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An overlooked gem in the rough – Mexico’s under-exploited oil and gas resources

In the years of the shale boom, North America has become one of the major players on the global oil and gas stage. Methods like horizontal drilling and hydraulic fracturing unlocked vast quantities of oil and gas previously untapped in the U.S. and Canada, but another major source of untapped energy potential remains in North America: Mexico. And companies like International Frontier Resources (ticker: IFR) are ready to make Mexico the next success story in the global oil and gas industry.

After 77 years of a government monopoly in the industry, Mexico decided to liberalize and allow companies like IFR to develop some of the 9.8 billion barrels of proved oil reserves in the country. In 2014, Mexico produced 2.8 MMBOPD (87% crude oil) through its state-owned operator Petroleos Mexicanos (PEMEX), down 27% from a peak in 2004. The continued declines in production sent the government searching for ways to revitalize the industry, which generated 11% of the country’s export earnings in 2014.

State-owned PEMEX has reported losses in 14 consecutive quarters dating back to 2012, which also encouraged the Mexican government to search for other companies to help turn the industry around. To that end, Mexico began an auction process to denationalize 914 oil and gas blocks, both onshore and offshore.

International Frontier Resources (ticker: IFR) is one of the first companies to successfully win a bid to develop Mexico’s onshore assets, and the company holds a unique perspective into the newly revitalized industry.

Resources have been discovered, and much of the infrastructure is already in place, all that remains is for companies with the experience to run the assets effectively to fully exploit the hydrocarbon wealth in the ground.

“Our view is that this is the largest oil and gas sales in decades,” IFR President Steve Hanson told Oil & Gas 360®. “The fact that it’s in North America, it has large oil reserves, and it has good infrastructure makes it even better. Mexico is not a country that is in exploration; they’re already in development,” Hanson emphasized.

“There’s a lot of negative press, and Mexico certainly has its challenges, but we’ve found the working environment to be better than expected, and the opportunities are very good,” he explained. “Finding and development costs in Mexico are in the top quartile in the world, and operating costs are significantly lower than in the U.S. or Canada.

“What was apparent to us going down there was that these fields have been underdeveloped and under-explored. In many cases, wells that were drilled back in the ‘50s, ‘60s and ‘70s have good 2D and 3D seismic, show good pay zones, and have not been exploited to the degree that they have been in the U.S. and Canada.”

How the Mexican bidding works: looking at the big picture when bidding

The first round of auctions to take place as the Mexican government embarked on denationalizing its oil and gas sector included 183 total blocks, encompassing some 7.2 million acres of assets. The bidding takes place in various rounds, with companies essentially bidding against their balance sheets, and trying to sweeten the deal for the government by offering a more favorable cut to them.

“The way that the auctions work, once you’re awarded a field, that bid is taken away from your balance sheet availability,” explained IFR’s president.

For example, a company with a $100 million balance sheet would be able to bid on any field the government felt a company of that size could reasonable afford to operate, but if the company was awarded a field that required a $25 million balance sheet, they would only have $75 million to use on future bids.

“In the last auction, there was a number of smaller companies that bid on multiple blocks, and they actually may have come first, but because they had already used up their balance sheet allotment, they weren’t awarded the field,” said Hanson.

IFR Licensing Round 1 Overview

Tonalli Energia – IFR’s 50/50 joint venture with Mexican petrochemical company Grupo Idesa – was awarded Tecolutla Field in bidding round 1.3 after the first place bidder was unable to meet the conditions and terms required by the Mexico Comision Nacional de Hidrocarburos (CNH) to close the bid. The incremental royalty Tonalli will pay to the government on the block will be 31.22%, less than half of the 68.40% offered by the first place bidder, and substantially less than the average 47.22% the 25 onshore blocks auctioned off will pay to Mexico.

The Tecolutla Block is 7.2 square kilometers in the Tampico-Misantle Basin located within the state of Veracruz. The oil reservoir in the block is the El Abra formation at a depth of 2,340 meters (about 7,700 feet). 3D seismic has been acquired over the entire Tecolutla Block and 7 wells have been drilled into the producing reservoir. Peak production of over 900 barrels per day was recorded in 1972 from 3 wells, with 1 producing well remaining as of December 2014.

Exporting its technical expertise from Western Canada to Mexico

IFR looked at more than just favorable geology and existing production when it put its bid down, however.

