While the latest revisions to the terms for shallow water areas in Mexico’s first licensing round have increased the attractiveness of the production sharing agreement terms by improving the contractor’s upside potential, the benefits remain significantly limited at higher prices compared to other fiscal regimes in the Americas, says an analyst with research and consulting firm GlobalData.
According to Will Scargill, GlobalData’s senior analyst covering upstream fiscal & regulatory regimes, even with revised terms, Mexico has yet to appease initial concerns that the adjustment based on pre-tax internal rate of return (IRR), combined with royalty rates that adjust according to price, offers exploration and production companies too little upside.
“The fact that royalties adjust to prices means the regime is relatively competitive in a low-price environment, insofar as a 30% bid for the state’s initial share of profit oil would be comparable to the fiscal regimes of Colombia and the US Gulf of Mexico at US$50 per barrel (bbl),” says Scargill.“However, as prices rise, the royalty and profit oil adjustment mechanisms kick in at an increasing rate, meaning that in order to be comparably attractive to the Colombian and US regimes, the bid would have to be around 25% at $70/bbl, 15% at $90/bbl and 0% at $110/bbl.”
The analyst states that despite competitive economics at lower prices, companies will likely be reluctant to bid at levels that would give them little upside potential and the effect that the government can have with further revisions to the mechanism is limited.
“Two possible options would be to base the mechanism on post-tax IRR rather than pre-tax, or to further increase the IRR thresholds by 5% each. However, the result of either of these options at a $90/bbl oil price would only be to increase the bid that is comparable to Colombia and the US to 20% rather than 15%,” says Scargill.“A 20% bid would mean that the state’s share of profit oil would range from 20–80% and contractors will pay royalties, taxes and fees on top of this. If the round is to be successful, the government will need to avoid setting an overly high minimum bid while striking a balance between market conditions and public sentiment.”