Plummeting Production Nudges Pemex to Drill

MEXICO CITY — Mexico’s national oil company has served as the country’s cash cow, its standard-bearer of nationalism, and its ticket into the ranks of richest nations.

But the burden of funding the government has taken a heavy toll on Petróleos Mexicanos S.A., known as Pemex. Oil industry analysts warn that without a massive injection of cash into oil exploration and production, Mexico is in danger of losing the goose that for decades has been the source of the proverbial golden egg.

In a meeting with journalists earlier this year, Pemex Chief Executive Jesús Reyes Heroles alluded to the crisis facing the oil giant, characterizing 2008 as “the company’s worst year.” Pemex’s daily production slipped to 2.8 million barrels last year, its worst performance since 1995, when the company was pumping 2.6 million barrels a day. Even though oil prices hit a record $147 a barrel in 2008, Pemex lost $10 billion on $119 billion in sales.

Much of Pemex’s problem can be traced to a precipitous decline in oil production at the huge oil deposits in Cantarell, located in the Bay of Campeche in the southern area of the Gulf of Mexico.

Pemex has relied heavily on the Cantarell fields, which have accounted for 60 percent of total production, much as the Mexican government has relied on Pemex, whose oil taxes and royalties cover some 40 percent of the federal budget. Just four years ago, Cantarell, one of the largest oil fields in the world, provided more than two million barrels of oil a day. In 2009, its average production is just 753,000 barrels a day, resulting in an overall 30 percent drop in Pemex’s total output.

Mexican politicians have long regarded Pemex as solely an engine for revenue, with no aspirations of it becoming a world-class oil company. Because of the lack of investment in exploration, oil output is declining at a rate of 8 percent annually. The volume of exports, including the one million barrels of crude oil shipped daily to the United States, fell by nearly 17 percent in 2008, while the value hit a record of $43 billion. At the same time, imports of gasoline rose 9 percent, costing Pemex, which lacks refining capacity, $13 billion.

Alarm over the falling reserves and the country’s need for new refining capacity helped forge energy reform in Mexico’s politically divided Congress last year. The reform did not touch Mexico’s constitutional ban on private investment in oil production – private-sector participation is restricted to drilling contracts for a fixed fee. But the changes do allow Pemex to increase its spending on oil exploration and to begin studies for a new $10 billion oil refinery.

The new law failed to please either side in the debate over the future of Pemex. Business interests want the production field opened to private investors. The left-of-center political opposition resists any additional private sector involvement.

Pemex has already announced plans to spend around $20 billion to find new oil sources in 2009, roughly double what the company was investing each year from 2001 to 2006.

“It is a diversification strategy,” said Carlos Morales, chief executive of the Pemex Exploration and Production unit. “The idea is to not depend on a single oil field.”

Pemex has focused its exploration efforts in the shallow waters and deeper offshore areas in the Gulf of Mexico, as well as the Chicontepec deposits in the Gulf Coast state of Veracruz, which will require the drilling of numerous oil wells.

“The long-term plan is to halt the drop in production and even start to increase, beginning in 2011,” Morales said.

The price tag for the exploration and new production is high.

Pemex estimates it will need $20 billion to drill in the shallow waters over the next 15 years and as much as $30 billion over 20 years for the Chicontepec field, which represents 55 percent of the probable and potential reserves.

The company is also betting on finding oil in deeper waters offshore, where the costs could run to $600 billion over 30 years. Morales estimated this area holds as much as 30 billion barrels of oil. “We have to go to the deep offshore waters to look for new reserves,” he said.

Private sector participation is crucial to finance and execute these projects. The new rules gave Pemex the flexibility to offer more attractive service contracts to private companies. “The private sector will be financing them, but the projects will generate the cash to repay them,” Morales said.
But investors are waiting to see what Pemex offers.

“They have to offer additional monetary incentives in exchange for the greater commitment from the contractors and the suppliers,” said David Shields, an energy sector analyst in Mexico City.

“The benefits for Mexico from high oil prices are diminishing under any scenario,” Shields said. “It is more important to view Pemex as a factor in promoting productive work through the contracts and not as a major exporter or the solution to the [country’s] financial problems.”

Energy specialist Duncan Wood warned that global service companies with the technology to explore in deep water are reluctant to sign contracts without the promise of high returns.

“What they want is to share the production, they want access to the reserves, but this is not permitted in the Mexican constitution,” said Wood, who teaches at the Mexican Technology Institute in Mexico City. “That is the heart of the problem.”

As an alternative, Pemex could develop its own technology by underwriting research and design in Mexican universities or partnering with other state-managed companies, strategies that are allowed under the Mexican constitution.

But that might require radical shifts in the culture at the giant oil company and its powerful union. “There is no political will for this type of change for Pemex,” Wood said.