MEXICAN OIL PRODUCTION DECLINING - IMPLICATIONS FOR MEXICO,

UNCLAS SECTION 01 OF 03 MEXICO 000042 SENSITIVE SIPDIS STATE FOR WHA/MEX, WHA/EPSC STATE FOR EB/ESC MCMANUS AND DUGGAN USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD USDOC FOR ITS/TD/ENERGY DIVISION TREASURY FOR IA (ALICE FAIBISHENKO) DOE FOR INTL AFFAIRS ALOCKWOOD, GWARD AND RDAVIS DOI FOR MMS ORR, TEXTORIS AND KARL E.O. 12958: N/A TAGS: ENRG EPET ECON PGOV MX SUBJECT: MEXICAN OIL PRODUCTION DECLINING - IMPLICATIONS FOR MEXICO, THE U.S. AND BILATERAL COOPERATION REF: A. 08 Mexico 3491 B. 08 Mexico 3210 ¶1. (SBU) Summary: As the largest source of export earnings and contributor of over one third of budget revenues, the oil sector is a critical component of the Mexican economy. Due to the decline of Mexico's largest oil field and underinvestment in new exploration and exploitation, Mexican crude oil production is declining rapidly. The Calderon Administration's October 2008 modest energy reform will internally strengthen Pemex, Mexico's state owned oil company, but will not address the key issue of opening the sector to foreign investment. For Mexico, declining oil income will require the GOM to search for alternative sources of revenue - perhaps through increased tax collection. For the United States, declining imports from Mexico will lead to our relying more heavily on countries outside North America for crude oil imports. Implementation of Mexico's energy reform offers some opportunities for increased bilateral collaboration which could allow for closer cooperation on hydrocarbons and other energy issues as these production changes take effect. -------------- CURRENT SITUATION -------------- ¶2. (SBU) Until recently, Mexico was the second largest supplier of crude oil and petroleum products to the U.S., providing over 1.7 million barrels per day of crude oil to the United States in 2006. Declining production and increased domestic demand have since caused Mexico to slip to third and occasionally fourth place behind Canada, Saudi Arabia and Venezuela. From January to October 2008, average Mexico crude oil exports slipped to less than 1.2 million barrels a day. Although some of the decline can be attributed to Gulf of Mexico hurricanes which disrupted production, Mexican oil exports to the U.S. clearly are on a downward trajectory. Declining imports from Mexico will require the U.S. to relying more heavily on countries outside North America for crude oil imports. ¶3. (SBU) The oil sector is a crucial component of Mexico's economy and is the largest source of export earnings for the country, accounting for 10 percent of all export earnings. However, Mexico's oil production has declined rapidly since 2004 and there are no signs that this decline can be arrested in the short to medium term. From January to September 2008, Mexican petroleum production declined by 9.5% over the same period of 2007 and reached its lowest production level since 1995. Mexico has relied heavily on the Cantarell oil field, one of the largest fields in the world. Despite nitrogen injection and other enhanced oil recovery techniques, the Cantarell field has entered a stage of long-term decline with production falling by more than 50% from its peak of over 2 million barrels a day in 2004 to less than 900,000 barrels a day in December 2008. Pemex projects that the decline is likely to continue at a rate of 14% a year. ¶4. (SBU) The Mexican government's reliance on oil revenue to finance over one third of the federal budget has deprived Pemex, Mexico's state owned oil company, of capital needed for exploration, production and infrastructure projects. As a result of decades of underinvestment, Pemex today finds itself without alternative oil fields which could compensate for Cantarell's decline. Pemex has accelerated the development of the giant Chicontepec oil basin with contracts for 500 new wells expected to be awarded in early 2009. Although the Chicontepec fields are estimated to contain almost 9 billion barrels of reserves, Chicontepec is a complex reservoir which involves technical challenges and significant operational costs. Exploiting Chicontepec will require high risk investments and the drilling of a large number of wells for relatively small returns. Many experts believe that even with substantial investments, Pemex will have a difficult time reaching its 600,000 barrel a day production goal by 2021. Other fields Mexico is currently exploiting - Ku Maoob Zaap, Crudo Ligero Marino and other smaller fields in the south - are largely enhanced oil recovery projects which will do little to reverse Mexico's production decline. ¶5. (SBU) Mexican officials acknowledge that the best prospects for possible reserves are in the deep waters of the Gulf of Mexico. The GOM has conducted some seismic studies in this area, but has only drilled some exploratory wells at depths of slightly over 1,000 meters with little success. (In the Perdido Spar on the U.S. side MEXICO 00000042 002 OF 003 of the Gulf of Mexico boundary, international oil companies plan to drill at depths of over 4,000 meters by the end of the decade.) Even if Mexico were to discover a significant oil field in the deepwaters of the Gulf, experts predict that it would take at least 7-10 years to move from discovery to production. -------------- 2008 Energy Reform -------------- ¶6. The energy reform package