding to this complexity is the larger issue of the shale revolution in the US and its implications for Mexico. In my opinion, the driver of change in Mexico’s energy framework is the US’s current positioning as a main export market of Mexican production. Over the next decade, it is expected that our northern neighbors will become a net importer of hydrocarbons while increasing the relative importance of gas to oil as a fuel. Gas is forecasted to play an increasingly important role in the future and the investments flowing into the US will only accelerate its production. Although these are only expectations, Mexico cannot afford to sit idle and lose its positioning in the global energy map. This is especially true once you consider other global energy players such as China.
Another important and welcomed industry development was the introduction of incentivized contracts over the recent past. Although it might not have been the solution to all problems, it was a good and necessary first step towards opening up Mexico’s oil and gas monopoly and to give an idea of what could be achieved. This saw the likes of Petrofac, Schlumberger and Halliburton to participate in Mexico’s hydrocarbons industry. However, it should be noted that these international players participated in Mexico’s more mature, and less risky, fields where experts such as themselves can do what they do best. By contrast, fields such as Chicontepec in the northeast of Mexico City still present significant development challenges which continue to restrict their full exploitation. The same applies to the prospective deepwater fields, which will also represent a set of new challenges.
Pemex has lost a cumulative $29 billion dollars in the last five years until 2012, despite a small profit margin last year. Economists suggest that despite the fat E&P profit margins, Mexico’s refining systems costs the company a fortune every year and cancels profits. What are the underlying causes for this and how can it be reversed?
On a global scale, investments across the oil and gas value chain have primarily been concentrated in the upstream segment and are supported by high crude prices. Only a few players are making investments in refining, such as in China and the Middle East. This investment shortfall in the downstream is generally a result of global over capacity, tight margins and a shift into gas-to-liquids plays. Given this reality, integrated oil companies like Pemex will tend to invest in the E&P side.
Closer to home, Pemex is also characterized by refining costs that are well above international standards. Perhaps even more importantly, Pemex must also contend with the contagion of fuel theft and organized crime in Mexico. By no means is this a negligible issue costing Pemex and the industry billions on a yearly basis.
In aggregate, increasing costs, aging assets, a complex labor environment (and a general slump in the downstream market), all come together to create a difficult and volatile operating environment for Mexico’s downstream industry. There are certainly solutions to these challenges but the fact of the matter is that they require significant resources and commitments.
This week saw the passing of the political reforms that boosted hopes for a definitive energy reform to follow soon after. It has been said that what Mexico really needs is budgetary autonomy and flexibility to form joint ventures. What is your view on this?
Broadly speaking, the National Action Party (PAN) has been working towards introducing a framework for production sharing agreements (PSA’s). Such contracts have two key characteristics. First, they allow prospective partners to book reserves. This is crucial if Pemex intends to partner with publicly traded integrated oil companies (IOC) and share the development risks. In effect, this would dramatically raise investment priorities in the industry. The fact of the matter is that not all IOC’s are lined up impatiently monitoring the progress with the reforms. They have professionally managed investment portfolios and will only invest in proportion to the given market environment.
Hence, Mexico really needs to consider who it wants to target as its long-term partners and accordingly create an attractive regulatory environment to suit. For instance, if Pemex wishes to attract significant investments from the IOC’s, they must allow them to book reserves, share production and pursue more aggressive opportunities.
On the other hand, President Peña Nieto’s ruling Institutional Revolutionary Party (PRI) is promoting the implementation of margin-sharing contracts, which do not permit the booking of reserves for international partners. Such contracts are perhaps best suited to attract interest from national oil companies (NOC’s) but whether or not they possess the technology necessary to develop Mexico’s more challenging resources is debatable. Similarly, these contracts could also attract the attention of smaller private investors who will have a less than optimal risk appetite leading to slower overall growth.
What is the strategic importance of Deloitte’s Mexican presence relative to the firm’s global strategy? How is Deloitte positioned to capitalize on this forecasted growth?
One great aspect of Deloitte is that it is a globally minded firm, with a local focus. This is important because it allows us to focus on our local market and this is as true in Mexico as anywhere else. Being a global company, we naturally seek to take advantage of our international network, but our primary focus remains to be Mexico. In turn, this allows us to understand the industries we serve as they truly are.
In light of the imminent energy reforms, we have made the strategic decision to focus on the oil and gas sector in Mexico. Through our tailored services, we aim to support our clients throughout the sweeping transformations across various industries and help them develop and grow. To this end, we are continuing to invest in developing our energy services portfolio. Our energy practice is spearheaded by a group of six partners; a relatively large number that reflects our commitment to the industry. In addition to this, we have also established a joint venture with our US affiliate in order to cross-pollinate our in-house knowledge and expertise. Given the global nature of the energy industry, this is of particular importance since the developments in the US are quite relevant to Mexico, and vice versa.
Moreover, it is no secret that reforms have sparked much interest from investors looking to seize the opportunities present here. Being well versed in the local energy sector, Deloitte also serves as an excellent facilitator. We can help investors positioning themselves in Mexico and make the right connections.
In a crowded marketplace, how does Deloitte set itself apart from the competition?
It is all about insight. Given our rich history, we have accumulated a wealth of experiences and, perhaps more importantly, we can combine those with the comprehensive knowledge of the sectors we serve in Mexico, by Mexicans. Having local professionals on our team is important because a Mexican can better understand Pemex than others would. As far-fetched as that may seem, Pemex is after all a source of national pride for Mexicans.
Having firmly established ourselves in the market after six years of dedicated services to the energy sector and significant investments, we are well positioned to take our clients further and guide them through Mexico’s historic transformation. Although everyone can have great ideas, the devil is in the execution. Oil and gas companies in Mexico find themselves in a highly complex environment and the effective execution of strategies is critical. The saying ‘culture eats strategy for breakfast’ summarizes this point well for Mexico.
Looking ahead, how would you like Deloitte to be perceived by Mexico?
Deloitte employs a large number of young professionals that expect something different. They expect an exciting workplace that serves as a platform for fast-track career development. In this regard, we need to focus on making perpetuating this characteristic since our key asset is our people. I personally believe that working at Deloitte must be, and is, a special experience.
To read more interviews and articles on Mexico, and to download the latest free report on the country, click here.