“The key for us is not just ‘is there a geological or geophysical business case for this asset?’ but the fact that there are tools and infrastructure already in place as well,” said Hanson. “We wanted to see that there was some existing production, or past production, good 2D and 3D seismic, and also good infrastructure in place. We wanted access to local services available at competitive costs, and we wanted manageable well costs of $1-$5 million.

“From there, we can leverage our technical expertise to maximize production. We’re going to be using techniques we’ve been using in Western Canada for a long time that have been highly successful in much more challenging structures.”

IFR Tecolutla Block

The company’s partnership with Grupo Idesa also proved key to IFR’s success, said Hanson. Grupo Idesa is a multi-billion dollar petrochemical company, which has given the Tonalli JV a stronger balance sheet, and allowed the company to bid on more fields.

“There were some fields that we could operate from a technical standpoint, but for which we didn’t have the balance sheet they were looking for in the qualification process,” Hanson said. “With Grupo Idesa, we had a multi-hundred million dollar balance sheet, and now we could bid on some more mature fields than some of the other smaller companies.”

The advantages of having an in-country partner

The joint venture with Grupo Idesa offers more than just a stronger balance sheet in the bidding process, said Hanson. IFR’s team has been involved in projects spanning the globe, but the importance of having a partner that understands the country is difficult to overstate.

“Grupo Idesa has facilities, ports, trucks, infrastructure, and they have people that understand the unions, the community and local issues,” said Hanson. “If you go down there and you’re perceived as a foreign company trying to take advantage of the situation, you’re going to run into trouble.

“Tonalli Energia is a Mexican company. We want to ensure that the interests of the local community and the country as a whole are a factor in our operations.”

Mitigating risks in new territory

The key to tackling potential problems while working in a new country is to be proactive, said Hanson. “Your first line of defense is best practices. When it comes to safety, operations, equipment or the caliber of the team, you want to make sure you’re considering best practices.”

Beyond that, having excellent insurance coverage, and that you understand local issues will go a long way in limiting risk.

“The liability issue has to be addressed with proactive measures rather than reactive ones,” said Hanson. “If you have all those things in place, the liability issue is significantly reduced.”

IFR plans to pursue future growth in Mexico aggressively

“Tecolutla is just a toe in the water for us,” said Hanson when asked about the company’s future development plans in Mexico. The company is still looking at bids in bidding round 1.5 in Chicontepec, and believes that assets available in round 2 will also be worth pursuing.

“We’re hearing that the onshore assets for round two are going to be announced soon, and we’re already analyzing some of the assets we believe will be in that auction. We very much like some of them,” said Hanson. “We’re going to be very aggressive in round two.

International Frontiers Resources - Mexico asset map

As for the Tecolutla block, Hanson said the company plans to focus on workovers of the existing wells for the time being. This will allow IFR to get production back on stream quickly, but it also offers the team a chance “to get their hands dirty” before drilling their first well, according to Hanson.

“Pressure in the block is still good, porosity is excellent and IP rates on some of those wells were up to 400 barrels per day – so we’re confident that with new technology and improved efficiencies, we can far exceed peak production from the ‘70s.”

Tecolutla is an oil-weighted asset, but Hanson said the company will pursue opportunities as they arise, whether they are oil or gas.

“We’re not going specifically after oil or gas blocks,” said Hanson, and while the company’s current assets are oily, IFR’s president points out that Mexico is an importer of natural gas. “There’s a lot of demand for natural gas. Mexico is a net importer, and our partner Grupo Idesa is also a huge user of natural gas.”

A bright future for the Mexican oil and gas industry

Hanson believes that as more companies like IFR begin to prove the potential of Mexico’s oil and gas assets, others will quickly follow suit.

“My guess is, if you fast-forward two or three years from now at EnerCom’s conferences, you’re going to see ten, twenty, potentially thirty companies of various sizes with footprints in Mexico. I think there are a lot of people on the sidelines that prefer the second-mover advantage. They want to see some success stories before they move in.

“We want to become one of the major success stories when people are talking about Mexican oil and gas companies five years from now.”

International Frontier Resources will be presenting at EnerCom’s The Oil & Gas Conference® 21 on Monday, August 15, in Denver. To learn more about the conference, click here.

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