Mexico & Nafta - 18 May 2004

Petróleos Mexicanos (Pemex), the state-owned oil company, should be enjoying the best of times. Oil prices are the highest they have been since 1990 and Pemex's production is starting to rise after years of stagnation. Yet the company is in dire financial straits. Analysts reckon that by the end of this year it will have negative net worth. This means that the sum of its liabilities exceed the sum of its assets. Besides this, the constitutional embargo on foreign oil companies developing Mexican oil may mean that Pemex will miss out on the development of the potentially immensely rich deepwater oilfields of the Gulf of Mexico.

Pemex's balance sheet should be the least of its problems. It is the country's biggest company and its export sales last year were over 12% of the country's total exports. What is more the company dominates the domestic market for petrol and other fuels. Its petrol stations are as much tax-collection operations as filling stations. 

Yet in the past four years the company has managed to lose M$150bn (US$14bn) worth of equity capital. The crazy system under which the company is taxed is entirely to blame. The government swipes 60% of its gross sales. The company has to run itself, therefore, on less than half its revenues. This would, possibly, be workable if the company was mature: but it has a huge investment budget. To finance this the company has hocked itself and thus seen its capital position deteriorate.

The company has to do all the borrowing itself, because under the constitution oil production and development is a state monopoly. The government of President Vicente Fox, which came to office promising to wean the government off oil revenues, has failed to overhaul the tax system. As the Fox government's power gurgles away (rather faster than most of its predecessors because of its breath-taking ineptitude) the problem of fiscal reform will be left to its successor. 

Pemex's problem is rather more pressing. Unless the company can repair its balance sheet it may find that investors are unwilling to buy its paper, despite the prop of a government guarantee. Some of the big international investment funds are forbidden by either their statutes or their trustees from buying the debt of companies that, like Pemex, have negative net-worth. 

The solution
The government has come up with a temporary measure that it hopes will see the company over the worst. On 11 May, the finance ministry announced that it would hand over to Pemex any windfall profits from oil exports in the first quarter of this year. The government budgeted on an average export price of US$20 a barrel this year. The export price in May was hovering at between US$31 and US$33 a barrel, when the international oil price was around US$40 a barrel. The discount reflects the heaviness of the bulk of Mexican crude. Maya (or heavy, more expensive to process) crude accounts for over two-thirds of the crude produced by Mexico. 
The average export price for Mexican oil in the first four months of the year was US$27.28 a barrel. The average for the year so far is probably a little higher, closer to US$28. 

Officials at the finance ministry reckon that they will hand around US$2bn over to Pemex. The government pointed out that it was obliged to do this under Article 8 of the revenue side of the budget law. 

Pemex says that it will use the money to meet part of its investment budget. The company is budgeting to spend US$12bn this year. 

Pemex's exports in 2003 were 1.84m bpd of crude oil, 8% up on 2002. Pemex's average daily production of crude oil in 2003 was 3.37m bpd. This was the highest ever recorded by the company. The company was also pleased to have produced more natural gas for the first time since 1998. In 2003 it produced about 4.5m cubic feet a day.

The company claimed that its heavy investment in exploration and production was starting to pay off. In 2003, it found 41 new oilfields. The company claims that its replacement rate (ie the amount of new oil it found compared with the amount of oil it produced) jumped to 45%. In the 1990s the replacement rate had averaged 26%. 

Pemex's total sales in 2003 were US$59bn. Despite being one of the world's top five producers of crude oil, and the fourth biggest exporter of crude to the US, Mexico still imports 25% of its petrol. Pemex supplies the federal government with about a third of its revenues.

Deepwater problems
Pemex's balance sheet is not the only facet of its business under pressure. Executives from international oil companies say that the company (and Mexico) is in danger of losing out from the development of the Gulf of Mexico. The constitutional bar on foreign companies exploiting Mexican oil means that Big Oil has preferred to explore and develop fields in the US part of the Gulf. Now there are signs that Big Oil may even rank Cuba ahead of Mexico. Cuba also has a share of the acreage in the Gulf.

Oilmen claim that the offshore fields in the Gulf are now the world's third biggest potential source of oil after the Persian Gulf and the northern fields of the former USSR. On 30 March, President Vicente Fox, apparently, accused foreign oil companies of siphoning off `Mexican' oil from fields in the Gulf. Academics say that there is no evidence that this has happened. Yet. But it certainly could because oilfields in the Gulf are likely to straddle international maritime boundaries, and Pemex's ability to exploit deepwater fields in next to non-existent.

