Scenesetter for February 15-18, 2010 Visit of David Goldwyn

UNCLAS MEXICO 000514

SIPDIS

E.O. 12958: N/A
TAGS: ENRG MX ECON
SUBJECT: Scenesetter for February 15-18, 2010 Visit of David Goldwyn
to Mexico City


1. (SBU) Summary. Your visit comes at a time when we have a
unique opportunity to deepen our bilateral energy relationship with
Mexico, our third largest source of oil imports. 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 and the country could
become a net oil importer within five years. The Calderon
Administration broke a taboo early in its term by addressing the
need for energy reform and engaging the public in a discussion of
necessary changes. However, the modest October 2008 reform package
that Mexico's Congress passed does not address the constitutional
prohibition on private investment in the oil sector. 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 have implications
for North America energy security - especially in the short and
medium term. The Calderon Administration's August 2008 proposal to
negotiate a US-Mexico agreement on trans-boundary reservoirs
demonstrates a new willingness by Mexico to engage bilaterally on
oil and gas topics. Our preliminary discussions on the Mexican
proposal have opened the door to other opportunities for
collaboration. End Summary.



Political Context

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2. (SBU) Present Calderon enters the last three years of his
six-year term facing a complicated political and economic
environment. His PAN party emerged seriously weakened from a
dramatic 2009 mid-term election in which the opposition (PRI)
gained control of the Mexican Congress. His popularity numbers
have dropped 10-points since the beginning of last year, yet they
still hover solidly over 50 percent. He is by no means a lame
duck. Still, the opposition PRI party is in the ascendancy,
cautiously managing its illusory unity in an effort to dominate the
ten gubernatorial contests that are up in the coming year, and to
avoid any missteps that could jeopardize its front-runner status in
the run-up to the 2012 presidential elections. In addition, the
public's deepening economic worries have begun to counterbalance
their concern about security.



Economic Context

--------------




3. (SBU) Following the 2009 electoral setback, Calderon made
promoting jobs and eradicating poverty his top two priorities for
2010, sharing the agenda with security issues that have become
acutely sensitive in the past weeks due to the persisting violence
in Ciudad Juarez. It is important that Calderon succeed in making
real progress on the economy and security in the last three years
of his term. The economic and security agendas are time-sensitive
and volatile, and the more momentum that can be achieved now, the
greater the prospect for continuity into a new administration.
However, the complexities of pushing viable economic reforms
through an opposition Congress complicate advancing such an agenda.
If Calderon is unable to strengthen Mexico's competitiveness in
order to promote jobs and eradicate poverty, the United States will
also feel the impact through immigration pressures and greater
volatility in high-violence cities that have been the battleground
for narco-traffickers. A stable and growing Mexico is in both our
security and economic interests.





Mexico's Energy Challenge

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4. (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 from a peak
of 3.4 million barrels per day in 2004 to a projected 2.5 million


barrels per day in 2010. Despite some optimistic GOM forecasts,
there are no realistic options for reversing this decline in the
short to medium term. Mexico has relied heavily on the Cantarell
oil field, one of the largest 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 70% from its peak of over 2 million barrels a
day in 2004 to less than 650,000 barrels per day in 2009.




5. (SBU) The Mexican government's reliance on oil revenue to
finance over one third of the federal budget has deprived Mexico's
state owned oil company, Pemex, of much needed capital 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 accelerated the development of the giant
Chicontepec oil basin in 2009, investing $2 billion with the goal
of increasing production from 29,000 to 90,000 barrels in 2009.
With 750 new wells drilled over the past year, overall production
remains stagnant and production per well has fallen dramatically.
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 include Ku Maloob Zaap, which has reached peak
production levels; Crudo Ligero Marino and other smaller fields in
the south which are largely enhanced oil recovery projects which
will do little to reverse Mexico's production decline.




6. (SBU) Mexican officials acknowledge that the greatest
opportunities for reversing declining production lie in the deep
waters of the Gulf of Mexico, with Pemex estimating that 56 percent
of prospective resources are in that area. To date, Pemex's
deepwater results have been disappointing. The parastatal has
contracted service companies to drill twelve deep water wells for a
total investment of approximately $750 million, but none of these
have proven commercially viable. Two new deepwater rigs will start
working for Pemex in 2010, boosting exploration efforts. Some
energy experts opine that Pemex is under such pressure to reverse
production declines that it has not conducted sufficient seismic
analysis to begin these exploration efforts. Even if Mexico were
to discover a significant oil field in the deep waters of the Gulf,
these experts predict that it would take at least 7-10 years to
move from discovery to production.



