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Pemex: Bigger Budget Not Enough

A bigger budget won't be enough to help Mexican oil company Pemex meet its goals, experts say.

Inter-American Dialogue 

Mexican state oil company Pemex could receive enough support from lawmakers to boost its budget by 54 percent to a record $31 billion in 2011, Bloomberg News reported July 29. Will the budget increase be enough to help Pemex reach its goal of increasing production to 3.3 million barrels per day by 2024? What other structural changes at Pemex, in addition to budget increases, could improve the company's chances for increasing production?

Gianna Bern, president of Brookshire Advisory and Research in Flossmoor, Ill.: I don't think additional capital spending is the primary answer to increasing Pemex's crude oil production. While budgetary increases to $31 billion could help, Pemex is in need of significant structural changes. Urgent problems require urgent solutions to stem the tide of declining crude production. Mexico needs the political will to open the oil and gas market to outside third-party investment by allowing the majors to participate in the Mexican market beyond the role of service providers. Mexico has never adopted this position, which would require constitutional changes. Over the years, various energy regimes have been passed and implemented, but none of which accomplished what really needed to be done. A budgetary increase of $31 billion may help with technology, but Pemex increasingly needs partners with significant technological acumen. The global majors could be interested in Mexico if the political climate were more progressive and Pemex was allowed greater autonomy in its bidding and procurement process. Ironically, Pemex has impressive 2P and 3P reserves. This is an example of Pemex's continuing need to invest in various developmental technologies to convert these reserves to commercially viable proven reserves (1P reserves). This process will take years. The Mexican government should lower Pemex's corporate tax rate and reduce fiscal dependence on Pemex so that it has increased financial flexibility to react to market changes. Pemex still has one of the highest corporate tax rates among national oil companies. Finally, lowering pension fund contributions and associated legacy costs will contribute to a reduced debt burden.

Duncan Wood, professor and director of the International Relations and Canadian Studies Programs at the Instituto Tecnológico Autónomo de México: The announcement of an increased budget for 2011 would certainly raise hopes of changing Pemex's fortunes, but much depends on how this new money would be spent. In addition to the urgent need to invest more in exploration and production, Pemex faces enormous debts that require expensive servicing, as well as pension and benefits liabilities that threaten to bankrupt the company. It would therefore be crucial to determine how much of the new money is directed toward these liabilities and how much toward increasing production and reserves. At present, the situation does not look good. Pemex has drilled fewer exploratory wells and has found fewer productive wells in the first six months of 2010 than it did in the same period last year. What's more, the company has announced that it will further cut back drilling in the Gulf of Mexico next year. Less exploration will likely mean fewer discoveries; fewer discoveries will likely mean a further drop in reserves and production. However, two reasons for optimism are on the horizon. The first is that the company is shifting resources away from the disappointing Chicontepec project and toward E&P in shallow waters in the gulf and adjacent onshore fields. This should produce a better return on investment. Second, Pemex has once again promised that incentive-based contracts will soon be ready, this time claiming that they should be issued in October. Such contracts are vital to generating greater interest in E&P from private sector partners.

George Baker, publisher of Mexico Energy Intelligence: Lawmakers' initial reaction to Pemex's budget increase proposal was positive, but there are multiple reasons for doubt about the probability that it will be approved and executed with the advertised results. First, the idea that adding more money to Pemex's capital and operating budgets will improve Mexico's political economy and its national oil company is incorrect. Pemex should not be asking for more money, but rather legal permission to act like any other national oil company of its size and stature. Pemex should have the ability to enter joint ventures and alliances, as former Pemex Director Jesús Reyes Heroles said in February 2009. A year and a half later, no progress has been made on this critical element of public policy. As a result, the new money that Pemex is asking for will be funded by Mexican taxpayers who assume all the geological, operational (think BP) and market risks. As for Mexico's petroleum endowment, Pemex has estimated that 50 billion barrels of oil equivalent of undiscovered resources exist. Presumably, Pemex anticipates substantial amounts of additional investment capital from oil companies (IOCs) who would operate in Mexico under technical service agreements (TSAs). In order to be able to reverse the declining of reserves and increase production, in the following five years, Pemex in combination with IOCs must triple its annual investment in exploration. But there are still structural problems. The upstream regulator—not Pemex—should manage contracts dealing with the national patrimony. Such a change is presently impossible, however, as the National Hydrocarbon Commission is an advisory body, not a regulator. Unfortunately, then, a bigger budget for Pemex, at least in the upstream, will not deliver the long-term, sustainable results that are achievable but only by changing the optics.

John D. Padilla, Managing Director, IPD Latin America: Should Mexico's Congress approve an aggressive capital expenditure allocation, given the austere 2011 federal budget, it is unlikely that such a move alone will help Pemex return to its 3.3 million barrels per day heyday. In addition to more money, Pemex also wants further cuts to its punitive tax regime—tough requests for the government to balance. Although Pemex's recent revenues have remained robust due to crude oil prices, the federal government's tax take has dropped; its 2009 take was about the same as it was in 2004. If further cuts are made, it will be the fifth Pemex fiscal reform in six years. Such tinkering reflects systemic problems. But increasing the Pemex budget seems to be the only thing congressmen can agree on, despite the strategy's limited potential for success. Between 2004 and 2010, Pemex received more than $100 billion in funding from Mexico's government for capital expenditures, an average of nearly $17 billion per year. During those years, crude oil production fell more than 800,000 barrels per day. With reserves continuing to slide and limited new major discoveries, Pemex has little to justify a bigger budget. Incomplete strategies, like those for deepwater (Pemex will receive three expensive semisubmersible rigs within six to 12 months, but just decided to refrain from drilling in 2,000 meter-plus waters through at least 2010) are also problematic. Moreover, Pemex's debt burden is nearly $100 billion and the company has negative equity (-$6.5 billion)—largely due to the tax regime. We doubt that another year of large CAPEX allocation alone will resolve the company's ailments.

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


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