On Sunday July 1, 2012, Mexicans went to the polls to cast their vote for president. Election authorities predict that Enrique Pena Nieto as the winner. The 45-year old former governor of the state of Tabasco, who is married to a Mexican soap opera star, was estimated to have captured approximately 38% of the vote, 7% more than his nearest rival, leftist candidate Andres Manuel Lopez Obrador. Obrador refused to concede, saying he would wait for the full count and a legal review, as reported by Fox New and CNN.
Nieto’s win is a big victory for the PRI (Institutional Revolutionary Party), which ruled Mexico like a single party with strict authority from Mexico’s revolution until 2000. Over time, the PRI became accused of corruption and cronyism, which helped sweep the National Action Party (PAN) into power with the victory of Vicente Fox.
It appears that after giving PAN a chance, Mexican politics have run full circle back to the PRI, amid popular frustration with the ongoing war between the government and the drug cartels. Cartel-related violence has claimed an estimated 50,000 lives, many of them innocent civilians. Under the PRI’s rule, there was a relative status quo between the cartels and violence was less and fewer civilians were killed.
Winds of Change in the Oil Business
For the petroleum industry, the PRI win signals a potential change in Mexico’s stance towards the oil and natural gas industry. Nieto ran on a platform of liberalizing the Mexican economy and taking on the drug cartels. The centerpiece of his campaign was opening up Mexico’s oil business to non-Mexican companies. That would be an about-face for the party, which originally nationalized the industry in 1938 when it designated Pemex as Mexico’s sole producer and retailer of petroleum products, making the company a state-controlled monopoly.
The importance of Pemex to Mexico cannot be underestimated. Depending on the source, it is estimated that Pemex contributes anywhere between 32% and 40% of the Mexican government’s revenues.
Mexico is an important supplier of crude to the United States. The Energy Information Administration (EIA) reports the U.S. imported approximately 1.2 MMBOPD from Mexico in 2011, which was 0.8% more than what America imported from Saudi Arabia that year. Clearly, Mexico is an important source of crude for America’s economy. Many of those barrels, however, are heavy crude that cannot be refined into product in Mexico, but instead are sent to refineries along the U.S. Gulf Coast with a portion of the products (including gasoline and diesel fuel) sent back to Mexico (much like the relationship between Venezuela and the U.S.)
Mexico’s oil production, however, has been on the decline. In 2011, Mexico produced 2.9 MMBOPD, which was approximately 0.8% lower than the prior year and 18% lower than 2001, according to the BP Statistical Review of World Energy published June 2012.
The majority of Mexico’s oil production came from the Gulf of Campeche where the large Cantarell and Ku-Maloob-Zaap (KMZ) fields are located. In 2010, EIA estimated that Cantarell and KMZ represented 54% of Mexico’s total crude oil production, a region exposed to passing tropical storms and hurricanes, which have the potential to disrupt oil operations.
[sam id=”4″ codes=”true”]
The industry has been paying close watch on Cantarell, which has been declining both in production and in importance to the country’s production mix. EIA further noted, “The Cantarell oil field was once one of the largest oil fields in the world, but production there has declined dramatically in the past several years. In 2010, Cantarell produced 558,000 BOPD, down 19% from the 2009 level and down 74% from the peak production level of 2.14 MM BOPD in 2004.
As production at the field has declined, so has its relative importance to Mexico’s oil sector: Cantarell contributed 22% of Mexico’s total crude oil production in 2010, compared with 63% in 2004, while other, more prolific fields have emerged. KMZ is now the highest producing field in Mexico. Another offshore field, Litoral Tabasco, has increased production from 212,300 BOPD in 2009 to 248,100 BOPD in 2010, partially offsetting the losses at Cantarell.”
