Schlumberger and Halliburton Can Benefit As Mexico Overhauls Its Energy Sector

Mexico recently passed new laws to overhaul its energy sector, allowing foreign and private companies to participate in the Mexican oil, gas and electricity industries. The move also ends a seven-decade long monopoly that Petroleos Mexicanos (Pemex), the country’s national oil company, has had over the oil and gas space and should allow the country to attract greater investment into an oil industry that has seen its production decline for close to a decade. While U.S. oilfield services firms such as Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB) have already been doing work in Mexico for Pemex, we believe that the reforms could enhance their activity levels in the country as large international oil companies begin to participate, particularly in underserved (and lucrative) areas such as deepwater and unconventionals.

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Pemex’s Declining Production And Proven Reserves

Mexico holds roughly 13.5 billion barrels of proven oil reserves and is among the ten largest oil producers in the world. Pemex has largely produced oil from easy-to-access sources located in shallow waters and onshore areas that are relatively simple to drill. However, most of Mexico’s largest oilfields such as the Cantarell field are currently in their mature stages and the country’s total oil production has been on the decline since 2004. While Mexico is still able to meet its domestic oil demand, oil exports, which are a significant component of the country’s exports (13% of export earnings in 2013), have been trending lower. ^[1] Moreover, growth in the country’s manufacturing sector has also been constrained by very high electricity rates and lack of natural gas. Pemex has been unable to boost exploration and production into new frontiers since it has lacked the technology and the ability to garner required investments to beef up its exploration program. This caused the country’s proven oil reserves to decline by roughly 3% last year, as new discoveries were not even able to keep pace with the falling production levels. ^[2] The energy reforms could bring in much needed capital and expertise to reverse the declining production and proven reserves trend.

While private companies have been participating in Mexico’s oil and gas industry, they have primarily been subcontractors to  Pemex, performing services for a fixed fee or through incentivized contracts. Now, as the reforms come into effect , oil and gas companies would be allowed to book a percentage of reserves on their balance sheet and operate on a profit and risk-sharing model, allowing them a greater upside and better exposure to the Mexican oil industry. Although the legislative process is through, implementation will be key. The oil industry in Mexico has a legacy of corruption, with contracts often subject to favoritism, kickbacks and insider deals. ^[3] While the new law creates a national oil commission that would be responsible for contracting decisions, it will remain to be seen whether the government is able to design contracts that are attractive to international oil companies and manage these contracts in a clear and transparent manner.

Unconventional Plays And Deepwater Are Two Key Areas To Watch

Under the new law, Pemex will have priority over other oil and gas companies, with the ability to choose the projects that it wants to keep. In an initial proposal that the company had filed earlier this year, it wanted to maintain roughly 83% of Mexico’s proven and probable hydrocarbon reserves and around 30% of the country’s potential oil and gas resources. ^[4] It seems likely that it will keep its core assets that it has the know-how to develop, while potentially leaving more complex areas for private players. While specific details on the projects that Pemex will keep and the blocks that will be opened up for private players is likely to be decided this week, we think its likely that unconventional and deepwater exploration will be two areas of interest for private and international players.

In the deepwater space, the Mexican portion of the Gulf of Mexico is likely to be an area of interest. Unlike the U.S. Gulf of Mexico, Mexico’s acreage is largely underdeveloped. According to Pemex, with proper investments, exploring these deepwater reserves could add as much as 27 billion barrels, effectively tripling the country’s proven oil reserves. Schlumberger has been making a big push into deepwater and subsea technologies and could see greater demand as more activity is undertaken in the Mexican portion of the Gulf of Mexico. Mexico is also facing a severe shortage of natural gas and has had to increase imports of costly liquefied natural gas (LNG) of late. Although Mexico has the fourth largest shale gas reserves in the world, its progress in tapping into unconventional gas reserves has been slow, with Pemex having drilled only a handful of shale wells till date.  Halliburton – a leader in unconventional plays and pressure pumping – could see greater demand for its services as private players deploy more risk capital into unconventional projects in Mexico.

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1. Mexico Country Analysis, U.S. EIA [↩]
2. Mexico’s proven oil and gas reserves fall 3 pct in 2013, Reuters, April 2014 [↩]
3. Mexico Opens Gas, Oil to Foreign, Private Firms, ABC News , August 2014 [↩]
4. Mexico to Decide on Details of Oil Sector Privatization, WSJ, August 2014 [↩]