Mexico & Nafta - March 2008 (ISSN 1741-444X)

Petróleos Mexicanos (Pemex) delivered another shock to local oil analysts with its ouput figure for January. This showed oil production at 2.95m bpd, 5.9% below January 2007's output.

The January figure was in line with production figures for 2007, which showed output down by 5.3% to an average of 3.082m barrels per day (bpd). The main reason for the continuing fall is decline in output from Cantarell, the huge offshore field which accounts for a third of the country's total output. Cantarell's production, Pemex warned, will fall even more sharply from 2011.

This may be too optimistic a forecast. In the first half of December 2007, Pemex's production fell to an average of 2.942m bpd. This was its lowest daily output for a decade. Production increased by 30,000bpd on 16 December, but crucially, the recovery did not take production back to 3m bpd, the longterm target for the company. As the January figure showed, Pemex is having difficulty pushing production back up to 3m bpd.

If crude oil output stays under 3m bpd this year, there will be significant implications for the government's finances. The 2008 budget calls for oil production to average 3.2m bpd and oil exports to run at 1.7m bpd. In January 2008 exports were 1.43m bpd.

Cantarell is now producing about 870,000bpd, well down on its peak production of 2m bpd in December 2003. Pemex has done well to cover this decline by producing 500,000bpd from two newer fields, Ku-Maloob-Zaap (KMZ) and Crudo Marino Ligero. Pemex, however, appears to have been surprised by the speed of the decline in Cantarell. Pemex had been forecasting that Cantarell would average 1m bpd in 2010 before falling to 600,000bpd in 2013 and 450,000bpd in 2015. Although the KMZ still has some scope for increased production in 2008 and 2009, Pemex is forecasting that production from this field will also start to fall from 2010.

So, barring a major discovery, by 2016 Pemex's total production is likely to be down to about 2.1m bpd. This should be just enough to ensure that Mexico remains a net exporter of crude oil, but as it is already a substantial (and the Banco de México pointed out growing) net importer of fuel and refined products, the country will run a trade deficit in hydrocarbons. In 2007, Pemex exported crude oil worth US$37.9bn. In the first 11 months of 2007 it imported fuel and refined products worth US$12.2bn. The bulk of the imports were petrol and diesel. In January 2008, imports of refined products were up by 29%, while exports of crude oil were down by 9%, year-on-year.

The big challenge for Pemex and the government is to develop the potential deepwater oil fields in the Gulf of Mexico. The problem is that the company simply does not have the exploration experience: finding oil in deepwater fields is an expensive business. Petrobras, the world leader in deep water exploration, drilled 63 exploration wells in 2006 and 44 of them were offshore. Pemex, by contrast, drilled 58 exploration wells in 2006 but 44 of them were onshore gas wells, drilled mostly by private sector subcontractors. In 2006 Pemex drilled only eight offshore exploration wells; in 2005, 14, and in 2004, 29.

The one advantage Pemex has is that high international oil prices and the unsettled international geopolitical situation mean that Mexican oil, if it were available, would be an attractive proposition to international energy companies. Pemex could probably extract good terms from companies, if they were allowed to look for oil in Mexico.

The government is signalling that it wants to open up the energy industry to foreign companies. The problem is how much to open it, and how. Any move to end Pemex's monopoly on exploration and production will involve changing the constitution. This will necessitate first a vote in favour from congress and then approval by the majority of the country's 32 state assemblies. It is far from clear that the reformers would win both these votes.

The reformers received a mild boost on 21 February when Cuauhtémoc Cárdenas (son of former President Lázaro Cárdenas, who nationalised the oil industry in 1938) suggested that it would be possible, under current legislation, to increase foreign participation in areas of the industry in which Pemex does not have a monopoly. Cárdenas suggested focusing Pemex's monopoly on strategic areas such as refining; pipelines; exploration and production.

The ruling Partido Acción Nacional (PAN), with some support from the Partido Revolucionario Institucional (which currently controls 20 of the 32 states), wants to go further than Cárdenas suggests. The PAN is proposing to allow foreign companies into the downstream part of the industry, such as refining or running pipelines and storage facilities.

Even the PAN is doubtful about its ability to convince the country to allow foreign companies into upstream activities such as exploration and production.

The problem with this solution is that Pemex will cut back in all these liberalised activities, as it did with petrochemicals, to focus on its monopoly activities. This will further handicap it, since it will not be an integrated company. It will most resemble the small exploration and production companies which take punts on finding oil in overlooked areas. These companies then sell out to bigger companies when they find oil and move on. Pemex, however, is far too big to have such a strategy.

Another problem with opening up downstream parts of the industry is that it will imply changes to the way fuel is sold. Currently the price of petrol and diesel is controlled and subsidised by the government.

The state of Pemex's finances also gives cause for concern. Although the government's reforms last year allowed it to keep more of its revenues, the company is still labouring under a huge debt of US$100bn. This is the legacy of years in which successive governments milked Pemex of its cash and forced it to borrow to finance its investment. The fairest option would be for the government to assume this debt. No politician however, from either the Left or the Right, wants to discuss the issue.

Gas: Pemex played up its 13% increase in gas production in 2007 (and its 14% year-on-year increase in gas output in January 2008). In January the company produced a record 6.53m cubic feet a day. Gas is the only part of the energy industry which is open to foreign companies: they can only produce from dry gas fields (ie, fields where there is no oil). In December 2007 Pemex noted that gas production was running at 6.4m cubic feet a day.

Prices: Mexico is budgeting on an average export oil price of US$49 barrel in 2008. In 2007, the average export price for Mexico's predominantly lower value heavy crude was US$61.6 a barrel. In January the average export price was US$79.6 a barrel. This is still comfortably above both the 2007 average and the 2008 forecast, but if the US did tumble into a recession, the price could threaten the conservative budget assumptions. The US still accounts for about 20% of the world's crude oil consumption.