When a country undergoes massive energy reform like Mexico did in 2014, the outcomes can vary greatly. Generally speaking, privatization of national assets and markets lends itself to more efficient companies and increased production. Proponents of nationalization argue that corporations tend to exploit their monopoly power ignoring the social welfare of the communities they serve. While these staunchly contrasting positions sum up the polar ends of the political spectrum, they fail to explore the possibilities in between. And in the case of Mexico’s newly nationalized oil markets, perhaps a 21st century win-win solutions awaits.
With the benefit of hindsight available to us, it is certain that Mexico’s opening up of their oil fields has largely produced the intended outcome of boosting production and increasing efficiency. This past May, the National Hydrocarbons Commission (CNH) announced that “251 million barrels of oil equivalent (boe)” had been included to the national reserves as a result of the discoveries by private foreign and domestic exploration and production companies. To put this figure in context, Mexico’s headline reserves number is roughly 8.5 billion boe.
If you are dividing 251 by 8.5 billion right now, you are likely coming up with a not so large percentage. But considering all parties involved in Mexico’s privatization are blazing new trails with every step of the process, such an increase in production is impressive. Plus, it is important to remember that Mexico’s reform was not a total privatization as Mexico’s Ministry of Energy gave the national E&P operator, Pemex, 83% of Mexico’s proven and probable hydrocarbon reserves leaving only 21% of the countries prospective resources to be bid on in “Round Zero”.
One of the first foreign companies to win a contract from Mexico during the earliest rounds of bidding was Talos Energy. In 2015, Talos won two of Mexico’s fourteen new blocks that were being offered in the first round of Mexico’s lease sale. Talos joined a consortium of companies including U.K.-listed Premier Oil and Riverstone-backed Sierra Oil & Gas, to begin developing the Zama-1 block. In 2017, Talos and company were the first private group to drill an offshore well in Mexican history. Upon further examination of Talos’ Mexican operations it seems the Houston based company provides a good case study when measuring the impact of the Mexico’s energy reform. For a closer look at Talos’ activities south of the border and the impact private E&P’s are having on Mexico, see below.
In Good Hands: Talos Leadership
To get an idea of the company that Talos is and what they are trying to do, one need to look no further than the companies Founder and President, Tim Duncan. Born and raised in the oil industry, Duncan has the natural proclivities seen in all of the successful oil-men. Duncan received his BS from Mississippi State University in petroleum engineering. It was here that he was honored in 2012 as a Distinguished Fellow of the College of Engineering. Further, Duncan holds an MBA from the Bauer Executive Program at the University of Houston. One of his first endeavors in the E&P sector was as a manager for reservoir engineering and evaluations for Gryphon Exploration. During this time Duncan was also working in various reservoir engineering and portfolio evaluation roles for Amerada Hess, Zilkha Energy, and Pennzoil E&P.
Prior to founding Talos in 2012, Tim Duncan was the senior vice president of business development and a founder of Phoenix Exploration. Phoenix had several E&P successes, most notably the phoenix oil field. Such success lead the founders to revision their goals and sell the company to a group of buyers led by the Apache Corp. in 2011. The $400 million stock and cash deal allowed Apache’s to boost their exploration efforts in Egypt and freed Duncan and his team to go after prospective developments.
Reflecting on his technical background and what advice he would give to budding entrepreneurs in the energy industry, Duncan commented,
Try to be the best engineer you can be. At the end of the day, we are a business that requires technical judgement, and it is still my primary focus every day, especially when I have to allocate capital. Dig in early in your career technically and don’t convince yourself that you are ready to handle the responsibility of someone 10-15 years your senior. When someone, in an unsolicited way, validates your technical efforts you will know you are ready to take on different responsibilities and then you can start thinking about the transition into being more commercial. Being an entrepreneur does not have a margin of error, you have to fully commit yourself to the effort. You are immediately more responsible for more than you have ever been responsible for and you have to be both more analytical in your approach and more decisive—which can either seem exciting or stressful and if it feels like the latter, it’s not for you.
