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Pemex: No Speedy Recovery

Can Pemex reverse declining oil production by 2010? Four experts share their predictions.


Inter-American Dialogue 


The leader of Mexico's Institutional Revolutionary Party, Beatriz Paredes, said at an event in Washington last week that critics shouldn't discount Mexico's recent energy reform before it is put into practice. Paredes said the reform passed in October would "simplify Pemex's operations, speed up the planning of its activities, and ensure enough cashflow to mobilize the company." Is Pemex seeing results, and if not, when will it? Is it too soon, as Paredes suggested, to begin thinking about further reforms to halt Pemex's declining production? Will oil production begin to recover by 2010 or 2011 as Mexico's energy ministry now predicts?

David Shields,
independent energy consultant based in Mexico City: Mexico's energy reform is a complex, well-intentioned piece of legislation, which tends to push Pemex in the direction mentioned by Paredes. It sets out a framework for restructuring the oil industry, for applying more flexible contracting procedures and for promoting a transition towards clean and renewable energy. The problem is that nobody is really committed to this reform. There is no enthusiasm, interest or urgency about putting it into practice. It is being implemented poorly and slowly, so the opportunities it offers are in danger of being lost. Yet, politicians and society at large do not seem to care less. President Felipe Calderon got most of what he proposed in the reform, but has repeatedly said that he does not like it, because Congress did not allow him to open up refining and fuel distribution to private investment. Owing to the rapid decline in output at Cantarell and to political and ideological excesses and corruption over the years, disenchantment with Pemex is overwhelming. As oil revenues fall, there is a lack of conviction that Pemex will be the solution to Mexico's problems, just [as] the global financial crisis whips the country. Profound ideological prejudice prevents meaningful debate on further reform that could engage direct foreign investment. So, despite upbeat official forecasts, signs are that declining oil production will not be reversed (though it may fall more slowly) and that no more reform will be forthcoming during the Calderon government. Beyond 2012, the outlook for output, investment and reform is unclear.

Hernando Otero and Liliana Diaz, principals with 1492 LLC: Indeed, it is perhaps too soon to discount Mexico's recent energy reform. That said, the country is dealing with very certain and short-term horizons of declining production. For that reason, even if more aggressive reforms had succeeded, tangible results in terms of production output would not be expected as soon as they are needed. Even if Pemex's new capabilities were to yield a new discovery today, it would still take years to bring those reserves to market. This is particularly true for the deep water exploration in the Gulf of Mexico. Similarly, further drilling and enhanced recovery at the inland Chicontepec basin on which the government is heavily relying to offset declines at mature fields in the near future, will require significant capital expenditures and technical capacity from oil service providers and will take time to bear fruit. As a result, it is very optimistic to predict a recovery in oil production as early as 2010 or 2011. But one could hardly expect the secretary of energy to say otherwise and undermine the reforms from the outset particularly given that they have yet to be fully implemented. Importantly, key oil service contracts with novel monetary incentives have yet to be rolled out. The recent sectoral reforms are as good as it is going to get in this regard for some time. Though the reforms may seem timid at best, a significant amount of political capital was spent to achieve them.

Mark Thurber,
partner at Andrews Kurth LLP in Washington:  Though most of the intended effects of the broad reforms finalized by the Mexican government last November (the 'Energy Reform') have yet to be seen, the hardwon legislation lays the groundwork for changes to improve Pemex's reinvestment and production prospects. The Energy Reform provides greater autonomy for Pemex through a tailored governance regime designed to enhance flexibility of its economic performance and improve accountability among the company's subsidiaries. Recent improved financial ratings for Pemex appear to reflect a positive industry reaction to these corporate governance changes, even if some measures evidence a level of industry disappoint- ment in the breadth of the overall reforms. In order for Pemex to reverse declines in crude production (not expected until 2012, when proven reserve replacement is expected to reach 100 percent), it will need outside investment and technology infusions. The Energy Reform creates a new procurement system for Pemex, independent from procurement norms of the Mexican government. Pemex will have the right to grant to its contractors (and pay from its own revenue sources) economic incentives if the contractors are able reduce Pemex's costs and increase production, transfer technology to Pemex or their operations otherwise result in higher profits or more favorable results for Pemex. However, the Energy Reform—and specifically the corporate governance and procurement reforms— require implementing regulations. Work on these is underway, with their entry into force anticipated for later this year so as to enable Pemex to launch the new contractual scheme by 2010. The pace of Pemex's progress in reversing production declines (and raising much-needed capital to drill Mexico's offshore hydrocarbon reserves) will depend to a great extent on how effectively the Energy Reform is implemented and how Pemex wields its new budgetary and legal autonomy to manage capital spending and potential financial leverage.

Gianna Bern,
president of Brookshire Advisory and Research, Inc. in Flossmoor, Ill: The wheels of change turn slowly. In its current state, we may see limited benefits from Mexico's energy reform legislation. There is still a considerable amount of government bureaucracy, for lack of a better term. I do believe that energy reform measures are steps forward. The overriding concern over declining reserve replacement rates remains. However, Pemex has considerable 2P and 3P reserves. If Pemex could get past the bureaucracy and legislative issues, there is long-term potential. In the next several weeks, the government will unveil greater details on structuring service provider contracts. How these contracts are structured will be key. It is not too early to begin thinking about additional reforms. There may be little that any reform can do to halt the natural declining production levels, but there are reforms that can provide Pemex additional operating and financial flexibility in managing its business. The most notable is that of pension reform. We haven't heard much on this front and the political will may not yet exist to restructure the mounting legacy costs Pemex continues to incur. While pension reform is non-production related, legacy pensions utilize resources that could be deployed elsewhere. As for production declines, Chicontepec initiatives are the best hope to mitigate the effects of the natural decline in Cantarell. However, there have been project delays. Crude production increases by 2010 and 2011 may be optimistic. I think crude prices will continue their march forward helping the entire value chain with increased cashflow.

Republished with permission from the Inter-American Dialogue's weekily Latin America Energy Advisor newsletter. 




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