oa Mexico energy reform: assessment of deepwater royalty mechanism

The complex royalty system developed by Mexico for deepwater contracts in the Gulf of Mexico (GoM) may deter companies from bidding during the final phase of Bidding Round 1, which is due to close on 4 December, 2016. The variable royalty system involves an adjustment factor that is triggered once the contractor has recovered the initial investment, rapidly increasing the royalty rate. The variable royalty system leads to a profit split between contractor and government of 42-58% (contractor NPV divided by the sum of the government NPV plus the contractor NPV), with an average royalty of 25% (total royalty collected divided by total gross revenue). The US has a more appealing profit split of 54-46%, in favour of the contractor, with an average royalty of 16.66%. Additionally, the US royalty does not move any higher, only lower when the deepwater royalty waiver applies, which brings down the royalty to 12.5%. However, Mexico’s deepwater royalty rate of 25% only applies when a meagre 5% over royalty is offered in the bidding process. Companies that would offer higher royalties are more likely to win the bid, but at the expense of their profits because the average royalty rate will then be even higher than 25%.