Mexico Oil Politics Keeps Riches Just Out of Reach

by Clifford Krauss and Elisabeth Malkin
Tuesday, March 9, 2010
provided by

To the Mexican people, one of the great achievements in their history was the day their president kicked out foreign oil companies in 1938. Thus, they celebrate March 18 as a civic holiday.

Yet today, that 72–year–old act has put Mexico in a straitjacket, one that threatens both the welfare of the country and the oil supply of the United States.

The national oil company created after the 1938 seizure, Pemex, is entering a period of turmoil. Oil production in its aging fields is sagging so rapidly that Mexico, long one of the world's top oil–exporting countries, could begin importing oil within the decade.

Mexico is among the three leading foreign suppliers of oil to the United States, along with Canada and Saudi Arabia. Mexican barrels can be replaced, but at a cost. It means greater American dependence on unfriendly countries like Venezuela, unstable countries like Nigeria and Iraq, and on the oil sands of Canada, an environmentally destructive form of oil production.

"As you lose Mexican oil, you lose a critical supply," said Jeremy M. Martin, director of the energy program at the Institute of the Americas at the University of California, San Diego. "It's not just about energy security but national security, because our neighbor's economic and political well–being is largely linked to its capacity to produce and export oil."

Mexico probably still has plenty of oil, especially beneath the deep waters of the Gulf of Mexico, but Pemex lacks the technology and know–how to get it out. Inviting foreign companies into the country to help is one of the touchiest propositions in Mexican politics.

As the Mexican government struggles to find a way forward, production keeps falling.

The basic problem is simply that Mexico's readily accessible oil is used up — pretty much the same thing that happened to the United States when production began falling in the 1970s. Output from Mexico's giant Cantarell field, in shallow waters near the eastern shore, has plunged by 50 percent in recent years. Output at the country's other large field is expected to begin falling in the next year or two.

Historically, oil has supplied 30 to 40 percent of the Mexican government's revenue. Confronting a potential calamity, President Felipe Calderón has pushed through the strongest reforms he can defend politically, in hopes of attracting foreign investment. But he dare not do anything that would appear to reverse the 1938 nationalization. Even the modest reforms he has managed to pass are being challenged in court.

Officially, the government is optimistic that Mexico can reverse its decline as an oil–producing nation. But its efforts so far have yielded more rhetoric than oil.

Last year, on the day celebrating the 1938 seizure, the president's helicopter landed in a hilly oil field outside this farming town. He announced that a new era of Mexican gushers would dawn soon.

"Under this soil," Mr. Calderón told thousands of oil workers, lay "the richness that could propel development in our country and help Mexico accelerate our path to progress and well–being." He promised that 20 wells would be spurting crude "very soon" from the ground on which he stood.

Almost a year later, only three wells were pumping on a recent afternoon. Eleven had been shut after producing little or no oil. In fact, the effort to develop the geologically challenging Chicontepec field here, near the gulf coast, is deteriorating into an embarrassing disaster for Pemex, the latest in a string of them.

In all, Mexican oil output has dropped from just short of 3.5 million barrels a day in 2004 to a projected average of 2.5 million barrels this year. Mexican oil exports to the United States, now 1.1 million barrels a day, have fallen by nearly a third in the last six years.

The United States Energy Department projects that Mexican production will decline by an additional 600,000 barrels a day by 2020; combined with growing domestic demand, that would probably make the country an oil importer.

In the last two years, Mexico provided about 12 percent of all crude oil imports to the United States, supplying about 8 percent of the total oil used by American refineries, according to the Energy Department.

Pemex — officially Petróleos Mexicanos — is the most important company in Mexico, employing 140,000 people. Oil money is used for everything from building schools to fighting the war against drug cartels.

"The fact that Mexico's production is rapidly declining could potentially cause a financial crisis not only for Pemex but for the government," said Enrique Sira, the Mexico director of IHS Cera, an energy consulting firm.

Mexican officials put the best face on the situation, hailing a reform package passed by Congress two years ago that gives Pemex more independence and leeway in negotiating service contracts with foreign firms.

"There is nothing to stop us from improving," Pemex's director general, Juan José Suárez Coppel, said at a recent university conference.

In an interview, the Mexican energy secretary, Georgina Kessel, said she expected the drop in oil production to level off this year, "and we can begin on the road back toward reversing the fall in production in the coming years."

To accomplish that, Ms. Kessel said, "Mexico is going to have to go to the deep waters of the Gulf of Mexico," where she estimated there are at least 50 billion barrels in potential oil reserves — more than double the country's current proven reserves.

International oil executives share the enthusiasm for Mexico's potential deepwater fields, which lie near rich new American fields. Mexico "potentially has, if not the largest, one of the largest undiscovered deepwater petroleum resources in the world," said Jon Blickwede, a senior geologist at Statoil, a Norwegian oil company active in the Gulf.

Pemex has stepped up exploration of its deep waters, but it will take specialized expertise and enormous financing to produce oil there. Just one deepwater rig can cost $365 million a year to operate, which is why even companies the size of Chevron and Shell look for partners to share the financial risk.

Carlos Morales, head of Pemex production and exploration, said in an interview that the company was in advanced discussions with foreign companies to develop "new models" of contracts to share costs and technology on land and offshore that would include cash payments. "Without doubt, Pemex is in a key moment in its history," he said.

Like the government, international oil executives said they were cautiously optimistic some arrangement with Pemex could be worked out. But in the best case, it will be 10 or 15 years before significant production can begin in the deep gulf — and by then, Mexico could already be an oil importer.

Stumbling blocks remain. The recent reforms do not lift constitutional prohibitions that effectively prevent foreign companies from booking Mexican reserves they help discover, which undermines their incentive to sign deals with Pemex.

The Mexican government hopes to interpret the new rules to allow foreign firms to share the profits of new discoveries, but opposition political parties have filed a constitutional challenge to the rules. The case is before the Mexican Supreme Court.

The 1938 nationalization, by the leftist government of Lázaro Cárdenas, came at the end of a long period of revolutionary ferment in Mexico. It occurred amid rising tensions between foreign oil interests, including American companies, and Mexican workers who felt they were being exploited. Schoolchildren learn about it as one of the great assertions of Mexican sovereignty.

An outright reversal of that act is unthinkable in Mexican politics. Carlos Fuentes, the Mexican novelist and former ambassador, said any government leader who would try to change the legal status of oil "would be hanged in the Zócalo," referring to Mexico City's main square, though he personally would like to see some arrangement with foreign oil companies worked out.

As a symbol of nationalism and sovereignty, Pemex is run like a government agency, not an oil company. Its budget is set by the Congress, so it cannot plan exploration far in advance. It is burdened by taxes, debt and pension liabilities that limit its ability to spend money discovering new fields.

Mexico's most important field has long been Cantarell. When production first faltered in the late 1990s, Pemex injected huge amounts of nitrogen gas to raise the pressure and increase production. But experts say the company may have gone overboard, bolstering production so much that the eventual collapse was accelerated.

With production in deep gulf waters still a distant dream, the hope of stabilizing Mexico's production has centered on the Chicontepec field here, on land. But Pemex's production forecast, of up to 700,000 barrels a day by 2017, has evaporated as hole after hole came up dry.

Chicontepec is now yielding only 35,000 barrels a day. The oil is contained in small pockets, and wet, hilly terrain makes it difficult to transport gear. Local corn farmers are slowing the drilling by blockading roads, demanding improvements like parks and pavement.

"The oil is down there," said Sergio Gómez, the Pemex production coordinator in Chicontepec. "The problem is getting it out of the ground."