MEXICO'S PLANS TO AVERT AN OIL CRISIS

UNCLAS SECTION 01 OF 05 MEXICO 005810

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: MEXICO'S PLANS TO AVERT AN OIL CRISIS

REF: MEXICO 1174

Sensitive but unclassified, entire text.

Introduction and Summary
--------------


1. (SBU) In the next 3-4 years, Petroleos Mexicanos
(Pemex) will likely be able to keep Mexican oil production
from falling sharply; however, in the medium to long term,
the outlook is considerably less certain. From 2010 on,
production volume will depend on Pemex's ability to get
significant production from deep-water in the Gulf of Mexico
and the technologicly challenging Chicontepec field. In
March 2006, Embassy Mexico reported on the decline of the
Cantarell oil field and Mexico's plan to replace that
production (reftel). Six months on, we spoke with Pemex and
GOM officials and outside consultants and observers to see
how Pemex was coping with the decline. In the intervening
six months, daily production from Cantarell has declined
about eleven percent. Pemex publicly calls for the drop in
Cantarell production to be made up in the short term from
production from the Ku-Maloob-Zaap business unit. To develop
the Chicontepec field and deep-water production from the Gulf
of Mexico Pemex must resolve a series of technical and
political challenges for which it is not prepared. End
introduction and summary.

Mexican Production
--------------


2. (SBU) Without hoped-for reforms to either the Mexican
energy sector or to the laws governing the operation of
Petroleos Mexicanos (Pemex),the company officially predicts
that nation-wide crude production will remain nearly constant
at from 3.3 million barrels per day (MBD) in 2006, down from
3.5 MBD in 2005.

Forecast Mexican Crude Production
2005-2010
Source: Pemex Statements
in millions of barrels per day (MBD)


2005 2006 2007 2008 2010
est est est est
-------------- -------------- -------------- -------------- --------------
3.3 3.3 3.2 3.3 3.3


Cantarell Decline
--------------


3. (SBU) Pemex's Cantarell oil field reached peak
production in 2004 and is now steadily declining. The field
currently makes up 61 percent of Mexican oil production. The
precise magnitude of the total decline in Mexican production
depends on (1) the decline rate of the field, as well as (2)
the rate with which Pemex can bring new production on line to
make up for the drop. This cable will review the various
scenarios for both the drop in production, and consider the
options Mexico will have to make up this lost production from
future developments. Based on best estimates released
recently, Pemex and other observers expect that Cantarell
will decline as follows:

Forecasts for Cantarell Field Decline
2005-2008
Source: as shown with date
in millions of barrels per day (MBD)

2005 2006 2006 2007 2008
act ytd est est est
-------------- -------------- -------------- -------------- --------------
Pemex Expected 2.03 1.86 1.90 1.68 1.43

Consultant I 1.90 1.70 1.52
(8/06)

Consultant II 1.93 1.73 1.46
(9/06)

PEP Informal 1.83 1.50 1.38
Forecast
(9/06)

MEXICO 00005810 002 OF 005



Pemex 1.54 0.87 0.52
"Do-nothing"
Case
(12/05)

As of August 2006, the most recent month for which public
production data is available, daily production in the field
had already dropped to 1.75 MBD, though senior Pemex
officials we spoke with note production in October-December
2006 may rise slightly as construction projects in the field
are completed.


4. (SBU) As Pemex produces the Cantarell reservoir, the
declining oil volume creates a number of technical challenges
that will reduce production volumes further. The Cantarell
reservoirs have a gas cap over an oil layer that in turn sits
over a layer of water. To continue to produce the Cantarell
field, Pemex injects nitrogen into the gas cap over the oil
layer. This assures that wells continue to flow freely as
the remaining oil in place is produced. The injection
increases the rate of oil recovery but also contaminates the
gas on top of the oil. As this happens, wells can produce
significantly more gas or water. Once the level of water
coming from a particular well increases beyond what can be
handled (traditionally, 20-30 percent by volume),the well
has to be "shut in" until steps can be taken to separate and
dispose the excess water. On the same principle, the well
also must be shut when it produces too much gas to avoid
reducing the overall reservoir pressure. As wells are shut
in due to excess gas or water flow, production from the field
drops. Plans for three-phase separators to handle the
additional water and gas have the equipment slated to come on
line later in 2006, allowing wells to produce as much as 40
percent water without affecting crude quality.


5. (SBU) Additionally, dissolved salt from the water can
leech into the oil layer affecting the oil's quality. Once
the salt concentration becomes too high for the oil to be
sold, the well also has to be shut in until steps can be
taken to address the higher concentration.


6. (SBU) Pemex is developing projects to control the quality
of gas and oil being produced, including equipment to
separate nitrogen from the gas in the gas cap and to
desalinate the produced crude. According to Pemex, these
investments should allow continuous production from Cantarell
regardless of the positioning of the oil/water boundary and
delay overall decline. Nonetheless, installation of the
water handling equipment has been delayed by at least a
month. Furthermore, as a result of Katrina-related
construction delays, nitrogen recovery equipment will be
delayed by four months. These delays, according to Pemex,
have led to additional lost production in 2006 that should be
partly reversible by early 2007.

