Reports issued in the past week state that Pemex, Mexico's national oil company, seeks operational control of Talos Energy's Block 7 oil and gas exploration area, located in shallow waters off the coast of the State of Tabasco in the southern Gulf of Mexico. Without giving merit to the sensational aspects of such reports or opining as to the appropriateness of Pemex's declarations, if such were indeed made, there is at this time no basis for making any determination with respect to such control other than one that affirms that Talos Energy and its partners in Block 7 have firm and vested rights in and to their exploration and production (E&P) contract for the area and to conduct all authorized E&P operations therein.

Background

Talos made a significant discovery in Block 7 after drilling the Zama-1 well back in mid-2017, less than two years after signing a production-sharing contract (PSC) for the block with Mexico's upstream oil and gas regulator, the National Hydrocarbon Commission (CNH). The discovery, dubbed by the Association of International Petroleum Negotiators (AIPN) as the "Discovery of the Year" during the association's 2018 summit in London, may hold up to 2 billion barrels of crude oil equivalent in place, and is the first true oil and gas discovery (i.e., one made pursuant to an authorized exploration program in a previously unexplored contract area or geologic formation) made after Mexico's historic energy reform in late 2013. To date, Talos has drilled the Zama-2, Zama-2 ST1 and Zama-3 wells to further appraise the discovery, the results of which have "met or exceeded the Consortium's expectations." Talos is the operator of Block 7 and holds title to the PSC in a consortium with Wintershall Dea and Premier Oil.

According to a report by Reuters, which is stated to be based in part on the statements of two former Mexican energy officials and two current company executives with knowledge of internal Pemex discussions, Pemex "wants to take over the lucrative project" and "is determined to operate Zama," with one of the industry sources saying that, "For them [Pemex], there is no other scenario."

These statements are certainly not inconsistent with prior comments made by Mexico President Andrés Manuel Lopez Obrador and other government officials in the sense that all such comments are in some form or another adverse to the interests of the consortium as a holder of E&P rights in and to the Block 7 contract area and the hydrocarbons thereunder, albeit with production-sharing obligations. In fact, both Lopez Obrador and Rocío Nahle, who leads Mexico's Departmentof Energy (DOE) and chairs the board of Pemex, stated as early as the date on which the Talos discovery was made that they would review the granting of the PSC. The motivation behind the statements, however, likely stems from the new government's view of the role of Pemex in the Mexican oil and gas industry, as well as the fact that Pemex drilled in 2008 a non-productive well (Pox-1) just 17 kilometers (approximately 10.5 miles) from the Zama-1 well, and 60 kilometers away from where López Obrador plans to build his signature project, the Dos Bocas Refinery. The reality, however, is that all of the statements are somewhat wishful in nature.

Potential Unitization Efforts

How would Pemex precisely take over the operation of Block 7? The reports state that Pemex has a potential claim to control the operation of Block 7 because it has drilling rights to an adjacent field, and the reservoir into which Zama-1 tapped likely extends into such field. The inference, however, is that such control will be attained through unitization. On Aug. 28, 2019, the DOE issued Pemex 64 E&P assignments in the shallow waters of the southern Gulf of Mexico, six of which (i.e., Assignments AE-148 through AE-153)¹ cover an area named Uchukil, which could share a reservoir with Block 7. A few days ago, the CNH approved exploration programs for the areas covered by the AE-150 and AE-151 assignments, the first to be issued by the CNH with respect to the Aug. 28 assignments.

In light of all that has transpired, it is not hard to infer that indeed Pemex desires and seeks a share of the pie through the unitization of Block 7 and one or more of the E&P assignments. The worry of some is further compounded by provisions set forth in Mexico's Hydrocarbons Law and its regulations that give the DOE power to establish the terms and conditions under which the unitized areas will be exploited, including the appointment of the operator and the determination of production-sharing percentages, if Pemex and the consortium cannot establish them through agreement.

Unitization is not a bad thing. To the contrary, it is the preferred way to address the various legal issues that arise when there is a single producing reservoir in which various parties have legitimate E&P rights under different contracts, such as the PSC and the Pemex assignments adjacent to Block 7. Many would even venture to say that any conventional exploitation of a reservoir under conditions that technically demand unitization is irresponsible and would result in inefficiencies in the development of the reservoir and the production of the hydrocarbons therein. When unitization is technically required, it is generally better to exploit the single producing reservoir under one head. The consortium must believe this is true, or it would not have approached Pemex last year and entered into a pre-unitization agreement (PUA) with it covering Block 7 and another Pemex assignment area named Amoca-Yaxche-03 (an area that is either carved out of or subsumed in the much larger Uchukil assignment areas). Under the PUA, the parties among other matters agreed to exchange information and "set a clear path for the signing of a Unit Agreement and Unit Operating Agreement," if one were technically appropriate.

Unitization Rules Apply

Once Talos made the Zama discovery, Mexico's prior administration took steps to issue administrative rules to govern the unitization of contract areas, and now, through the granting of the Uchukil assignments and the approval of their respective exploration programs, steps are being taken to assess whether in fact the reservoir under the Talos contract area extends into any of the foregoing Pemex assignment areas. This seems entirely appropriate and prudent given Pemex's duty, as Mexico's national oil company, to increase production and maximize oil and gas revenues for the country. If Pemex were to remain indifferent to the Zama discovery, it would clearly be in dereliction of such duty.

Under the unitization rules and the laws which they complement, any unitization terms and conditions to be established by the DOE, should the need arise, must be based on economic, competitive, efficiency, legal and transparency considerations. Further, any determination by the DOE in this respect must be supported by "the methods, standards and procedures generally accepted and applied by prudent and diligent E&P operators who, acting reasonably in the exercise of their judgment and in light of all facts known at the time, make a determination which seeks to achieve the desired results and increase production" – in other words, best practices. Thus, operational control of a unit cannot be arbitrarily determined.

Best practices criteria commonly considered in the designation of a unit operator include: the amount of committed investments each operator has in its contract area; the percentage of the single reservoir that extends into each contract area to be unitized; the percentage interest each operator has in its consortium, if any; the operators' qualifications and experience in operating unitized contract areas; whether any operational-related sanctions have been imposed on the operators; etc. The unitization rules thus give both the consortium and Pemex a good degree of protection against any undue, unfair or politically motivated determination by the DOE should such parties fail to reach an agreement between themselves or reach an agreement that is ultimately not acceptable to the DOE.

Any discovery that extends beyond the contractor's or assignee's contract area must be reported to the DOE and CNH within 60 days of such event, and the notice must include all technical information that supports the inferences made in such a report. This means that prior to the delivery of any such notice, no one is in the position to determine – in light of best practices – whether Talos Energy, as the operator of the consortium, or Pemex, as operator of its assignments, is in the best position to become the operator of any unit to be formed out of the applicable contract areas.

Notes

¹ E&P assignments are similar to E&P contracts in that they grant the assignee the right to conduct the same E&P operations that contractors perform under their E&P contracts. E&P assignments, however, are awarded only to "productive state enterprises" such as Pemex