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Round One: Gloom is Good for Investors

by Jed Bailey | April 29, 2015   [wpdm_package id=1272 template=”link-template-button.php”]

 

Despite making astonishing progress in a remarkably short period of time, a pervasive sense of uncertainty surrounds Mexico’s upstream opening. Oil prices, although trending upward, are well below last year’s levels and remain volatile, with oil companies reducing investment accordingly. The government has adjusted the blocks on offer in the first phases of Round One and is delaying the later phases. Concerns regarding fiscal and other contractual terms, access to infrastructure, and security remain.

Far from signaling the imminent demise of Mexico’s reform effort, this underlying pessimism is actually a good sign for investors as fewer companies compete for the blocks that are offered. More importantly, the sense of uncertainty reduces the risk of government overreach in this critical stage of Mexico’s new upstream regime. Indeed, a sustained oil price rally may put the remaining Round One phases at risk if the government adjusts its expectations more rapidly than the private sector does.

The government’s perspective

The Round One stakes are high for Mexico’s government: it must extract sufficient value from Mexico’s upstream assets to protect against political backlash without setting the bar so high that it scares away potential investors.

• Reduce exposure. Offering fewer blocks and focusing on the most attractive opportunities allows the government to limit the risk of a failed bid round and to save assets for future rounds when they may secure a better price.
• Stay flexible. As the oil price and investor sentiment evolve, it is helpful to avoid premature commitments.
• Reduce barriers to entry. Any reduction in uncertainty should help improve investor confidence and, ultimately, the price they are willing to pay.
• Pre-emptively define success. The government necessarily started out as an industry cheerleader, talking up the reform and its benefits in order to secure political support. Now that the process is well underway, it is important that officials shift gears and actively manage expectations.

The private sector angle

In marked contrast to the government’s dilemma, private companies now face less pressure to enter new markets, in part owing to the low oil price environment.

• Don’t drink the Kool-Aid. While healthy skepticism may be helpful at the sectoral level, individual companies must maintain a neutral view to accurately value the blocks on offer and prepare their bids.
• Stay flexible. Given the fluidity of the situation, it is natural for the government to adjust the details of each phase as they move forward.
• Support the “success story” spin. A successful round will be critical to consolidating the reforms made to date and maintaining momentum for further change in the future.

 

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