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MEXICO CITY (Reuters) - Mexico's commitment to opening up its oil industry to private investment faces a key test with the next round of contracts to be offered by state-run monopoly Pemex.
Mexico is the world's No. 7 oil producer but production has fallen sharply in recent years. In a bid to shake up an industry under state control since 1938, the government has allowed private companies to operate -- but not own -- seven oil fields scattered around the country.
The experiment stumbled when Pemex PEMX.UL failed to award two offshore oil fields to private operators in June auctions, rejecting all bids for one field as too expensive and receiving no bids at all for another.
Those failures have cast a shadow over the upcoming third round of private service contracts set for next month, designed to lure much-needed private investment and spur production in the massive Chicontepec basin, home to Mexico's largest certified hydrocarbon reserve.
Proven reserves at Chicontepec totaled 650 million barrels as of the beginning of this year, according to Pemex data.
"A lot of Pemex's future depends on this type of incentivized contract," said Luis Labardini, partner with Mexico City-based energy consultancy Marcos and Associates. "If Pemex proves that these contracts are successful, it can prove that it can be the only operator in Mexico."
Foreign interest in Mexico's oil patch, long seen as a mature region with limited potential, has expanded in the past two years as drillers reckon that it could become the next player in the shale energy boom, with untapped reserves along its U.S. border.
Mexico's incoming president, Enrique Pena Nieto, has ambitious plans to open the energy sector even further to private investment, but the problems with the recent auctions have led analysts to question Pemex's commitment to private-public partnerships, let alone their expansion.
Under the private contracting scheme, launched last August after reforms passed by Mexico's Congress in 2008, companies win the right to extract oil from mature fields and are paid a set fee per barrel as an incentive, but the crude belongs to Pemex.
The scheme was designed to lure both domestic and foreign private investment.
Mexico's overall production remains stuck at 2.5 million barrels per day (bpd) and if Pemex cannot find new discoveries to replace a 25 percent drop in production since 2004, it risks becoming a net importer of crude within a decade.
At the June 19 auction, Pemex said it was prepared to pay a maximum $7.25 per barrel for oil from the Arenque oil field, in shallow waters off the northern state of Tamaulipas and including 100 million barrels of proven, probable and possible (3P) reserves. Pemex's trademark Maya crude sells for $100 or more per barrel.
But it found no bidders at or even near that price of $7.25 per barrel and the auction was declared null. At the same time, the smaller Atun field, off the coast of Veracruz, attracted no bidders at all.
"I really don't know what Pemex was thinking," said Luis Puig, commercial director for Saipem, one of the oil service firms that bid on Arenque.
Puig and others noted the maximum bid price set for Arenque was about 20 percent lower than the prices set for four onshore blocks that were successfully auctioned at the same time.
"Offshore fields require a lot more investment" and should have triggered a higher bid ceiling from Pemex, Puig said.
The scheme is designed to increase production at a set of mostly aging onshore and offshore oil fields, where many if not most of the wells Pemex drilled in the past are no longer functioning.
At Arenque, for example, 51 wells have been drilled, but only 17 are currently operating and they produce just 5,600 barrels per day (bpd). The block's other wells are either shut-in, or plugged and abandoned.
Pemex has said it will directly award the Arenque block later this month, adjusting both its size and price tag, but no further details have been announced.
Pemex brushed off the recent wobbles, saying companies were turned off by the risk associated with the two offshore blocks as well as questions over the size and profitability of the fields, although it acknowledged bidders saw the contract for Arenque as under-priced.
In July, Pemex CEO Juan Jose Suarez Coppel said the company is tweaking the process to make the contracts more attractive. "We are working to clarify the risks," he said.
Carlos Morales, Pemex's director of exploration and production, told Reuters the company faces a delicate balance when it calculates the prices it is willing to pay firms to develop oil fields as part of the contracting scheme.
"We can't leave money on the table," he said. "We also can't set very low prices... because we may be left without any offers, just like what happened with Arenque."
Morales adds that developing deposits offshore is not always more costly than onshore, depending on the type of crude, the permeability of the rock, and amount of reserves.
Still, Pemex can count on added scrutiny over its upcoming third round of contracts. Morales says the oil fields up for grabs will be tendered sometime in September. Pemex's June auction, however, was originally planned several months earlier.
Morales says the third round of contracts will cover six blocks, each around 200 square km in size, within the onshore Chicontepec basin, home to 40 percent of Mexico's crude reserves.
The specific design of the blocks in the geologically complicated basin, the amount of investment needed, and the corresponding bid prices have not yet been set.
Miriam Grunstein, an energy researcher with Mexico's CIDE institute, says the failure to auction off Arenque calls into question Pemex's very commitment to expanded private sector involvement.
"The next government may want an opening," said Grunstein, "but Pemex loves being a monopoly."
Whether or not broader energy reform is achieved by Pena Nieto, the existing private contracting model represents a limited tool reserved for low-risk fields that already tout significant output, according to John Padilla, oil analyst with energy consulting firm IPD Latin America.
"Anything that's more complicated than plain vanilla mature fields is going to be very difficult under the current version of the model," he said.
He adds that applying the contracting model to Chicontepec or even riskier deep water deposits in the Gulf of Mexico is out of reach for lack of sufficient existing production to offset the large infrastructure investment needed to tap more crude.
The entire Chicontepec basin currently produces on average about 70,000 bpd and is struggling to boost output to the 100,000 bpd Pemex is aiming for by the end of this year. Company executives have said production could reach 300,000 bpd by 2018, aided by additional investment and technological expertise from private contractors.
But the contractors' ability to significantly boost output at Chicontepec will depend on the incentives Pemex offers.
"Anything that is going to require a lot of up-front capital expenditures that then have to be recovered over time, as will be the case with deepwater and other more complicated assets, just isn't going to fly at the maximum fee per barrel levels Pemex has included in the two bid rounds to date," said Padilla.
Constitutional reforms supported by Pena Nieto - among others, allowing partial foreign ownership of reserves - would entice additional private investment to develop energy riches, but would also upset many who view Pemex as a near-sacred symbol of Mexican independence.
At present, the private service contracts represent the only ongoing option capable of significantly boosting investment.
But lately, the model seems better at generating criticism from analysts like CIDE's Grunstein.
"If the model is not functional for mature fields (like Arenque), forget Chicontepec or deep waters," she said.
Reporting by David Alire Garcia; Editing by Kieran Murray and Sofina Mirza-Reid