Oil Majors Balk At Mexican Offshore Proposals

The Mexican government has unveiled much-anticipated offers for offshore acreage in the Gulf of Mexico for oil exploration.

In this second phase of "Round One" auctions, Mexico is offering up nine production sharing contracts across five areas, holding an estimated 355 million barrels of oil combined. The Mexican government has anticipated very strong interest for this round as the fields are located in shallow water where state-owned oil firm Petroleos Mexicanos (Pemex) has already been actively drilling.

Even better, the fields that the government is putting up for bid include areas that already have oil reserves that have officially been discovered, and could be profitably produced at $20 per barrel. The government estimates that around 125,000 to 150,000 barrels of oil could be produced on a daily basis from the nine fields.

Despite what appears to be an attractive prize for the oil industry, several companies are balking at the terms offered by the Mexican government. Mexico offered 14 contracts in December 2014, and this second phase broadly follows the same terms offered then, to the chagrin of some oil majors.

BP's CEO Bob Dudley said the contract terms "need to be a little more competitive," according to Bloomberg. In less diplomatic language, the CEO of Occidental Petroleum, a Houston-based oil and gas firm, said that his company would prefer to focus on oil and gas in the U.S. rather than "fool around with some ridiculous contract" offered by Mexico.

The problem is that some of these companies say Mexico's terms include too many restrictions. For example, Mexico is seeking to require 25 percent local content for the first year of the contract. Requiring companies to use local materials and labor is a conventional strategy to build up the host nation's infrastructure and create employment. When done right, it can boost the local economy and can be a much better outcome. But oil companies don't like the restrictions because they potentially lead to higher costs. In Brazil, for example, strict local content mandates have raised the cost of some projects by as much as 50 percent.

Mexico's new contracts would also require winning companies to drill at least nine wells within the first two years. To even qualify for consideration, companies must have at least ten years of offshore drilling experience, and have already invested $1 billion across three projects.

Some of the most attractive acreage lies in the Perdido Fold Belt in the western Gulf of Mexico. The tracts are located relatively close to some existing operations in American waters. The Mexican government predicts that its plans to open up the country to drilling could attract more than $50 billion in investment over the next three years.

It remains to be seen what kind of interest the auction will receive, but Mexico has said it will award contracts to the winners in September 2015.

Despite releasing new proposed contracts for bidding, the government is looking to delay the auction of some other oil and gas regions eyed by the industry because of low oil prices. For example, some deepwater sections in the Gulf of Mexico, and onshore shale acreage could be pushed off until some later date.

Mexico is thought to be sitting on an abundance of shale oil and gas, especially in the northeastern part of the country, which lies just across the border from the Eagle Ford shale in South Texas. But, with a dearth of infrastructure and no shale industry presence on the ground yet, costs of development would be significantly higher than the shallow water tracts the government is putting up for bid this year. If Mexico auctioned off its shale acreage now, it could see much less interest than expected, a major political risk for President Enrique Pena Nieto, who has staked much of his legacy on energy reform.