Migration of Contract Information I had some conversations with some of the managment team.
The Amititlan contract that was signed between Pemex and Lukoil was a service contract. This contract has performance requirements. Apparently the key service requirement was that Lukoil was to drill at least ten wells in the Chincontepec formation and have the economic wells brought into production on or before June 30, 2018. This contract does not require that a deep well be drilled into the Upper Jurassic formation.
Pemex has drilled various wells over time on the Chincontepec formation with what you would call hit or miss results, meaning some wells were dry holes, some were declared to be economic producers at 30 Bopd and were brought into production. Others as high as 372 Bopd were declared uneconomic for various reason, even though they had good production were never brought into production. The data in the report shows there was just some random holes drilled.
See: https://contratos.pemex.com/en/chicontepec/chicontepec_areas/Documents/Executive%20Summaries/20121204amatitlan_ing.pdf
Lukoil obtained the service contract then apparently did not have the “know how” to drill this formation and sought out ROE, because of it’s highly experienced and knowledgeable team to become a partner and to take over and be the lead operator.
ROE, wanting to have rights and an ownership position to the property,
especially the Upper Jurassic formation, bought into the Contract on a 25% ownership position, with the (option) right to go to a 62.5 % ownership of the partnership.
This contract will migrate, but it does not happen automatically. The service terms of the contract have to be completed and the various Government Authorities review and sign off on the performance. The terms of the new (migrated) contract have to be negotiated between the parties, which are Pemex, ROE, Marak and Lukoil.
ROE took over the Contract as lead operator and did all of the pre-drill contract work such as getting all of the necessary approvals, permits, building the roads, the drill pads, lining up contractors, drill rig, etc. The real slow part was getting the permits.
The reason for the permitting process and the various approvals being slow is that the regulations that the operators have to comply with, under the Service Contract and the new Exploration and Production Contract are being written and being approved, amended and changed as the process moves forward.
The News releases of ROE in January of 2017 had indicated that ROE had, at their own time and expense, drafted a white paper for the new regulations that would be required for the new, developing oil industry. This white paper was presented to the Government authorities. ROE has been involved with the development of the regulations they have to comply with. ( This is a big plus, but a slow process.)
ROE and its partners will have all ten (10) wells completed, fracked, and on full production on or before June 30, 2018, and they will have ROE’s contract terms proposal ready and submitted to PEMEX and the Government on or before June 30, 2018.
There is no minimum level of production that has to be obtained to complete performance, just drill the wells and bring the producers on line.
The production level achieved will be used to a great extent to determine the value of the property prior to migration and the terms and ownership percentages in the contract.
Pemex will become a partner, it will not be a royalty contract.
ROE and its partners will have spent about $45.0 million by the time all of these wells are completed and in production by June 30, 2018.
So by that point in time, Pemex will owe the partners of ROE, Lukoil and Marak, $45.0 Million. ( Remember, this is a service contract where Pemex is to pay all expenses plus $7.00 per barrel of production.)
Pemex is basically broke. Or at best has no money for exploration expenses. They do not want to pay out all money owing on these various contracts.
Now it comes time to work out (negotiate) the terms of the New Exploration and Production Contract.
This whole process is pretty much known as “earning in” a contract. In essence the one party drills and determines what oil is in the ground. ON the basis of the results, the value of the property is determined. Then the share ownership is determined based on the amount spent to determine that value as compared to the determined or appraised value based on the results. So the poorer the results on the drill program, the lower the appraised value of the property, the bigger the percentage you can obtain on the property. However the results have to be good enough for the parties to want to continue, but ROE and its partners are a lot better off with good results instead of spectacular results on this Chincontepec drill program.
ROE will be better off if they can get this contract migrated before they drill the deeper, Upper Jurassic formation as this is the formation where ROE expects to obtain better results.
For example, for the Amititlan contract, if the property, at the end of the ten well drill program has an appraised gross value of $75.0 Million and there is $45 Million owing, then Pemex will trade $45 / $75 Milllion of equity or ownership so the Partnership owed the $45.0 million ends up with 60% of the equity in the field. If the property has an appraised value of $90 Million and there is $45 million owing, then Pemex will trade $45 / $90 million of equity or ownership so the party owed the $45 million ends up with a 50% ownership.
So, the lower the appraised value the bigger the percentage to the partnership.
ROE then ends up with either 25% or up to 62.5 % of the ownership of the partnership group of Lukoil, Marak Financial and ROE.
ROE’s intention is to exercise their right to take a 62.5 % of the partnership.
It is obvious that it would be better for ROE to obtain the migration of the contract before they drill a big producer which could cost the partnership $4.0 million to drill and may up the value of the property by $25 million or more.
ROE has to put some safe guards in place in the event that Pemex won’t put up exploration money once the contract migrates. The reality is that Pemex likely won’t have exploration funds and won’t be able to put up the percentage of drilling funds that represents Pemex percentage of ownership. Pemex currently does not have funds or the willingness to spend the funds required to pay its share of the development costs on Amititlan.
It is obvious this contract migration is not simple, but in my conversation with management it was indicated that they ( the partnership group) will have all of the proposal put to Pemex and Government of Mexico before June 30. They are pushing hard to have this migration process concluded as soon as possible. Once signed off, ROE gets its percentage ownership, up to 62.5 % of the partnership, with respect to the property and with respect to the production.
The production results on this drill program likely won’t move the share price much, but will be a good indicator of how much the price will move once the contract migrates. Also the amount the price moves on the migration of the contract will depend on the percentage of ownership or the net acres.