Energy authorities in Mexico will need to address multiple above-ground issues in order for the country’s unconventional oil and gas resources to be considered economically attractive.

These issues include competition from abundant and cheap gas produced across the border in Texas, stringent environmental regulations in Mexico and a contract scheme that is ill-suited to the particularities of unconventional exploration and production (E&P), according to Gonzalo Monroy, managing director of Mexico City-based energy consultancy GMEC.

Despite the “promising” nature of shale resources in Mexico’s Burgos Basin, “Mexico has not yet [completed] the de-risking of what is still a frontier play,” Monroy told NGI’s Mexico GPI.

Monroy’s assessment could explain the tepid interest so far in Mexico’s Round 3.3 auction, which makes available nine Burgos concessions targeting shale resources.

Although the sign-up period for prequalification ends July 20, only three companies as of Friday had expressed interest in the auction, which was already postponed once. Only one of those companies, state-owned Petroleos Mexicanos (Pemex), has actually paid the inscription fee to prequalify for the bidding. The Comision Nacional de Hidrocarburos (CNH) is scheduled to award Round 3.3 contracts on Sept. 27.

While the Burgos Basin’s shale potential is thought to be on par with that of the Eagle Ford Shale in Texas, the continued ramp-up of cheap U.S. gas imports to Mexico will initially make it tough for Mexican shale gas to compete, according to experts.

“Mexico is part of the most competitive market in the world in terms of natural gas,” said Pablo Zarate, director of information for think tank Pulso Energético. He added that “there is still a learning curve ahead” for the country’s nascent unconventional E&P segment.

Mexico’s stiff environmental regulations for unconventional hydrocarbon extraction present another potential barrier. Authorities, including CNH, the Comision Nacional del Agua (Conagua), which oversees water resources, and the environmental protection department for the oil and gas sector, Agencia de Seguridad, Energia y Ambiente (ASEA), undertook an exhaustive consultation process with communities and environmental groups as part of the effort to regulate unconventional E&P.

“What they did was to push the envelope a little bit too far,” Monroy said, citing the costliness for drillers to comply with rules related to water quality assurance in aquifers near well sites, and with those for the storage and reuse of water and chemicals required for unconventional drilling.

The rules require drillers to monitor water quality not only in the area immediately surrounding the drill site, but also to take “a more regional approach, in order to have a more comprehensive understanding of how the quality of the water … [is] not being affected,” Monroy said.

Even more challenging for the industry, Monroy said, are regulations that prohibit the storage of fracking wastewater in open containers prior to recycling it, and which instead require that wastewater be stored in above-ground, double-membraned containers.

Given the immense amounts of water required for unconventional drilling, complying with this restriction will be “prohibitively expensive” for E&Ps, Monroy said.

A positive step cited by both Monroy and Zarate is a differentiated fiscal regime enacted by Mexican authorities for unconventional projects, in which royalties are calculated as a percentage of operating income as opposed to a percentage of revenue.

While the fiscal scheme is “an improvement,” it still “is not good enough to be competitive, especially with opportunities north of the border like Eagle Ford” and the Permian basin in West Texas and New Mexico, “which is going to be one of the most successful stories ever in the oil industry,” Monroy said.

Another issue that must be addressed is the contract model for unconventional projects, which Monroy said is “not really that different” from the scheme used for offshore and conventional onshore fields. The shale contract “will have to be completely different because [shale is] a completely different animal [with] different economics [and] different requirements in terms of operations.”

Although Mexico’s landmark 2013-2014 energy reform cleared the way for a massive buildout of pipeline infrastructure to transport cheap U.S. gas to Mexican industrials and power plants, Mexican authorities have also emphasized the importance of ramping up domestic gas production to avoid overdependence on American imports.

Although shale gas will likely be key to achieving this goal, the more important question, according to Zarate, is whether gas-focused upstream projects in Mexico can strike the right balance between gas and natural gas liquids (NGLs).

“At the end of the day, if we’re in the infancy of an industry, or [if] we are competing with U.S. natural gas, which is incredibly competitive, the way to make Mexico competitive in the early stages of…unconventionals, or to make projects that have a significant gas component competitive, will be in the liquids component.”

Referring to the liquids market, he said “its pricing forces are determined by global mechanisms…rather than just a regional component.”

The awarding of contracts for Round 3.3 will occur on the same day as Round 3.2, which places 37 conventional onshore blocks on offer. So far, 18 firms have formally expressed interest in Round 3.2, while eight have entered the prequalification process.