Growth Initiatives at Chicontepec
The onshore Chicontepec project, located northeast of Mexico City, is a key initiative for Pemex’s plans to diversify away from dependence on offshore production and mitigate production declines at Cantarell and KMZ. The Chicontepec Basin consists of 29 fields spread over 2,400 square miles. Most of the crude is heavy and Pemex believes the area contains up to 17.7 billion barrels of oil equivalent.
One of the challenges faced by Pemex is the monopoly’s lack of innovation and application of modern horizontal drilling techniques and multi-stage fracture stimulation technologies. To close the technology gap, Pemex has been working closely with OilService companies like Halliburton (ticker: HAL).
EIA reported that based on industry reports, the area’s geology is complex when they wrote, “The reservoir is also highly fractured and at low pressure, meaning that recovery rates could be low and Pemex will need a large number of wells to fully exploit the area.”
One approach to increase well productivity at Chicontepec has been to apply drilling and completion techniques that were developed in North America’s unconventional plays. On July 2, 2012, HAL announced that its partnership with Pemex has resulted in “extraordinary success” in Mexico’s Chicontepec Basin. Halliburton claims that the unconventional basin is “one of the most complex reservoirs in the world” and that “the average well produces 40 barrels of oil per day with a maximum cumulative production of only 40,000 barrels of oil over its productive life (30 years),” HAL said.
Halliburton’s announcement explained the benefits of employing modern drilling and completion techniques when the company wrote, “Using Halliburton’s most advanced technologies, the team designed, drilled and completed a horizontal well of unconventional design – a maximum-contact well with an 822-meter horizontal section. While the well had an initial production of 4,200 BOPD, it reached a cumulative production of 180,000 barrels in four months, and is still producing 1,100 BOPD. In one of its publications, PEMEX called the well its ‘champion well.'”
Flying Like An Eagle (Ford Shale) Across the Border
Further upside exists in Mexico from unconventional resources. EIA estimates that Mexico has the fourth-largest reserves of shale natural gas in the world, located mainly near the U.S.-Mexico border along the Rio Grande River, mainly attributed to an extension of the Eagle Ford shale play in the United States.
Reducing Barriers to Entry
Pemex is restricted by Mexico’s constitution from entering into risk contracts with third parties, but is permitted to enter service contracts. Even though Nieto has promised to loosen restrictions on Pemex, he needs the agreement of Congress, which may not be guaranteed.
Also, the form of greater flexibility for the monopoly hasn’t been fully defined, and giving Pemex the ability to enter into risk-sharing contracts, giving foreign oil companies the ability to participate in the upside, would require fundamental cultural and political changes that Mexican politicians and voters may not necessarily be ready to make.
Rex Tillerson, CEO of ExxonMobil (ticker: XOM) noted as much when he gave his thoughts on Pemex opening up to Reuters on Wednesday, June 27, 2012, “I think it is going to be a long process. And what we’re advocating is just for Mexico to take the next step.”
Geopolitical Implications and North American Energy Security
Tillerson also floated the idea of greater cooperation between North American states, when he said, “It’s my hope that at some point energy security can become a policy issue in our foreign policy discussion with Mexico, Canada and the United States.”
If Pemex engineers see the benefits to loosening the monopoly’s grip on the industry at Chicontepec, then we are hopeful that Mexico’s politicians and voters will eventually come to realize that there is more to gain by letting Pemex cooperate with the global industry to grow the total Mexican oil and gas “pie,” rather than maintaining control over a shrinking production base.
This is not lost on Pemex executives and Mexican authorities. At several of EnerCom’s investor conferences, the Brazilian state-controlled Petroleo Brasileiro SA Petrobras (Petrobras – ticker: PBR) noted that Pemex executives had been meeting with and learning from their Brazilian counterparts.
We wonder aloud — could there come a day when we have collaboration between major oil producers in the Western Hemisphere, which could include Canada, the United States, Mexico and Brazil? After all, by 2020, nearly half of the crude oil America consumes will be produced at home, while 82% will come from this side of the Atlantic, according to EIA.
