IS MEXICO RUNNING OUT OF OIL?

UNCLAS SECTION 01 OF 03 MEXICO 001174 SIPDIS SENSITIVE SIPDIS STATE FOR WHA/MEX, WHA/EPSC, EB/ESC DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND SLADISLAW DOC FOR ITA/TD/ENERGY DIVISION E.O. 12958: N/A TAGS: ECON ENRG EPET MX SUBJECT: IS MEXICO RUNNING OUT OF OIL? Sensitive but Unclassified, entire text. Not for distribution outside the USG. Not for Internet distribution. Summary -------------- ¶1. (SBU) Production from Mexico's Cantarell complex of offshore oil fields, responsible for 61 percent of the nation's oil production, has begun to decline. Recent press reports suggest the decline rate could be as high as 25 percent per year. However, Pemex officials and industry analysts place the decline rate closer to 10 percent annually. While Pemex tells us they will be able to maintain national production through 2010 near the current 3.3 million barrels per day, without significant changes in legislation to exploit medium and long term prospects, Mexico will not avoid a precipitous decline after that date. Washington officials should consider reinforcing the private message to their Mexican counterparts that additional Mexican legislative flexibility will be necessary to ensure North American energy security. End Summary. The Future of Cantarell -------------- ¶2. (SBU) In December 2005, David Shields, a local journalist, reported a leaked Pemex study showing that production at Mexico's Cantarell complex would decline much more sharply than previously expected. The story lit off widespread debate and provoked a mini-tempest at the state oil company. Commentators have called the release a pre-election stunt, engineered by Pemex to ensure congressional support for planned Pemex investments. Others in industry have taken the release as confirmation that Pemex is mismanaging resources by producing excessive crude volumes to take advantage of high prices at the cost of damaging the Cantarell reservoirs. ¶3. (SBU) The study included five cases, the worst of which suggested that production from Cantarell, which reached 2.03 million barrels per day (MMBD) in 2005, would decline at near 25 percent per year to 520 thousand barrels per day (MBD) in ¶2008. Cantarell, called the second largest oil field on earth, represented 61 percent of all 2005 Mexican oil production. The study called increased encroachment of water into the reservoir's oil layer the primary culprit for the reduced volume figure. Shields told us that Pemex had already shut in a much higher than expected number of wells due to water encroachment. He reported publicly in December that Pemex had canceled additional wells planned for the field. ¶4. (SBU) Pemex immediately countered, noting that the negative report Shields had published was a "do nothing" base case, when, in fact, Pemex contemplated significant enhancements to maintain production. Nonetheless, in December the company published new Cantarell forecast that showed a more significant production decline to 1.905 MMBD in 2006; 1.683 MMBD in 2007; and 1.430 MMBD in 2008. The company also reported that total proven and probable reserves for the field as 6.9 billion barrels as of January 1, 2005. Pemex continues to make significant investments at Cantarell, continuing with infield drilling in those areas of the field that will support it. Additionally, Pemex will be installing water handling facilities in the field beginning in April ¶2006. ¶5. (SBU) CFO Juan Jose Suarez Coppel told EMINCouns and Econoff February 27 that Pemex was "reasonably comfortable" with Pemex Exploration and Production's decline rate of "less than ten percent per year" which he called "not trivial, but not catastrophic either." He agreed that the company had been "worried" about the decline since 2003. He added that investments made during the Fox Sexenio would permit Pemex to maintain production at relatively constant rates through ¶2010. Over the next four years, production from the Ku-Maloob-Zaap fields located close to the Cantarell complex in the Bay of Campeche should largely make up for declines from Cantarell. After 2010, Suarez Coppel said, Mexico's situation would require additional legislative flexibility to enable Pemex maintain total production volumes near the current 3.3 MMBD level. Without those reforms, production MEXICO 00001174 002 OF 003 would certainly fall. Given that oil revenue accounted for 40 percent of Mexico's federal budget in 2005, a decline of this magnitude would have serious economic consequences for the nation. ¶6. (SBU) Sergio Guaso, Pemex's Exploration and Production Vice President for New Business Models (Nuevos Modelos de Ejecucion) provided additional detail. Pemex's ability in the medium to long term to maintain Mexican crude production depends on its ability to successfully increase production from mature fields; significantly increase production from the Chicontepec field; and begin a deep water development program. Nonetheless, without relaxing or working around the Constitutional restrictions that reserve oil development rights for Pemex, the company will not be able to implement the three programs to the degree necessary to make up for the post 2010 decline. Mature Fields -------------- ¶7. (SBU) According to Guaso, a fifth to one half of Pemex's onshore reserves are in fields with old facilities and low production that Pemex overhead makes too expensive to produce. Through new contracting mechanisms, Pemex will develop ways to contract operation of the fields to outsiders. Possible first candidate fields for this treatment include Cinco Presidentes and Poza Rica in the state of Tabasco and Altamira in Tamaulipas. Guaso was beginning to develop a contracting model that would allow an outside operator to take on this operational responsibility. Current Pemex union employees, now without gainful employment because production is shut in, remain on the payroll. The proposed scheme would have those unproductive