Lack of access to midstream infrastructure poses challenge to Mexico’s deepwater development

Natural gas options from Mexico’s new offshore reserves
Natural gas options from Mexico’s new offshore reserves

A panel held at the recent Offshore Technology Conference in Houston addressed the challenges facing Mexico’s midstream infrastructure, particularly with regard to access for producers who have obtained leases in the 2015-2018 international bid rounds.

Speakers included:

• Ulises Hernández, Pemex E&P, Director of Resources, Reserves and Associations

• Andrés Brugmann, Fieldwood Energy Mexico, Country Manager-Mexico

• Felipe Arbeláez, BP Latin America, Regional President

• Gabriel Gómez, Murphy Oil, Mexico Country Manager

• Guillermo García, Energy Regulatory Commission (CRE), President

• Mark Cizek, Williams Pipeline Group, Vice President, Eastern U.S. Gulf of Mexico

• Emiliano Pescador, Blue Marine, President

Robert Howse, Kiewit Mexico, Business Line Manager

• Craig Castille, HWCG, Managing Director.

Pemex’s Legal Department had been repeatedly invited to send a speaker to address contractual issues, but the invitation was declined.

The panel was meant to open a conversation on midstream topics, many of which would revolve around the open access use of existing Pemex infrastructure. The presentations and discussions that followed provided new insights on the goals and aspirations of the new administration led by President Andrés Manuel López Obrador, with regard to energy policy and public institutions.

Key issues discussed in this panel included access to midstream infrastructure and midstream contracts with Pemex, and the encouragement of price transparency and free markets.

The new administration seeks to accomplish a turn-around in the performance of Pemex, which, by almost all measures, has deteriorated in recent years. As part of its strategy, it seeks the roll-back of regulations that “limit Pemex’s ability to compete.”

As President-Elect, López Obrador urged the top officials of both the National Hydrocarbon Commission (CNH) and Energy Regulatory Commission (CRE) to resign in order for the new government to shape its own regulatory policy. CNH’s Juan Carlos Zepeda resigned effective Nov. 30, 2018. CRE’s Guillermo García, in contrast, chose to continue in office, affirming that his appointment for five years had been confirmed by the Senate. Participation on the OTC panel underscored the importance with which investors regard the role of CRE as the midstream regulator. (García would resign fewer than 10 days later, effective June 15.)

While CRE recognizes that access to Pemex’s gas processing facilities is essential for both onshore and offshore leaseholders, its ability to regulate Pemex in this area is made awkward by the absence of an explicit mandate regarding gas processing. The Hydrocarbon Commission (CNH) has legal authority for permitting midstream infrastructure at the wellhead, but permits alone do not create a commercial framework. In effect, the midstream at present is unregulated.

Pemex’s director of strategic alliances, Ulises Hernández (who, at present, also serves as ad hoc director general of the upstream division), provided information—not previously made public—that showed that there is ample spare capacity in Pemex’s gas processing plants. He described contractual formats that establish the point of sale of leaseholder gas upstream of the plant.

At present, no contracts have been written with offshore leaseholders for the shared use of midstream infrastructure, and there seems to be no urgency on the part of the government, CRE, CNH, or Pemex to get them signed. In this light, the use of FPSOs and FSOs may come to have an unexpected advantage for leaseholders in Mexico in a midstream strategy that is independent of Pemex.

Delays in sorting out matters of regulatory authority and contractual agreements will jeopardize plans for early production and the fulfillment of expectations for aggregate contractor production of 240,000 b/d for 2021.

Gas processing capacity

Pemex’s Ulises Hernández presented slides with information about Pemex’s gas processing plants, including nameplate capacity and current level of utilization. The biggest plant in the Tabasco-Chiapas area, Cactus, has a daily capacity of 1.9 MMcf, with a 65% utilization. Some other plants had utilization rates below 20%.

Hernández explained that Pemex had already signed 69 contracts with 29 operators to handle the production. Pemex is in the process of signing additional contracts with offshore operators for the use of Pemex’s offshore facilities to handle production. Contracts, he explained, have not been signed because it was not necessary until now, but they will be signed in time for them to bring production online according to their work schedule. Pemex, he emphasized, is open to discuss the utilization of its transportation and processing facilities with other operators and production companies.

