FEATURE: Forecast for output, future reform

Monday, November 24, 2008

Perhaps the most critical question facing Mexico in the wake of the long-fought process to achieve energy reform is what the effects will be on oil production and whether another reform will be needed in the future.

State oil company Pemex's E&P subsidiary PEP has seen production fall consistently since 2004 and the decline shows no signs of slowing. Production in the third quarter was 2.76Mb/d, marking a 300,000b/d drop compared to the same three-month period of 2007.

And given Mexico's government depends on Pemex for roughly 35% of federal revenues, the impact of declining production - and falling prices of late - could have serious repercussions in the country.

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Declining output is mainly due to the prolific Cantarell field, which at one point in time accounted for more than 60% of overall production but now makes up less than 40%, or roughly 1Mb/d.

Mexico watchers agree that, despite the reform, production will continue to drop largely because most productive fields like Cantarell are already mature. In March, the company estimated that 83% of proven reserves are in fields either already in a state of decline or nearing their inflection points.

"I think nothing can stop the decline in oil production in the short to medium term because basically Pemex has the severe problem that most of its fields are mature and declining and it has not yet found major fields to replace them," Mexican energy expert David Shields told BNamericas.

PFC Energy analyst RoseAnne Franco likewise said the reform will have no impact whatsoever on production in the short term, although in the medium-term a marginal improvement might be possible.

"Over the long term, it becomes an issue of do they permit private investment in deepwater," Franco added.

US consultancy Eurasia Group painted a grimmer picture in a recent report.

To begin with, Eurasia cited anonymous Pemex engineers as saying Cantarell could decline even faster than official estimates, falling to 800,000b/d by the end of 2009.

Despite Pemex's efforts to employ nitrogen injection to minimize production declines, greater-than-expected saltwater incursions have reduced the number of areas that can be drilled, Eurasia quoted the engineers as saying.

Further, the report cited anonymous industry sources as saying production could drop even below 500,000b/d.

Vinicio Suro, PEP's deputy director of planning and evaluation, said in July he expected Cantarell output to fall to 1Mb/d by end-2008. However, just one month later production fell below that level, marking the lowest output recorded under normal operating conditions since April 1990. This failed to inspire confidence in Pemex's Cantarell forecasts.


The Ku-Maloob-Zaap (KMZ) project in the Campeche sound has been Pemex's first line of defense to offset the drop-off at Cantarell. KMZ production averaged 725,000b/d from January to September of 2008, up 35.9% on the same nine-month period of 2007. The company said in August it is aiming for 800,000b/d from the three fields in 2009.

The Eurasia report, however, said that "this swift production increase has likely done considerable damage to KMZ, hurting its longevity and overall production capacity. This could mean that, instead of stabilizing around 750,000b/d for several years as Pemex forecasts, the complex could suffer production losses sooner."

One contrary view on Mexico's short-term oil production comes from Mexican politics expert Pamela Starr, who thinks production will go back up to 3.1Mb/d.

"It is strikingly suspicious, when you look at Pemex's production figures, the fact that they fell off sharply precisely a year ago. There's no explanation for that and the rumor floating around is that the Calderón government told Pemex not to try too hard in order to make it look bad. I have no evidence of that other than the production figures, but the figures themselves are very suspicious, so that leads me to believe that if the Calderón government wants this reform to work in the short-term, it will," Starr said.

Reform is unlikely to enable Pemex to avoid medium and long-term production and export declines unless the company makes another serendipitous discovery like that of Cantarell, Starr said.

Regarding longer-term production increases, Pemex said in March that its plan through 2021 is to increase production from the southeast marine basin by 700,000b/d, have output from the Chicontepec field reach 600,000b/d, (up from some 30,000b/d currently) and incorporate another 500,000b/d from the deepwater Gulf of Mexico.

Exploration in the southeast basin, however, will have its fair share of challenges. To begin with, potential discoveries will be far smaller than in the past and therefore costlier to develop.

Further, the number of Pemex engineers has declined in the past years, while the expertise of the remaining engineers has fallen behind the level of their private-sector peers, according to the Eurasia report.

"As long as Pemex continues to centralize all exploration decisions, most decisions will remain uninformed by the most experienced and well-equipped engineers in the private sector," the report said.

Deepwater exploration obviously will face the same hurdles in addition to the problem that increased availability of funds and new flexible contracts are unlikely to help Pemex in the region.


Although reform will make Pemex a more efficient and autonomous company, the new legislation is unlikely to spur significant advances in E&P development. The question that is raised, then, is if a future reform might be in the pipeline.

Even Pemex CFO, Esteban Levín offered a less-than-subtle hint in the company's third quarter earnings webcast that the firm is hoping for more reform.

"[The reform] is a great first step in terms of what can come next. We think Pemex is now headed in the right direction," he said. "We're very confident this is a great first step and we hope that there's more to come at some point."

First, Mexico must wait to see the results of this first reform, and that will take considerable time. For example, Mexico's energy minister Georgina Kessel has indicated the first contracts with incentives would not be signed until the end of 2009.

Ruben Camarillo, PAN senator and secretary of the senate energy committee, also highlighted the need to see how the reform plays out, particularly given the dynamism of the oil industry.

"It would be very risky at this time to say that there is going to be [another reform], if something more is or isn't needed. I think that what we have to do first is evaluate the results that we start seeing, the conditions we start having and evaluate based on that" Camarillo said in an interview.

David Shields said he doubted Calderón would attempt another energy reform, particularly because the process was so arduous. He also echoed Camarillo's sentiment that Mexico will have to see what results can be achieved with the existing reform.

"What they need to do is take all the positive points that are in the reform and make them work. Maybe there are not that many, but maybe they are quite important," Shields said. "I see it as a framework for getting down to work on many different things that range from making budgetary and financial autonomy real, making the building of a refinery real, making internal restructuring real, making efficient contracting real. It is a basis for work. It is not the basis for another reform."

Starr agreed reform during Calderón's term is unlikely, but on the basis that she expects production to rise back up to 3.1Mb/d.

"Under that scenario, I don't think anyone has the stomach to come back to Pemex reform before 2012. This has been too long, too politically costly for Calderón. The fact that [former PRD party presidential candidate] Andrés Manuel López Obrador didn't back down means he's going to be out there biting at Calderón's heels on any future reform," Starr said.

If, however, the reform quickly proves insufficient and production continues to decline, Starr deemed it "probable" Calderón would assert that the "PRD-style reform" of more autonomy and more capital for Pemex did not mend the situation, and that more drastic measures are required.

It is certain that any future reform, if one were to happen during Calderón's administration, would have to take place following the 2009 mid-term elections when the political air is cleared and more conducive to reaching consensus.

Eurasia Group anticipates that discussions about the energy sector will resume before the 2012 presidential campaign as a result of the impact declining production will have on government revenue. Any legislation before the election, however, would be unlikely.

But the discussion of possible energy reform could be reshaped if Mexico becomes a net oil importer during the coming six-year presidential term.

Such an upheaval would shift discussion "from how to protect the nation's oil reserves and control export revenues to how best to find oil reserves to maintain self-sufficiency. As long as Pemex makes no new discoveries in the coming years, Eurasia Group believes that the next administration will be forced to open the sector to unfettered private investment," according to the report.