Monday, May 25, 2015

Pemex and its 'Farm-out' Strategy, an Opportunity for Mexico

Mexico Energy Intelligence

In proposing farmout[1] as the central column of Pemex’s strategy for deepwater, heavy oil and deepwater gas plays, Pemex caught everyone by surprise. In Mexico, no more than a few dozen public servants had ever even heard the term “farmout.” In one respect, the strategy may be considered brilliant: It is a plan for escaping from the barbed‐wire compound in which constitutional restrictions and a xenophobic narrative have limited Pemex’s ability to share risk with other oil companies in frontier plays.

There is a downside risk, however. Mexican government officials point to the geographical proximity of blocks that were grandfathered to Pemex as allotments (asignaciones) with other blocks that have been designated for public auctions. They speak of synergy as the mechanism by which Pemex in time would come to operate its own blocks. The logic may be questioned by analogy: It is the supposition that if a farmer watches how his neighbor is able to grow corn better; he will be able to look over the fence and copy his techniques. The problem is that what is harvested is under 5,000 feet of water and in a well 18,000 feet deep, thus sharply restricting the ability of the farmer next door to learn from his neighbor’s example.

But if successful, the strategy will eventually empower Pemex to carry out with equal competence the development of its nearby blocks.

This report briefly describes the commercial logic and hypothetical terms of a farmout agreement. The future terms of Pemex’s proposed farmout agreements are presently unknown, and much remains to be seen about the assurances to the investor of a Pemex farmout.

SUMMARY

Pemex has ambitious plans for deploying the commercial figure known as “farmout” for the development of conventional as well as frontier plays.

“Farm‐out” (commonly written without the hyphen) may be thought of as a form of outsourcing with contingent payment linked to the future production of petroleum liquids and natural gas. The premise of a farmout agreement is that one party has commercial mineral rights, either by ownership or lease (or something else, in Pemex’s case), and that this party seeks the involvement of another party for the development of all, or a part, of the acreage to which mineral rights pertain.

As a farmout agreement may take any of a myriad of forms, it is not possible even to classify them. Common also to any farmout agreement is the requirement that the oil company that is to take responsibility for all or a portion of the acreage is to explore and develop it at its cost and at its risk. Only if petroleum in commercial quantities is discovered will the incoming company, or farmee, recover its investment.

The owner of the mineral rights will retain a portion of any future revenue stream from the well or reservoir in the form of a royalty, over‐riding royalty or other form of right to a share in production. He may require an annual fee from the farmee to keep the agreement current, but any substantial reward will be contingent on a commercial discovery.

In the U.S., a farmout agreement onshore is normally for the commercial life of the field. As a commercial arrangement, it is used on private and public lands and in federal waters. The commercial terms of a farmout agreement are not subject to governmental review or permission.

The future terms of Pemex’s proposed farmout agreements are presently unknown, but Pemex’s concerns and the issues to be addressed may be anticipated.

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For the full report, see "The Farmout Opportunity in Mexico - The Pillar of Pemex’s Frontier Play Strategy," MEI Report No. 783, May 18, 2015, at Energia.com