Mexico's Oil Dilemma

As production declines, state-run Pemex struggles to find new reserves under daunting restrictions on foreign involvement

Carlos Morales Gil, head of exploration and production for Petróleos Mexicanos, or Pemex, Mexico's state oil company, is sunburned. But it's not because of his frequent visits to offshore oil rigs in the Gulf of Mexico; that out-in-the-sun-too-long look is from a weekend spent in a dusty ring, waving a red cape in front of raging 550-pound bulls.

Morales' passion for amateur bullfighting may come in handy in his day job, where he commands thousands of engineers and roughnecks attempting to coax oil from Mexico's complex onshore fields and from thousands of feet below the ocean floor. Like his bosses at Pemex, the world's sixth-largest oil producer, Morales needs grit and fancy footwork to keep the oil flowing in spite of the many restrictions placed on the company by nationalist politicians determined to keep foreign oil companies from partnering with Pemex.

As Mexico's Congress prepares to debate an ambitious energy reform (BusinessWeek, 4/24/08) aimed at modernizing Pemex so that it can stem a precipitous drop in the country's oil production, engineers such as Morales are racing to drill as many wells as possible to discover new reserves. Last year, Pemex drilled 700 wells; this year, around 900 will be completed. "Not many oil companies in the world do that," says the 54-year-old Pemex veteran.

The Days of Easy Oil Are Over

For decades, Mexico has been the world's leading producer of oil from shallow waters, thanks to its Cantarell field in the Gulf of Mexico. Cantarell is the world's second-largest "super-giant" field. Since it was discovered in the mid 1970s, after a local fisherman complained to authorities about oil slicks ruining his nets, Cantarell has provided two-thirds of Mexico's oil production. While a well drilled onshore might typically yield a few hundred barrels per day, some Cantarell wells in the past would serve up gushers of as much as 50,000 barrels a day. That's one reason it costs just $4.20 a barrel to "lift," or pump, a barrel of oil in Mexico.

Today, though, the days of super-cheap, super-easy oil are over. Cantarell is near the end of its useful life, its production dropping 15% per year over the past few years. Today, a typical Cantarell well might produce around 8,000 barrels a day, Morales says, and the reservoir provides just 45% of Mexico's oil. The country's crude oil production peaked at 3.38 million barrels per day in 2004, but by March of this year had fallen to just 2.8 million. Mexico, which in 1999 had 25 billion barrels of proven oil reserves, neglected its exploration duties when oil was easy. Much of the country's drilling equipment became obsolete during years of low investment, Morales says. As a result, the country has just 14.7 billion proven barrels today.

Stepping Up Exploration

At current rates of consumption, that oil will last only 9.2 years, which means Mexico could stop exporting oil within a decade. "Unless something is done quickly to allow Pemex to operate more as a real oil company, and not as a bureaucratic state-run firm, it will become a marginal exporter in the very short run," says David Shields, a Mexico City-based energy analyst and author of two books on Pemex.

That would be a national disaster. The country's treasury relies on Pemex for nearly 40% of overall tax revenues, and oil exports, which in 2007 were worth $44.4 billion, account for around 10% of the country's export revenue. The government has known for years that Cantarell would start declining around now, but Finance Ministry officials ignored the entreaties of Pemex engineers to reduce the oil giant's tax burden so that it would have more funds for investment in exploration. Finally, in 2003, the message was heard.

So now, Morales is stepping up exploration efforts: Four years ago, Pemex spent just $200 million annually on exploration, and this year, it will spend 11 times that much. But Pemex needs more than money: It needs to tap foreign companies to find enough oil to reverse the downward slide.

Potential Reserves in the Gulf of Mexico

Already, oil-service companies such as Houston's Schlumberger (SLB) and Halliburton (HAL) and Irving (Tex.)-based Fluor (FLR) are heavily involved in the efforts (BusinessWeek, 1/3/08). They, along with other smaller service companies, drill two-thirds of Pemex's wells and conduct nearly all of the seismic work needed to locate oil reservoirs.