Hernández described two commercial arrangements between Pemex and third parties regarding to use the spare capacity that Pemex has in the upstream facilities. The second arrangement allows any operator to contract for gathering, transportation and processing services with any of the Pemex business units. It is possible for the operators to keep title to gas to the tailgate of the processing plant. It just has not been done that way in Pemex’s current contracts, Hernández noted.

He gave a range of tariffs for the transport of gas and oil. His tone was optimistic about the development of workable midstream contracts between Pemex and third parties.

In response to an audience-survey question, he also opined that a pipeline from Perdido to Bagdad Beach near the US-Mexico border at Matamoros will be justifiable in the coming years.

Felipe Arbeláez, president of BP’s operations for Latin America, offered highlights of BP’s broad commercial ambitions in Mexico in several markets beyond the exploration and development of the several lease blocks in which it has a working interest. BP has made significant recent investments in retail and is progressing several initiatives in midstream infrastructure. The company seeks to lease capacity and use long-term contracts, favoring partnerships in Mexico. The company has over 30 direct customers in the industrial natural gas market. In commenting on one of the audience survey questions about how price transparency requires that the sale of gas and gas liquids (NGLs) take place at the tailgate of gas processing plants, he observed that in other mature gas markets, unbundling of the assets and price transparency allows for public price points along the length of the value chain.

Gabriel Gómez, the country manager for Murphy Oil in Mexico, observed that an ideal scenario for the eventual development of its block would be an FPSO with direct access to international markets. Meanwhile, the company is appraising its recent oil discovery and the additional potential of the block, which, in size, exceeds the area of 100 blocks in the US Gulf of Mexico. Gómez mentioned that the lease block is within tieback distance of the Zama discovery by Talos Energy.

Gómez also referred to Annex 13 of the contract, which requires that operators carry out inquiries with nearby leaseholders to learn their interest in collaborating in the development of infrastructure. He noted that there is also Pemex infrastructure in the area that could be employed by operators on a shared-use basis, including some facilities that are currently not in service.

Among his remarks, Andrés Brügmann, manager of Fieldwood Energy’s joint venture in Mexico, observed that there are important issues regarding tariffs that are yet to be worked out. He noted that Pemex’s infrastructure has long been amortized and will need to be replaced in the coming years. Tariffs, he implied, should reflect the age and condition of Pemex’s infrastructure. Building a new line would require an additional two years of construction, delaying first oil and cash flow. Negotiations for gathering and transportation agreements in Mexico are much more complex than in the United States. Fieldwood, who won block 4 in 2015 in Round 1.2, is negotiating an agreement with Pemex to tieback to Pemex’s Tumut platform for an early production solution. 

Midstream opportunities

Guillermo García, the President-Commissioner of the Energy Regulatory Commission (CRE), discussed the authority and mandate of the commission in relation to the Mexico’s midstream infrastructure. He commented that open access in gas processing plants is integral (“consubstancial”) to the commercialization of natural gas.

He said that the commission had wondered if the market value of natural gas could be established at the wellhead, using the caloric value of the gas as a benchmark. Regarding a difference between gathering lines (“recolección”) and transportation lines, the commission had been unable to find a technical basis for the distinction. It proposes survey operators to determine if the access and terms of a new pipeline should be regarded as a transportation line that should, as a public utility, be regulated by the commission.

Asked about one of the audience survey questions concerning the need for a level playing field to ensure fair competition, he explained that by the application of the principle known as “asymmetrical regulation,” Pemex will be required to divest some of its portfolios in markets where it is the dominant player.

Regarding the change in tone of the new administration about the role and footprint of Pemex in oil and gas markets, he allowed that there may be some CRE regulatory determinations affecting Pemex that should be reviewed.

Mark Cizek, manager for Williams Pipeline for the Eastern Gulf of Mexico and México, observed that making use of existing infrastructure on the US side of the maritime boundary — owned by Williams, he added — would offer attractive solutions to rapidly bring oil and gas to market. The key to the Williams solutions is getting revenue for Mexico started more quickly by quickly monetizing new production. Cizek emphasized that operators and service companies should be free to work out what makes the best sense in relation to engineering and commercial arrangements.

Emiliano Pescador, the president of Blue Marine, described how the deployment of FPSOs and FSOs could have important roles in Mexico’s deepwater development. He noted that his company had the first contract with Pemex in 2005 for an FPSO to operate in the giant Ku-Maloop-Zaap field for the purpose of blending light and heavy crudes. He spoke about how available solutions such as mini-FPSOs could serve operators in early production as well as during extended well testing.