And then there was Talos. Talos is an oil and gas company that engages in the exploration, development, and production of oil and natural gas properties in the Gulf Coast and Gulf of Mexico. Initially backed by private equity firms Apollo Global Management and Riverstone Holdings, Talos Energy merged with Stone Energy Corp last year. That merger added scale and cash to Talos balance sheet and gave them a public platform. Having full access to such capital markets opened up how the company thought about sources and uses in future transactions. Duncan relayed, “It certainly comes with challenges…we will need to execute under more scrutiny, push our story out to sell side and buy side analysts and investors, and prepare our team (many of whom have been with us on the private side for years) about what it means to manage a public company—but I’m looking forward to the challenge.”
Up for the Challenge: Duncan and Talos Make the Move to Zama 1
The decision to bring Talos down South was not an obvious one but that resulted from a long hard look at the company’s strengths and weaknesses. At the time of the decision to once again go international, the fracking industry was taking off and the leadership team at Talos had to overlook some massive short-term gains to ultimately do what they best, off-shore E&P. “I think it started with believing in our team and the process we went through to determine whether we thought there was the resource potential to proceed. The Mexican government made the barriers of entry low and we were bidding for the government profit share,” commented Duncan to the Society of Petroleum Engineers, “If we were going to bid in the first sale, we had to trust the government would run a transparent bidding process and they did. Had we waited, we likely would have come up empty, which is what happened in our five subsequent bids after the first bid round.” Talos then reprocessed the 3D seismic data of the region in the same or similar way they would in the US side of the Gulf. This better defined the underground opportunities which has led to some historical findings.
In 2017, Talos’ risky position down south began to pay off in the form of a large oil deposit discovered under 1,000-foot-thick layer of oil-soaked sandstone in the Zama-1 field. Talos spudded the Zama-1 well in which they found a tremendous subsea formation. Zama-1 is now one of the 20 largest shallow-water field discoveries internationally over the last twenty years. Current estimates to hold between 1.5 billion and 2 billion barrels of oil. Not wanting to get lost in the numbers, Tim Duncan suggested the find was much larger than anticipated. Discoveries that rival Zama-1 in size on average produce 100,000 barrels per day.
The Latest and the Greatest with the Zama Appraisal Program
Talos recently announced that the Zama-2 appraisal well was spud on this last November. The spudding of the Zama-2 well is just the beginning Zama discovery appraisal program, which will consist of three reservoir penetrations, including two wells and one sidetrack. The site at which these reservoir penetrations are chosen is of high importance. The same is true if you are drilling an exploration or production well. Sidetrack drilling is a type of maintenance operation used to capture extra hydrocarbon reserves, that are not reached by the standard drilling.
The first well, the Zama-2, will be drilled to the north of the Zama discovery well and will look to confirm the oil water contact and collect information to better understand the reservoir’s aquifer support. The Zama-2 well will also be deepened approximately 500 meters below the Zama reservoir to test the Marte exploration prospect. The Marte exploration project has an unrisked recoverable resource range between 60 MMBoe and 150 MMBoe. Rough estimates to deepen the Zama-2 wellbore for the Marte test are currently gauged at approximately $10 million gross, with Talos’ share expected to be approximately $3.5 million. This exploratory well will then be followed by an up-dip vertical sidetrack from the main bore hole, which will be cored and a drill stem test (“DST”) will be performed, which is expected in the second quarter of 2019.
The second appraisal well, Zama-3, will be drilled to the south of the original discovery well and will help delineate reservoir continuity and quality in the southern part of the field and will be cored to be better understand the reservoir geology. Core drilling is used when the productivity of oil well drilling needs to be assessed. Coring provides valuable information about the makeup of the rock being drilled. Obtained core samples are worth their weight in gold when in the right hands.
The appraisal program is expected to be completed by mid-year 2019.
The Ensco 8503 rig is contracted and will be utilized for the entirety of the appraisal program. Talos is no stranger to operating the rig as it was the same one that was involved in the Zama-1 discovery. The rig was in the U.S. Gulf of Mexico, where it has a contract with Deep Gulf Energy but is now back with Talos in the Zama field.
