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. Visit Mexico City's Classified Web Site at http://www.state.sgov.gov/p/wha/mexicocity GARZA