Observations

From the remarks made at the panel, several observations can be made. Pemex has ample spare capacity in its gas processing plants—665,000 cf/d in the Cactus plant alone. Pemex’s contracts with onshore operators require the point of sale to take place upstream of (prior to) the gas processing plant. Contracts with operators have not yet been written to have the point of sale at the tailgate of the gas plant.

Pemex is friendly toward the co-use of its offshore infrastructure by operators in southern blocks and will respond to requests for the use of its gathering, transportation and gas processing facilities. The Pemex speaker reported that 69 contracts have been signed with 29 operators (out of 70), but the terms and conditions regarding liability, losses, and fees are not in the public domain.

CRE is not yet sure of its role in relation to the needs of operators to have access to Pemex infrastructure. CRE’s mandate is to regulate gas “transportation,” but it is not clear to CRE where gathering lines (ductos de recollección) end and transportation pipelines (ductos de transporte) begin. CRE views gas processing as integral to gas transportation, but its regulatory authority over open access and tariffs has not yet been exercised. CRE sees its regulatory authority over gas processing as implied by the law and regulation, but not specifically stated. Said differently, CRE is extrapolating backwards to include open access on gas processing as essential to a regulated market in gas transportation. CRE has industry practice and commercial logic on its side, but not the law or energy policy.

This regulatory ambiguity (coupled with institutional issues in Pemex E&P and CRE) contributes to the slow advance of midstream contracts that promote price transparency and competitive markets in gas and liquids. These goals are not served when Pemex takes title to gas upstream of the processing plant, but no oversight authority has yet been established. Operators in offshore blocks in the southern areas are concerned about their inability to execute shared-used contracts with Pemex in a timely fashion.

To draw from lessons of other jurisdictions in which legacy operators have been reluctant to reach new agreements with third parties for open access to existing infrastructure, Mexico’s Energy Ministry (SENER) will need to exert pressure on Pemex and, in parallel, affirm that CRE has regulatory oversight that includes gas processing as part of the transportation value chain.

A potential bottleneck that was not discussed at the panel concerns the permits that must be obtained from SENER for the exportation of oil and natural gas. For some operators in northern leases, it could make sense to pipe gas to US markets for oil production to proceed. Whereas in 1995, free trade in natural gas was the government’s policy, in the Hydrocarbon Act of 2014 (Art. 48), processing gas and importing and exporting hydrocarbons requires permits.

Conclusions

The 2013-14 energy reform legislation placed great emphasis upon the upstream sector but failed to establish a regulatory regime that would allow access to Pemex’s legacy infrastructure. The missing regime would have been based on the principle of open access with transparent tolling arrangements that would require the point of sale of natural gas to be at the tailgate of the processing plant.

The details of how the midstream is supposed to work for CNH operators were left unclear by the previous administration. In the list of areas of responsibility for CRE, gas processing does not appear.

CRE has not yet tried to insist on market and price transparency regarding the midstream challenges of operators. One inference is that in the pro-Pemex atmosphere that is being promoted by the current administration, CRE is hesitant to assert its implied authority to regulate Pemex’s midstream practices.

Price transparency and market liquidity—two of CRE’s core values—are not served when the point of sale of associated natural gas comes before the tailgate of a processing plant.

Plans for early production by some offshore operators are in suspense pending the negotiation of acceptable contracts with Pemex. Delays and uncertainty put at risk the achievement of the government’s goal to production of 240,000 b/d by CNH operators by 2021. Cross-border tiebacks to blocks in the northern offshore area offer the quickest solution to monetizing oil and gas.

Overall, the slow progress of negotiations with Pemex about the shared use of infrastructure jeopardizes leaseholder plans for early production, and, in consequence, puts at risk the ability of leaseholders to meet the frequently stated production expectations of President López Obrador. The strategy of some leaseholders to circumvent Pemex’s infrastructure entirely may become the new normal. •

Editor’s note: George Baker served as moderator for the panel, “Mexico: From Acreage to Markets: how leaseholders production from Mexico will safely reach markets,” held on May 7, 2019, at the Offshore Technology Conference in Houston. He is managing director of the firm consulting firm Baker & Associates and publisher of Mexico Energy Intelligence.

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