But Mexico's largest potential reserves are believed to be located in the deep waters of the Gulf of Mexico, as much as 10,000 feet below the surface. Pemex does not have the technology or the expertise to go after that deepwater oil. Over the past five years, it has drilled six test wells in waters about 3,000 feet deep, finding some gas, but it needs the help of international oil companies, such as Brazil's Petrobras (PBR) or Norway's StatoilHydro (STO), to mount a concerted deepwater campaign.

However, Mexico's constitution, which declares that all oil belongs to the state, bars Pemex from signing conventional "risk" contracts with international oil majors that would compensate them in oil or cash for the amount of oil found. Representatives of oil companies in Mexico say it makes little sense for them to invest hundreds of millions of dollars in a joint venture with Pemex and lend their expertise if they would be unable to register proven reserves on their books, as they normally do.

Nationalized Oil a Sacred Cow

Even if the foreign companies were willing to join forces with Pemex under simple service contracts just to get their foot in Mexico's door, nationalist politicians would likely mount a legal challenge to their presence. Over the years, successive governments have interpreted the constitution very narrowly as barring all participation by private companies in exploration and production activities of any sort.

When Cárdenas nationalized the oil industry in 1938, kicking out American and British companies, thousands of Mexicans applauded, donating family jewelry and their hard-saved pesos to the government to help pay for the expropriation. Sixty years later, Pemex remains a sacred cow for most Mexicans, who view with suspicion any effort to expand the activities in which foreign oil companies are allowed to engage.

So Morales does what he can. "We just want to be able to work with them [the international oil companies] to do more of the work that we're already doing—to find and pump more oil," he says. Pemex has technical cooperation agreements with a handful of foreign oil companies, which has allowed Morales' team to learn more about directional drilling (i.e., drilling at angles and sideways through rocky formations, instead of drilling straight down, to aim directly at oil reservoirs) and deepwater formations.

Yearning for Joint Ventures

What do foreign oil companies get from the deal, apart from garnering goodwill and getting a rare inside glimpse into the way Pemex is run? Morales says they learn from Pemex about producing the heavy crude that Mexico is known for, and about working with oil flows under high pressure, at high temperature, and within the fractured rock formations typical of Mexico's geology.

Others are more skeptical that the technical cooperation is that significant. David Victor, who heads Stanford University's Program on Energy & Sustainable Development and is coordinating exhaustive studies of the world's leading state-run oil companies, including Pemex, believes the technology-sharing agreements are less about technology than they are about strategic posturing for the day when Mexico may be ready to work more readily with foreign oil majors. "The foreign oil companies don't know what the future is going to look like, so they're jostling for a place in line, to get some information and connections that might be useful in the future."

What Pemex would really like to do is form joint ventures with foreign oil companies to explore for deepwater oil so that its own engineers can learn the ropes. Last year, Brazil's Petrobras approached Pemex about forming a joint venture to drill for oil on the U.S. side of the Gulf of Mexico, and five other foreign companies have made similar offers, Morales says. Forming such partnerships overseas would allow Pemex to gain deepwater experience it could later apply at home. (Such offshore deals aren't unprecedented: In the 1990s, Pemex joined with the private sector in a successful oil exploration and production venture in Argentina, which it later sold. And, with Shell Oil, it jointly owns an oil refinery in Texas where much of the gasoline that Mexico imports is refined.) Morales says Pemex is currently studying the offers to see whether they make strategic sense. "We haven't made a decision yet; we're still evaluating those projects to see if they are better than projects we have here in Mexico," he says. Pemex is only barred from forming such joint ventures at home, where Mexican oil reserves are in play, he says.

Chicontepec Contracts

That may change if the energy reform now under consideration by Mexico's Senate is approved. For now, Morales' team is limited to working with the oilfield service contractors. Since last year, Schlumberger, Halliburton, and Fluor have won contracts (, 4/15/08) to drill hundreds of onshore wells in southern Mexico, including a promising area called Chicontepec. Chicontepec is a complicated field, with dense rock structures that will make it necessary to drill some 15,000 wells, each of which may produce just a few hundred barrels of oil a day.

Pemex is relying on the oilfield service companies to do much of the work because they can deliver a well 20% faster than Pemex employees can, and with fewer operators, Morales says. "The faster we can start pumping the oil, the more quickly the revenues start flowing." That is key to maintaining Mexico's status as one of the world's top oil producers—and exporters.

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