Mexico Just Made A Historic Change To Its Energy Policy - Here's Why It Might Not Matter

Doug KlineMexico's Congress has just approved a major energy reform bill that opens up the country's oil and gas sector to outside investment.

It's getting a lot of press because it transforms a policy that's been in place for 75 years, during which time the state enjoyed a monopoly on all energy revenues, produced through a company called Pemex.

The question is, what will this actually accomplish?

And the answer seems to be that while this was a necessary step to modernizing the country's energy sector, there's uncertainty about what kind of an impact it will have.

Barclays has been most bullish on the initiative. In an August note, the firm's oil services research team said the initiative could boost Mexico's economy by more than 1.5%. They're also inclined to take Mexican President Enrique Pino Nieto at his word that production could climb to 3 million barrels a day by 2018 and 3.5 mbd by 2025, from about 2.5 mbd currently. That would put Mexico on par with Iran as the world's sixth-largest producer, and put a statistically significant dent in oil prices.

But other analysts are being far more cautious.

"Mexico energy reforms could unlock near term and long-term supply," Citi's commodities team, led by Ed Morse, said in a recent note, and they characterize its potential as one that "could surprise." A lot needs to go right for that potential to be realized. Deepwater production could get up and running quicker than expected "if Mexican energy reforms proceed smoothly and [fields] can be tied back to nearby US subsea lines through Pemex partnerships with [independent oil companies]." Morse recently told the FT's Jude Webber that it is premature to quantify what that surprise could look like.

The biggest problem is that no one knows how much oil and gas Mexico is sitting on. According to the EIA, Mexico has 10.4 billion barrels of proved oil reserves. The next closest is Algeria at 12 billion barrels. The U.S. now has at least 30.

But Pemex (per Reuters) says more than 3/4ths of Mexico's oil and gas resources are made up of prospective, or unproved, oil and gas deposits - about 100 billion barrels worth. (The U.S. has more than 200 billion).

In large part as a result of the absence of outside investment, Mexico has lacked the ability to explore those areas further. Instead, according to AllianceBernstein, it's found itself largely confined to a few highly productive fields, like the Cantarell in the Gulf of Mexico (just above Mexico's "elbow"), which at peak production in 2004 comprised 50% of the country's oil production. Since then, Cantarell production has declined 80%, and the country's overall production has fallen 24%, according to AllainceBernstein.

All that's to say reform was sorely needed. But even though it's now going to happen, questions remain. For its part, Bernstein sees three hangups that could curb the reform's impact.

First, oil majors are sort of strapped for cash these days, and can only go after so many plays at one time. Here's the chart - capex has slowed significantly:

The best hope may be from the Chinese - but that would come with its own problems as they lack the technical expertise enjoyed by Americans in exploiting deepwater and shale.

Deepwater development is also much more difficult than landed plays - and part of the reform is designed to attract investment into offshore development. Meanwhile, The U.S. boom is so massive that there's no way Mexico can overcome American cost advantages, Bernstein says:

"According to the EIA, the initial shale wells drilled by Pemex have run $20-25 mm each, or ~4x the cost of a US shale well. Thus for years to come, it will remain cheaper for Pemex to simply increase gas imports from the US rather than develop domestic shale gas."

Finally, there's still an outside chance the reform could get scuttled. Since the bill actually took the form of a constitutional amendment, it must now be approved by Mexico's individual states. And the bill continues to face fierce criticism - it was passed over cries of "traitors" from protesters who'd occupied the Mexico's Congress - and a movement has developed to hold a referendum on it in 2015, though such an initiative would have to be approved by Mexico's supreme court.

Barclays says oil service firms like Halliburton and Baker Hughes are best positioned to take advantage of the reform, whatever its impact. In a recent presentation, Derek Mathieson, Baker Hughes' VP for strategy and corporate development, said, "We have some really exciting opportunities in Mexico which comes with a little challenge as well but in Mexico it looks like it's going to be a pretty interesting story as it holds the next year or so."

But the oil majors are being more circumspect. According to Reuters, William Colton, Exxon's VP for strategy and corporate development, told reporters limited his reaction to saying the initiative "would be very good for the people of Mexico." And Tim Cutt, BHP Billiton's oil division head said he would have to wait and see how the reforms unfold before judging what their ultimate impact will be. Asked whether the gains seen in Texas' Eagle Ford shale play could be extended south of the border, Cutt said there was a "decent extrapolation."

Bottom line: this is a big deal for Mexico, but the rest of the world should be a bit cautious about the reform's broader impact.