approved by the Mexican Congress in late October was a significant political victory for the Calderon administration. The fact that the three principal political parties in Congress acknowledged the need to reform this sensitive sector - long a taboo subject on the Mexican political scene - was in itself historic. Substantively, the reform will give greater financial autonomy and more decision making power to Pemex. However, the Calderon Administration made a political decision not to tackle the sacrosanct Constitutional prohibition on private sector investment. As a result, the reform does not address the most pressing issue facing Pemex - declining production. To explore and develop Mexico's more costly, difficult but promising fields - especially deepwater - Pemex needs to diversify risk, attract private investment possibly through joint ventures and access the technological capabilities and expertise of the international oil companies. ¶7. (SBU) The energy reform will allow more flexibility on exploiting potential transboundary reserves. According to Mexican government officials, since not all the oil resources in a transboundary field belong to Mexico, the constitution would not prohibit PEMEX from entering into a joint venture with an IOC. The reform provides that transboundary fields would be exploited in accordance with the provisions of a bilateral treaty that has been ratified by the Mexican Senate. The Chamber of Deputies, which would be more critical of such provisions, would not have jurisdiction. PEMEX added that their intention on potential U.S.-Mexico transboundary fields would be to collaborate closely with the companies and use the infrastructure on the U.S. side of the boundary. The Calderon Administration in August formally requested that the USG and GOM consider bilateral negotiations on a treaty to govern transboundary reservoirs. -------------- Outlook for Future Reforms -------------- ¶8. (SBU) Energy experts and the private sector are in general agreement that declining production will eventually force Mexico to introduce energy reforms which will open the oil and gas sector to private investment. This could take some time, however, as the October 2008 reform will take over a year to implement. Pemex and the Ministry of Energy continue to put forward unrealistic production forecasts taking off some pressure - at least in the short term - for additional reforms. Moreover, politicial pressures, particularly in an election year, will make it difficult for the administration to move aggressively on this front in the short term future. -------------- Potential for Bilateral Cooperation -------------- ¶9. (SBU) Mexico officials remain extremely sensitive about any foreign - especially U.S. - comments regarding energy reform and production. Quietly, Mexico is reaching out to other countries - especially those with state owned oil companies - for assistance with implementation of the reforms. We should retain the USG's long-standing policy of not commenting publicly on these issues while quietly offering to provide assistance in areas of interest to the GOM. Mexican officials have asked for USG assistance in recent months on select topics involving implementation of the October 2008 reforms. Most importantly, the GOM is interested in learning how the USG organizes grants for energy research and development programs. The Calderon Administration would also be interested in discussing how to jointly address the global shortage of petroleum engineers, geologists and other technical experts. ¶10. (SBU) Engaging the Calderon Administration's on preliminary discussions regarding transboundary reservoirs also provides an opportunity for fostering bilateral cooperation. Mexican officials MEXICO 00000042 003 OF 003 have told us that the GOM would allow joint ventures with Pemex to exploit transboundary fields. This opening could allow Pemex to engage more closely with U.S. and other international oil companies, potentially opening the door to deeper reforms in the future. (Note: Collaboration on other energy topics such as renewable energy and energy efficiency will be discussed septel. End note.) -------------- Comment: -------------- ¶11. (SBU) Declining Mexican oil production creates policy challenges for both Mexico and the U.S. Even if Mexico introduced reforms allowing foreign investment in oil exploration and development now (which is not politically possible),it takes seven or more years from discovery to oil production in the areas of Mexico which show the most promise. As revenues from petroleum decline, the GOM will have to look for alternate budget income - probably through higher rates of tax collection in a country with one of the weakest tax collection structures in Latin America. Declining oil imports from Mexico will require the U.S. to depend more heavily on other oil exporting countries. ¶12. (SBU) At the same time, the USG should look for opportunities to enhance bilateral cooperation on energy topics with Mexico as we confront these challenges. While the USG should maintain its longstanding policy of not commenting publicly on Mexican energy reform or production prospects, the U.S. could offer to enhance bilateral cooperation on Mexican energy reform implementation, research and development, potential transboundary reservoirs as well as renewable energy and energy efficiency. GARZA