Fabio Barbosa, an economic researcher at the Universidad Nacional Autónoma de México, told AméricaEconomia, a business magazine, that there was no evidence yet that the US had been tapping Mexican oil from its side of the border. Fox claimed that the US had actually done this on shore, with natural gas, in the Burgo field, bordering Texas. Offshore, the Trident field, in the US part of the Gulf, is only 5km from the maritime boundary. The problem is that the oil lies at a depth of 3,000 metres. Not even the Brazilians, who claim to lead the world in deepwater oil technology, have produced oil from such a depth. 

Pemex has been active in the shallow waters of the Gulf. The Cantarrell field in the Sonda de Campeche, is by some way the company's most important asset. The Gulf oilfields account for 2.8m bpd of the 3.4m bpd the company is currently producing. Cantarell alone has accounted for 60% of the company's production over the past 23 years.

This year is a pivotal one for Cantarell and Pemex. This year is likely to be the first in which the field's production will decline. Secondary recovery projects, such as gas injection, may slow the rate of decline, but the uncomfortable news for Pemex's senior managers is that it will have to look for oil in deeper waters. 

Given what is happening in Iraq and the generally vulnerable and unsettled state of the Middle East, the US is likely to step up its advocacy of a hemispheric energy policy. Deepwater development of the Gulf of Mexico is likely to be a key element to this. The Gulf fields are comparatively easy to protect and the US has a huge refining capacity along its Gulf coast. 

What is the current position?
So far, international oil companies have produced 566m barrels of oil from fields in the US bit of the Gulf. Cuba has yet to produce any significant amounts of oil from its bit of the deepwater area, though it auctioned the right to explore for oil in 10 blocs, off its northwest coast, in 2001. The geology points to oil lying at about 1,500 metres below sea level. This sort of depths are worked by Petrobras.

Petrobras has been active in the US bit of the Gulf since the 1980s. The company claims that the geology of the region is similar to the Campos Basin, Brazil's main oilfield off Rio de Janeiro. Mexico has not even started to explore its deepwater acreage in the Gulf. Geologists say that there is no reason why the Mexican portion should not hold as much as the US bit.

Pemex reckons that its deepwater acreage could hold 22bn barrels worth of oil. That is more than its current proven reserves of 18.9bn barrels. Throw in the gas that is also likely to be present in the Mexican bit of the deepwater Gulf, and the country's production of natural gas could be doubled or trebled. Oilmen reckon that all this energy could be discovered and its development started in six or seven years. 

Suppose there is 22bn barrels of oil there. Assume that Pemex can tap it at 70% of the rate at which it taps its current reserves. That would mean that by 2012 Pemex's production would be up to 5.5m bpd. Gas production could be up to 12bn feet a day. 

Pemex is looking harder for oil in the Gulf. In 2003 it drilled 23 exploration wells in the south-east bit of the Gulf. The previous year it had drilled only three exploration wells there. International oilmen, eyeing the huge potential of the area, argue that Pemex and Mexico need to do more. They point out that when the Texas oilfields began to run down in the early 1980s, the US government threw open the Gulf to oil exploration. According to AméricaEconomia 1,800 companies started to explore in the area and found 146 deep and ultradeep fields. The Gulf now accounts for 13% of the US's proven oil reserves and this figure could rise to 20%, oilmen say. 

So what can Pemex do?
Some oilmen suggest that Pemex should do what Petrobras did in the 1970s when it wanted to develop its Campos Basin fields. What Petrobras (which then, like Pemex now, had a constitutional monopoly) did was to bring in foreign companies which had the technology. Petrobras then paid them in cash, but it had the oil. 

The irony is that Pemex's senior management realise that they have to let foreign companies in. The company's director, Raúl Muñoz Leos, has said as much on several occasions. The problem is that he has failed to convince congress, which will have to change the constitution. Oilmen say that even if the deepwaters of the Gulf of Mexico do contain oil the high risks involved in finding it and getting it out mean that Pemex multiple service contracts, which allow foreign companies to act as lead contractor, do not stack up financially. The oil companies say that it costs anything from US$50m to US$100m to drill a deepwater well. They add that it can take up to six years to build the infrastructure needed to get the oil from the well and to a storage area.