2008 Energy Reform

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7. (SBU) The energy reform package approved by the Mexican
Congress in late October 2008 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. The reform allows only for
performance-based contracts. Pemex and SENER, in consultation with
the international oil companies and other interested parties, are
developing the draft contracts now. We understand that a draft
text will be sent to stakeholders February 15 for comments.
Tenders will likely begin with projects in Chicontepec this
spring. GOM officials claim that a constitutional challenge
against the implementing regulations for the new contracts will not
delay this process, but companies may be less inclined to bid given
legal uncertainties.



8. (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 reservoirs 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 exploiting
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 as a way of making cooperation with IOCs more
palatable.



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 reforms are still being implemented. Moreover,
political pressures as Mexico approaches important gubernatorial
elections in 2010, 2011 and a presidential election in 2012, make
it difficult for the administration to move aggressively on this
front in the short term future.


9. (SBU) Mexico officials remain extremely sensitive about any
public - especially US - comments regarding energy reform and
production. Quietly, Mexico is reaching out to other countries -
especially those with state owned oil companies - for advice on
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. The GOM has expressed interest in learning
more about the US Minerals Management Service, US gas flaring
regulations, how US grants for energy research and development
programs are organized, gas and oil leasing procedures and other
topics. The Calderon Administration may also be interested in
discussing how to address jointly the global shortage of petroleum
engineers, geologists and other technical experts. You may want to
emphasize our interest in working with Mexico on these topics.



Electricity

--------------


10. (U) Under Mexico's constitution, the generation, transmission,
distribution and marketing of electric power is reserved for the
federal government, specifically the Federal Commission of
Electricity (CFE),with few exceptions. Since 1992, the
government has encouraged private sector participation in the power
sector in the following areas: independent power production (IPP)
or private power generation facilities which sell production to
CFE; self-supply; co-generation; small scale (less than 30 MW);
export; and import for self supply. The total installed capacity
in the country in 2008 was 51,000 MW, of which fourteen percent was
cogeneration or self supply. Mexican power production comes from
the following resources: 40 percent natural gas; 27 percent fuel
oil; 22 percent hydro; 6 percent coal; 3 percent nuclear and 2
percent wind and geothermal.




11. (U) The government encourages IPPs to construct combined cycle
gas fired power plants.

The key issues facing IPPs, however, include the lack of
infrastructure to supply natural gas to power plants under
development and the increasing cost and scarcity of natural gas in
Mexico. As a result, liquefied natural gas (LNG) has become more
important for Mexico as CFE develops its own long-term
arrangements with LNG suppliers. There are two LNG terminals in
operation in Mexico: Ensenada - Sempra; Altamira - Shell, Mitsui
and Total; and one under construction in Manzanillo.




12. You can use this opportunity to ask the GOM about their long
term natural gas production and supply plans. You may want to ask
what plans Mexico has to improve its natural gas infrastructure,


especially along the Caribbean coast.



Renewable Energy

--------------




13. (SBU) Advancing bilateral cooperation on renewable energy,
energy efficiency and the environmental agenda has been a top
priority for both President Obama and President Calderon since
their first meeting January 2009. This agenda was formalized when
the Bilateral Clean Energy and Climate Change Framework was
announced during President Obama's April 2009 visit to Mexico. On
January 25-26 a senior level working group met in Washington to
discuss pragmatic steps to advance this collaboration. The working
group agreed to establish a bilateral task force which will work to
create a renewable energy market between Baja California and
California. The task force will consider standards, transmission
capacity, regulatory issues and financing. This pilot project
could be applied more broadly across the border, creating
significant opportunities for US companies to export green
technology to Mexico. The January 25-26 meeting also helped
advance cooperation on the Framework Convention on Climate Change
16th Conference of the Parties (COP-16) which Mexico is hosting in
late 2010.




14. (SBU) You may wish to stress President Obama's personal
commitment to advancing a joint agenda on climate change and
renewable energy. You could stress the administration's commitment
to use all available policy and financial tools, drawing on DOE,
EPA, State, TDA, USAID, OPIC and EXIM to create a viable renewable
energy market between the countries. This wider context will also
help reinforce USTR's Trade Climate Initiative, which seeks to fast
track tariff cuts for climate friendly technologies. Ambassador
Kirk raised this point during his February 8-9, 2010 visit to
Mexico.
PASCUAL