Impact of Privatization on Mexican Economy
Talos has previously announced it is expected to set the final investment decision for the Zama-2 and Zama-3 project in 4Q 2019 or 1Q 2020, with first oil expected in 2022. Production will be ramping up through 2024, as supplementary facilities are brought on-line in the field. The company and the consortium plan is to mature Zama with 3 production platforms over the structure. The field will continue to be developed until 2024 when Platform C is expected to be installed.
Perhaps what is most impressive is Talos estimate that the Zama discovery could contribute nearly 10% of the country’s oil production by 2024. That is, if the political climate for Mexico’s energy reform holds up, which many experts predict will happen. The recent election of Andres Manuel Lopez Obrador as the nation’s President have some on edge as candidate Obrador viewed the reform as a neoliberalist movement that he was unwilling to be apart of. Many of these concerns have been to laid to rest as Lopez Obrador has vowed to honor and to respect contracts already awarded and the investments of foreigners.
But with a President that is skeptical about the impact of foreign investors and private businesses on his country, it is prudent to keep in mind the exact consequences of Mexico’s reform. And this is where Talos, as an independent E&P, stands as a great model of the positive impacts private businesses are having on the region.
Talos is also working with several local Mexican suppliers who support the operations with many critical services, including shore base support, casing supply, anchor handling, helicopters, and communications, amongst others. Additionally, engineering professionals from McDermott’s Mexico City office are assisting in the pre-FEED analysis of the potential development options post-appraisal. Overall, Talos and its partners plan to spend approximately $250 million, excluding contingencies, in Mexico during this appraisal program while exceeding the National Content requirements of the contract through the exploration and appraisal phase.
Talos Energy’s President and Chief Executive Officer, Timothy S. Duncan, commented, “We are excited to enter this phase of the Zama project with our partners. We are also very pleased with the new partnerships formed with local Mexican suppliers. There is a significant amount of Mexican presence in our workforce in the Zama project, both on the rig and in the local communities that support offshore operations and we are proud of the impact this project will have in the local Mexican economy. The timing of the commencement of the appraisal program will allow us to stay on track of our goal, which is to achieve initial production from the Zama discovery in 2022.”
Probably the biggest motivator to privatize any industry is that private businesses have a responsibility to their shareholders to increase profit incentive, to cut costs and be more efficient. Government run industries do not usually motivate their management with monetary incentive to be better, faster, stronger. But with a private company the name of the game is the bottom line and so cost savings and efficiencies are everything. A big part of these efficiencies is the synergies found within the industry. For a first-hand example of such synergies, one can look to the Talos-Hokchi transaction that occurred last October. It was mid- October when Talos announced they had entered into a transaction with Hokchi Energy, a subsidiary of Pan American Energy LLC, to cross assign the Company’s Participating Interest (“PI”) in Block 2 and Hokchi’s PI in Block 31, both in the Sureste Basin offshore Mexico.
When there is only one government operator, it is impossible to reach such synergetic agreements, and privatization seems to already be increasing efficiencies. As part of the Talos-Hokchi agreement, Talos will assign a 25% PI in Block 2 to Hokchi in exchange for a 25% PI in Block 31, which is immediately to the south of Block 2. At the end of the transaction Hokchi will be the operator of both blocks and Talos will own a 25% PI on Block 2 and a 25% PI on Block 31. The transaction is subject to approval by the Mexican oil & gas regulator, the National Commission of Hydrocarbons (CNH), and has not yet been approved by CNH.
“On both of our Mexican assets, we are taking action to facilitate quicker, more robust investment and shorter cycle time to production, and potentially a more material level of production”, said Timothy S. Duncan, President and CEO of Talos. “The swap with Hokchi is a great way to pool resources between two operators that have a proven track-record in offshore Mexico. And this trade also allows us to aggregate our neighboring opportunities. We look forward to working alongside the Pan American team on Blocks 2 and 31 while we focus our operational efforts not only on Zama but the other material opportunities, we have put together on the Block 7 acreage.”