Future
--------------


7. (SBU) In an October 10 presentation, Pemex Exploration
and Production (PEP) Chief Operating Officer Carlos Morales
Gil laid out Pemex's four-part strategy for managing
Cantarell's decline: (1) Conduct additional studies to better
model the field and improve exploitation schemes. (Observers
have noted that Pemex has a relatively poor understanding of
the Cantarell reservoir's mechanics.); (2) Conduct additional
analysis of fractures to ensure production of remaining oil
in place; (3) Optimize the field's infrastructure during the
decline and divest assets as necessary; and (4) Conduct an
analysis of the Akal field with a view to include new
reserves.


8. (SBU) Although it is not currently budgeted, Energy
Secretariat Technical Advisor Edgar Rangel added that, in his

SIPDIS
view, Pemex will have to consider enhanced oil recovery (EOR)
techniques for the field for those areas that have already
been "swept", that is once the oil/water boundary has
"pushed" oil completely away from the well bore. Pemex and
GOM officials also suggest horizontal wells be drilled in
Cantarell to most effectively drain the shrinking reservoir.
The idea is in the planning stage as a priority for
2007-2008, though Pemex Exploration and Production CEO Marcos
Ramirez told us, the plan would be "difficult to immediately
implement." Pemex engineers, who have never drilled a
horizontal well, are currently working with North Sea

MEXICO 00005810 003 OF 005


producers to develop expertise in this area.


9. (SBU) Accoding to a July 2006 presentation by Pemex
officials of the company's capital budget projection,
Cantarell will not be a "first-priority" in the budget for
the first time in 2007. The Ku-Maloob-Zaap business unit
(KMZ) and Chicontepec development capital spending will be
more significant. According to senior management at Pemex
Exploration and Production, company officials expect
Cantarell production to drop below 1 MBD by 2012-2013 and
have presented this view to the Calderon transition team.

Opportunities to Make Up
--------------


10. (SBU) As reported reftel, Pemex states that in the next
3-4 years, production lost from Cantarell can be made up by
production from KMZ immediately northwest of Cantarell in the
Bay of Campeche. Over the medium and long term, Pemex
believes that the onshore Chicontepec field and eventual
developments in deep-water will maintain production near
current levels of 3.3 MBD.

KMZ in 2009-2010
--------------


11. (SBU) KMZ has been in production since 1981. After
Cantarell and Chicontepec, it represents the third largest
Mexican producing area in terms of reserves. When business
unit operations started in 2002, Pemex had announced its
intention of increasing production to between 700 and 800
thousand barrels per day (kBD) by instituting a significant
drilling program and injecting nitrogen for pressure
maintenance.


12. (SBU) According to Pemex and Energy Secretariat (SENER)
officials, KMZ drilling work is "slightly behind schedule",
and additional nitrogen injection capacity is slated to come
on-line in "late 2007". Currently producing about 400 kBD,
Pemex officials we spoke with agreed that the 800 kBD would
be reachable between 2009 and 2010. Most of the work
required to reach this production volume is drilling in the
Maloob and Zaap fields.


13. (SBU) Currently, most production from the Ku field is 22
degree API oil; similar to the current Mexican Maya blend
crude. Most future production will be much heavier 12-13
degree API oil from the Maloob and Zaap fields. To make the
Maloob and Zaap production marketable, Pemex plans to blend
it with onshore light oil production from Tabasco State, to
reach the Maya blend specifications. Current plans call for
blending in a Floating Production Storage and Offloading
(FPSO) vessel to be permanently moored in the area in the
"first half of 2007." The FPSO will have capacity for 600
kBD of oil handling. 2.5 MBD of oil storage and 120 MSCFD of
gas compression. According to Pemex Marketing, when the KMZ
FPSO comes on line, the Mexican Maya blend viscosity will
drop by 1/2 degree API and the crude will become sourer. The
blending process should permit sales to remain
on-specification.


14. (SBU) Rangel raised concerns that in order to ensure
sufficient light, sweet crude for blending with KMZ
production, Mexico may likely have to begin EOR techniques in
the Tabasco fields. Rangel also noted that Mexico had begun
looking to outside companies for experience with "upgrading,"
a kind of in-situ refining process, as another option for
making the Maloob and Zaap heavy oil lighter and thus more
marketable.


15. (SBU) In order to gain the benefits of KMZ production to
offset the Cantarell decline in the short and medium term,
Mexico will have to continue the aggressive drilling program
in the area, and meet the technical and business challenges
the fields' extra-heavy oil will present. It is in
recognition of these challenges that most observers,
including PEP Chief Operating Officer Carlos Morales, agree
that production can reach the 700-800 kBD range for the
complex; though it is very possible the production plan could
shift as a result of delays.

Chicontepec 2010-2013
--------------


16. (SBU) In 2003, Pemex contracted a consortium of

MEXICO 00005810 004 OF 005


Schlumberger and ICA/Flour Daniel to conduct a 300 well pilot
in the Chicontepec field to examine the feasibility of
producing from the giant reservoir. Active for over 50
years, production has always been difficult and expensive;
nonetheless, Pemex estimates the 72 mile long by 18 mile wide
field has 136.5 billion barrels of oil in place, though 2P
(proven plus probable) reserves are 6.6 billion barrels,
second only to Cantarell.


