Upstream oil market risks: Politics today, markets tomorrow.
By Jed Bailey | May 10, 2018
The United States’ announced withdrawal from the Iran nuclear deal reminded me of this report that Energy Narrative wrote in January, 2016 comparing Mexico’s upcoming tender of deepwater exploration blocks with Iran’s proposed new upstream contract regime. The report concluded that the two countries’ upstream offerings represented distinct balances of near-term political risk and longer-term exposure to global greenhouse gas policies and oil price risk. Today, political risks are in the spotlight in both countries, but pressures are also building behind the longer-term market risks that we identified then.
Two years ago, both Mexico and Iran were on a path to dramatically change their respective oil sectors. Mexico’s comprehensive energy reform process that began in December, 2013 had opened the country’s upstream oil and gas sector to private investment for the first time in eighty years. The Ministry of Energy was preparing for the reform’s most important test – the Round 1.4 tender for deepwater assets near the US-Mexico border. Although highly prospective, investors’ appetite for long-term, complex and expensive projects under Mexico’s nascent upstream investment regime—and dramatically lower global oil prices—was not certain.
In Iran, the United States had just lifted its sanctions related to Iran’s nuclear program through the Joint Comprehensive Plan of Action (JCPOA). Iran used the improving geopolitical climate to promote a new upstream oil and gas contract regime, called the Iran Petroleum Contract (IPC). The IPC aimed to bring in foreign investors to revitalize and expand Iran’s aging oil and gas fields, offering roughly 70 blocks that ranged from undeveloped discoveries to assets that had been producing for decades.
In Energy Narrative’s January, 2016 report, we compared the assets and contract terms that each country was offering. Our analysis suggested that while Iran’s blocks offered a potentially larger prize with less geological risk, Mexico offered the better investment climate. More importantly, the decision to invest in either country would reflect investors’ assessment of, and relative comfort with, Iran’s greater political risk and Mexico’s greater exposure to long-term greenhouse gas policies, such as a carbon price, and oil market risk.
Iran clearly presented higher political risk, but Mexico’s upstream investment regime was also very new and had not been tested by a national election. In addition, Iran’s offerings were primarily redevelopment of previously discovered resources, allowing for rapid development. Mexico’s deepwater blocks would require much higher investment and longer development time, potentially pushing first oil into the late 2020s and maintaining production into the 2050s or later. This much longer production profile created additional risks as global greenhouse gas policies and the demand and price for oil could change dramatically over that time.
Since then, Mexico has maintained the rapid pace of upstream tenders with minimal delays. The Round 1.4 deepwater blocks were snapped up by Chevron, ExxonMobil, Total, and China National Offshore Oil Company, while BHP Billiton won the coveted Trion farmout from Pemex. Round One was then followed by a successful Round 2 and Mexico is now in the middle of Round 3. In Iran, nearly 30 companies were short listed to compete for the new contracts, but Iran’s government delayed approving the contract structure and lingering international concerns further slowed the negotiations. In the end, only Total and the China National Petroleum Corporation signed a joint contract to help develop the South Pars natural gas field.
Political risks are now rising for both countries. The U.S. withdraw from the JPCOA will halt international investment in Iran’s oil sector for the time being. In Mexico, Andres Manuel Lopez Obrador (known as AMLO) leads in the polls for the July 1, 2018 presidential elections. AMLO has a long history of opposing Mexico’s energy reforms. He claims he will not reverse the reforms or break contracts should he be elected president, but is widely expected to resist further opening and to scrutinize existing contracts for any irregularities in their award or implementation.
Oil market risks are growing as well. Although prices have stayed in the US$60 per barrel range since the beginning of the year (and rose above US$70 per barrel on the news of the U.S. JPCOA withdrawal), rapid advances in electric vehicles and related technologies and infrastructure threaten future gasoline and diesel demand. New sulfur restrictions on marine transportation emissions that take effect in 2020 are expected to dramatically reduce demand for high sulfur fuel oil, potentially shifting that sector toward natural gas in the future. This uncertainty about future oil demand weighs most heavily on projects with long lead times and long productive lives, such as Mexico’s deepwater projects. Quicker, shorter-lived projects, such as US shale oil plays, become more attractive in comparison.
Nevertheless, Mexico’s current deepwater success, and similar success in Brazil’s offshore rounds and exploration offshore Guyana, suggests that these longer-term risks are not yet affecting oil companies’ investment decisions. Even so, oil companies’ criteria for sanctioning new offshore projects will no doubt continue to tighten in the years to come. That process will affect where and how companies explore for oil, with important consequences for prospective oil producing countries and offshore service providers.
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