employees begin work on those fields for management firms. While Pemex was not at the point where it could present a formal proposal, Guaso expected an initial release of the plan "soon." He had already held exploratory talks with Slumberger on participation in the venture. Chicontepec -------------- ¶8. (SBU) Discovered in 1926 and producing since 1952, Pemex estimates that the field contains 1/3 of all Mexico's proven reserves (approximately 2 billion barrels). Nonetheless, because of the extremely tight reservoir, production now is now very low. Current recovery in the reservoir is approximately 4 percent while production costs are approximately USD 15 per barrel. Guaso noted that Chicontepec's structure is similar to the West Texas Spraberry Field now being developed by Pioneer Natural Resources of Irving, Texas. Without the technology and experience of firms like Pioneer, Pemex will not be able to develop significant production from the field. Guaso said that Pemex had held initial discussions with Pioneer and wanted to move further, but needed a contractual mechanism that would provide Pemex the ability to work with a partner. This would entail not only a significant change in Pemex's operating statutes, but concurrent political buy-in. ¶9. (SBU) Pemex had depended on "Multiple Service Contracts" (MSCs) to attract outside service companies to work on Pemex projects on a fee for service basis. Most foreign companies with the necessary expertise, however, were not interested in this arrangement because it forced the outside participants to risk the same investment but capped the revenue stream an outsider could receive to the amount of the contract. While outside firms sought an equity stake with theoretically unlimited upside potential, Mexican constitutional restrictions prohibited granting of any equity stake in production. Guaso was developing a financial agreement that, while it would not allow a company to "book" Mexican reserves in the traditional sense, might be able to offer a potential partner in these fields a cash flow stream that would be based on production from the field without offering ownership of the reserves. While Pemex expects only 30 MBD out of Chicontepec in 2006, with the application of more advanced technology, this could increase to 300 MBD by 2012. Deep Water -------------- MEXICO 00001174 003 OF 003 ¶10. (SBU) As step further, Pemex Exploration and Production has also convened a working group chaired by Planning Vice President Vinicio Suro to begin developing the methodology necessary to begin joint ventures for deep water development. Guaso suggested that such a contract would also provide a Pemex partner a guaranteed cash flow based on production from the developed field and the hydrocarbon price. While Guaso agreed the move would not require a Constitutional change, it, like the development of Chicontepec, would require significant political buy-in and changes to legislation beyond those currently contemplated. Given the long (10 years or more) lead time for deep water development, even if Pemex started today, new production would not come on line until well past the 2010 mark. Pemex Reform -------------- ¶11. (SBU) Pemex's execution of these major medium and long term developments hinges on its ability to circumvent or alter federal procurement rules. The Mexican Chamber of Deputies briefly considered a proposal which included such a provision at the end of 2005. Informal debate continues during the just-opened 2006 session in the Chamber of Deputies and Senate Energy Committees, though no member has brought forward a specific draft. Guaso punctuated the problem noting that right now, to build an offshore platform, Pemex must follow the same procurement rules that the Secretary of Education uses to build a school. Such SIPDIS contracting rules would make partnership schemes like the ones described in the Chicontepec and Deep Water examples in the previous paragraphs impossible. Both Guaso and Suarez Coppel characterized the reform proposal as having broad based support with both the PRI and the PRD supporting the changes. Staffers from the Senate and Chamber of Deputies Energy Committees have told us separately that representatives from the Secretariats of Energy and Economy, as well as Pemex, are working with Committee members to prepare a bill (dictamen) that would include the government's proposals. Their goal is to have a draft agreed by all parties approved before the end of this session (in April). No actual draft has yet been prepared, though the legislators say they are committed to have it ready by the end of March. Comment -------------- ¶12. (SBU) Mexico is not running out of oil, but the continued investment plan for Pemex at Cantarell will likely result in a ten percent per year decline over the next four years. Production from Ku-Maloob-Zaap should largely counterbalance this production decline through 2010. After that, any significant Mexican production volume increase would come only as a result of real policy reform. The measures already in play for this April are only a first step, and even in this case, the likelihood that these reforms will pass is in question. Discounting the Cassandras that expect a precipitous fall in Cantarell production, and assuming oil prices stay at least flat, the government entering in December will still have to begin the next set of reforms immediately to permit the new developments needed to offset a significant fall in production after 2010. While we should avoid making public pronouncements about this very sensitive sector of the Mexican economy, it may be appropriate to tell senior Mexican officials privately that Mexico's own economic security will hinge its ability to bring needed expertise and capital to the sector. The upcoming SPP and BNC would provide opportunities to reinforce this message. Visit Mexico City's Classified Web Site at http://www.state.sgov.gov/p/wha/mexicocity GARZA