Energy Projects in Latin America

Focus: Mexico
Given the current market situation, energy projects in Mexico and Latin America are facing some constraints. However, in the case of Mexico, the power sector and the midstream sector are generating more opportunities and are being conceived as more vibrant sectors in the economy than large upstream projects.

Mexico may have one advantage vis-à-vis its fellow Latin American countries; it underwent a very comprehensive structural energy reform. This reform started in December 2013 with amendments to the Mexican constitution. Thereafter, in August and October the implementing laws and regulations were published. The purpose of the energy reform was to end the State monopoly and thus liberalize the sectors of the energy industry previously closed to private investment; one of the effects of the reform was to foster competition in energy markets. Mexico was one of the few countries in the world with a close investment system in the energy sector, and the liberalization has placed Mexico below the spot light, attracting numerous investors in the sector. In that context the natural gas midstream sector was not changed as substantially as the oil & gas upstream, downstream and power sectors.

However, the energy reform has not yet triggered the magnitude on influx of capital, as the implementation phase has taken more time to develop than original expected. It can be said that the first stage of its implementation was the bidding rounds for oil & gas blocks. First, Round “0”, under which the Mexican Government granted Pemex (Mexico’s NOC) the exclusive right to explore and produce hydrocarbons from specific blocks (through a concession – type of instrument). In addition to Round 0, the Mexican Government launched Round “1”, which consists of 3 tenders organized by the Mexican Government (through the National Hydrocarbon Commission), under which said entity would award exploration and extraction contracts to winning bidders. Thus far, under Round 1 three tenders have been organized, and in the first one only one company was awarded two blocks. Investors are still cautious about investing in the Mexican oil & gas sector, especially in this new phase. Although Round 1 has attracted a lot of interest, the fiscal terms being offered by the Mexican government, and cash flow constraints that IOC’s are experiencing, have made many investors wary about their participation in the tenders.

The reform of the power sector was perhaps more complex, as it changed completely the electricity system and market in Mexico, by introducing a Wholesale Market. Before the reform, the CFE (Comisión Federal de Electricidad – the Mexican National Power Company) as the national State monopoly, was the “master” of the industry – the sole entity that could generate, distribute and wheel power. Private investors could generate power in limited circumstances. As a consequence of the reform, several players were introduced in this new market organization; a Wholesale Electricity Market was created where electricity, power, clean energy certificates and other products may be traded, and the market will be operated by a government operator. However, given the complexity of the reform, there is uncertainty as to how the Wholesale Market will operate, making investors cautious about their potential investments in the sector.

What is next?

Upstream. A lot of activity is expected in the oil & gas upstream and midstream sectors. The Mexican Government will continue to tender exploration and extraction contracts for blocks under Round 1. For the first three stages of Round 1, exploration and development activities are expected to start shortly after the contracts are awarded. As for the new stages and tenders, we perceive a lot of interest in deep water projects. However, given the current market conditions and cash flow and expenditure limitations IOC’s are facing, we believe it is uncertain IOC’s will be interested in participating in these rounds; a lot will depend on the fiscal terms of the contracts.

Another area of great interest are Pemex´s “farm-outs”. Pemex will be able to “migrate” its “government concessions” (asignaciones) awarded to it under Round “0” to regular exploration and extraction contracts, under which it may partner with private parties to develop the blocks awarded under Round “0”. The terms of these associations will be set by the National Hydrocarbon Commission and the partner for Pemex will be selected by said agency through a public tender procedure.

Midstream. Activity in the development of large natural gas transportation systems is being seen in Mexico, most of it sponsored by CFE, which purpose is to import cheap natural gas from the US to use it in its power generation plants. We expect CFE to continue sponsoring and tendering projects of the type. Opportunities for pipeline companies will exist for the development and operation of these projects, which are usually linked to long term supply contracts with CFE.

Downstream. Downstream activities are now liberalized and, as such, wholesale of gasoline and diesel, importation and refining (among others) activities can be carried out by private parties. Although we do not identify that investment and development activities in the refining sector will happen in the short or medium term, we believe that the wholesale of gasoline and diesel will be activities where investors may be interested, especially through the acquisition of assets (service stations).

Power. Activities in the new Wholesale Electricity Market may formally start at the beginning of next year. We believe next year will be critical for the implementation of the reform in the power sector. In the short term, we identify opportunities and investment activities in power projects developed under permits granted prior to the reform. These projects will be grandfathered (provided they meet specific qualifications) and there is certainty as to the regulatory framework applicable thereto, which make them very attractive projects for developers, sponsors and lenders.