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

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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
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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.


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