'Operators want to be exposed to market risk'

Mexican NOC Pemex's return to service contracts means that production sharing agreements and licensing agreements are off the table. But will operators accept the push toward lower risks and middling returns? Layla Vargas, a lawyer and specialist in the energy sector, sheds light on the matter.

BNamericas: What are currently the most important developments in Pemex contracting models?

Vargas: At the moment Pemex is promoting integral service contracts for the extraction and production of hydrocarbons. These are so-called incentivized contracts, meaning that companies are paid a quota depending on the amount of barrels extracted. In a presentation held by Pemex they say the rate paid is such that the greater the risk the higher the rate. So if you're going for prospective reserves your rate will be higher. This is how they want to create incentives for new service providers.

BNamericas: How new is this scheme?

Vargas: The first service contracts were the so-called multiple service contracts that were later called contracts for financed public works, COFs. These were created between 2003 and 2005 for the development of natural gas in the Burgos basin. Afterwards between 2011 and 2013 the government created the integral exploration and production contracts [CIEPs], which were the first incentivized contracts. The last round of CIEPs had the objective of developing Chicontepec. The latest development is the integral service contracts for the exploration and production of hydrocarbons [CSIEEs]. At the moment two such contracts have been signed: that for Olmos and that for San Ramón-Blasillo, which were signed in 2018. The recent contracts issued by the new Pemex administration have different terms. For instance, it has been offering 50% recovery of costs in the higher risk exploration and production activities.

BNamericas: And is there any kind of production sharing?

Vargas: No, in these contracts you share risks but not production. The production stays in Pemex hands and the reserves are incorporated in the national reserves.

BNamericas: Is this the end of production sharing in Mexico?

Vargas: What the president [Andrés Manuel López Obrador, who took office in December] has said is that after the third year of his administration, when the results of the contracts awarded during the bidding rounds are clear, it is likely that new bidding rounds will be held. The bidding rounds have up to now had two contract forms: production sharing and licensing. So if this really happens it's likely that they will again activate these contract models, but only if there are new rounds. These contracts will only be applied to contracts from bidding rounds and migrations of Pemex assignations to these contract models. Currently the government is migrating the contracts of seven areas for Pemex farm-outs, which will be auctioned in October.

BNamericas: What exactly is the difference between production sharing and licensing agreements?

Vargas: The difference is the way the state receives production. In the production sharing agreement you share production with the state, while in the case of licensing the state receives the equivalent value of the production in cash. The state has defined the contract modality based on information regarding the costs and the risks of the project.

BNamericas: What is behind these changes in contracting?

Vargas: I think they want to make the service contracts more attractive by incentivizing the industry to collaborate with Pemex in developing projects in shallow waters and onshore. But in any case they're still service contracts meaning the state doesn't share its production and its profits with contractors. So independently of prices and market conditions, contractors receive the same amount and don't benefit from market conditions. That is one of the comments we have had within the industry. Since oil and gas is a risk-taking industry, operators want to be exposed to market risk and what that can represent in terms of profits. They don't have that with service contracts.