17. (SBU) The challenge is that the Chicontepec reservoir is
"tight," not allowing oil to flow to the well bore and the
reservoir pressure is very low. If the pilot is a success,
Pemex's current plans call for a 13,000 well development plan
at a total cost of USD 25-30 billion. Our GOM interlocutors
admit that "no real exploitation plan is in place for
Chicontepec," but observers mention a possible 320 kBD peak
in 2013 in the first phase.


18. (SBU) Even this first phase depends on the outcome of
the pilot project. Assuming technological solutions are
found to address the tight formation, full development would
still involve significant social, political, and financial
challenges. The 13,000 wells will have to be drilled in an
area with over 2,200 communities causing significant
disruption and displacement. According to PEP CEO Marcos
Ramirez, production costs for the field originally about USD
4.50 per barrel are likely to exceed USD 7 per barrel.


19. (SBU) Given Pemex's current tax position, without a
further change to its fiscal regime, the company would lose
money when producing from Chicontepec. Before large scale
development can begin, Pemex will have to work with the
Finance Secretariat (Hacienda) to modify the tax structure to
permit Pemex to develop the resource without losing money,
most likely by changing the fiscal regime for fields with
high production costs.

Deep-Water Challenges in the Long Term (post 2010)
-------------- --------------


20. (SBU) Pemex has previously announced that it believes 54
billion barrels of oil equivalent are in place to be produced
from deep-water deposits in the Southern half of the Gulf of
Mexico. In their long-term plans, according to PEP CEO
Marcos Ramirez, the company plans to produce 500 kBD for its
own account from 400-500 deep-water wells by 2016.
Nonetheless, beyond the political obstacles, Ramirez admits
Pemex lacks both the technology and the investment to move
forward with deep-water development. Pemex officials admit
that the 500 kBD figure is an optimistic one given the
difficulty of constitutional reform.


21. (SBU) PEP Chief Operating Officer Carlos Morales laid
out a five-part strategy for Pemex deep-water development at
an industry meeting October 10. The strategy called for the
company to: (1) accelerate incorporation of deep-water
reserves through exploration; (2) accelerate deep-water
production through definition of production goals; (3)
strengthen Pemex deep-water ability throughout the value
chain;(4) Increase PEP ability to execute through work with
third parties; and (5) insure that drilling resources are
available. Morales went on to say that for Pemex,
partnership with third parties was not an option, but rather
the only way the company could meet its production goals. He
added aggressively that if Constitutional change were
required to make this possible, it was Pemex's responsibility
to see that it happened.


22. (SBU) According to SENER Hydrocarbon Director General,
Rafael Alexandri, Mexico will drill approximately 4 wells per
year in deep-water -- up to 1000 meters water depth --
through 2009. While company officials admit that significant
reserves lie even deeper, technology and rig availability
keep Pemex from drilling in water more than 1000 meters deep.
Its most recent effort, Langkawasa cost $48 million to
drill, and Pemex expects Mexican "deep- water" wells cost
about $60 million each a current prices.


23. (SBU) Alexandri told us he believed that given changes
in the market, and the growing market power of service
companies, Mexico could find enough expertise to allow them
to continue with an exploration and development program that
will enable Mexico to remain at 3.3 MBD average until the
Mexican congress is able to pass realistic reforms to allow
some form of partnership with outside expertise.

MEXICO 00005810 005 OF 005




24. (SBU) At the same time, he believes that given the size
of the opportunity, the International Oil Companies would
remain in Mexico to make certain that the service companies
do not take too large a share of the relationship.


25. (SBU) Strategically, Alexandri added, once political
restrictions are lifted, Pemex would like to drill its own
"discovery" wells in deep-water first to give it more
leverage to negotiate with international partners on
development. To assist in Pemex negotiations with
international firms, Pemex would most likely go with a
consortium model to allow Pemex to work off of all the
members in an outside group, rather than trusting a specific
one.

Comment
--------------


26. (SBU) While the worst-case scenario predicted for
Mexican production decline has not materialized, the 11
percent drop from Cantarell in the past six months is steep.
We believe that production plans from the KMZ business unit
will be almost enough to mitigate the somewhat larger than
expected decline from Cantarell resulting in just slightly
reduced Mexican production through 2009. This seems to match
anecdotal reports we have received from local U.S. company
representatives who tell us that Pemex Marketing Officials
warned U.S. Gulf Coast customers in August that the company
would not be able to regularly fulfill all of their
contracted deliveries next year. After 2010, Mexican
production will depend on Pemex's ability to get large
volumes from Chicontepec and deep-water. Whether or not
Chicontepec makes up large volumes will depend on Pemex's
ability to tackle the technical challenges involved, as well
as maintain a robust (greater than 1000 wells per year)
drilling schedule. Pemex's success in deep-water will depend
on changes to Mexico's constitution that would allow
partnerships with third parties, a far from certain outcome
despite bold statements from Pemex management.


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