Mexico’s New Oil Discoveries: Too Good to be True?

Mexico’s successful deep-water drilling of wells “Trion-1” (August 29) and “Supremus-1” (October 5) in the northwestern Gulf of Mexico has caused national euphoria. It has shown the country’s considerable oil potential and revamped public confidence in state-owned company Pemex (Petróleos Mexicanos), whose reputation had dwindled for the past years following a decrease in production, corruption scandals, an inability to stop criminal groups from stealing oil, and drilling failures.

The news has brought a much needed respite for President Felipe Calderón, helping him to balance a record that has been severely undermined over the past years due to his security strategy and the situation of the economy. In fact, the drilling of both wells would have turned into ammunition for his detractors had there not been any positive results, as it follows a 528-percent increase in investment for exploration. Now, however, the outgoing administration has had no qualms in affirming that the discovery may be part of an oil system with an overall production potential of up to 10 billion barrels of oil.

Yet, what has become a “golden egg” for President Calderón may quickly rot for President-elect Enrique Peña Nieto.

The high expectations produced by the discovery will be difficult to achieve due to Pemex’s lack of technological capabilities and the prohibitive cost of deep-water drilling. Indeed, it would be a mistake to take the successful drilling of the aforementioned wells as a sign that Pemex has recovered from decades of managerial excesses, corruption, vested interests, inefficient populist policies, and discretionary policy-making.

The negative effect of these factors, along with the government’s dependence on oil exports for revenue, have resulted in a severe decrease in Pemex’s efficiency.

For instance, the company is currently unable to refine most of Mexico’s heavy oil, which makes up around 52 percent of the country’s total proven, probable and possible (3P) reserves. To satisfy its growing demand for refined fuels, Mexico has had to export its crude to the U.S. and then import it back as a refined product.

Another example of this inefficiency is the wasteful drilling of the Chicontepec basin in the states of Puebla, Hidalgo and Veracruz. The basin is believed to contain around 15 billion barrels of oil in reserves, but its geological complexity demands state-of-the-art equipment for extraction and production. Still, pressure to compensate for the decline in oil production since 2005 led to a substantial increase of drilling projects without considering the commercial viability of the investments and the potential productivity of the wells.

Indeed, it was only after public pressure from the Comisión Nacional de Hidrocarburos (CNH), Mexico’s hydrocarbon overseer, that Pemex was forced to conduct the necessary geological studies and test for better recovery techniques. As a result, and after much controversy, inefficient drillings were halted, and potential production figures were driven down. Currently, Chicontepec’s oil recovery rates are around 6 to 8 percent.

This all leads to questions around the recent discovery. While it is true that Pemex was able to successfully drill in deep waters for the first time in its history, it is also true that the cost of deep-water drilling remains prohibitive. For instance, Pemex expects to spend around 73 billion pesos to drill 31 wells in deep water from 2012 to 2016.

Furthermore, producing what has been discovered will prove extremely difficult. According to Juan Carlos Zepeda, president of the CNH, Pemex does not have the finances or the infrastructure capabilities to take care of this endeavor on its own.

In other words, to make deep-water oil production commercially viable, Pemex would have to associate with another company, which is impossible because it is constitutionally prohibited. It would first be necessary to advance a reform to allow private and foreign investment in Mexico’s hydrocarbons industry, as well as Pemex’s association with foreign companies. However, the prospects of achieving this remain dim. Any attempt to depart from the status quo in the energy sector has becomes a politically charged debate in which many vested interests intervene.

This is worrying: Pemex’s continuing profitability, thus its financial viability, and a considerable percentage of the public budget (about 36 percent in the first quarter of 2012), depends not only on the current developed reserves, but on improving capabilities to ensure further development. According to Pemex’s 2012 reserves report, up to January 2012, Mexico’s total 3P reserves amounted to 43.83 billion barrels of oil equivalent. Of these, 13.8 billion barrels correspond to proven reserves, but only 9.14 billion are developed.

Differentiating these numbers is necessary: when talking about proven, probable and possible reserves, people usually leave out (intentionally or unintentionally) any discussion regarding production certainty. But not even the proven reserves have a 100 percent production certainty. Only the ones that are developed can be recovered with current infrastructure and/or minimum to moderate investment costs. Moreover, there is a maximum period of five years to initiate production of the undeveloped reserves before they are reclassified as probable or possible.

Cooperating with top-ranked foreign companies would allow Pemex to learn from their managerial and technical expertise, close the technological gap, and, more importantly, share the risk of any project.

Fortunately, President-elect Peña Nieto seems to understand this. He has shown an interest in Brazil’s Petrobras and Colombia’s Ecopetrol (both SOCs) as potential benchmarking models for Pemex. He also has declared that he intends to push forward the idea of foreign and private participation in Mexico’s hydrocarbon industry. He may be able to achieve this, as the PRI and allied parties hold a relative majority of seats in the Congress and the PAN, whose cooperation is a must to reach the necessary quorum to modify the Constitution, is not ideologically opposed to the reform. If an agreement were to be reached, approving an encompassing energy reform would not be impossible.

However, as already mentioned, there are powerful vested interests opposed to any change in the status quo. Among them we can find Pemex’s syndicate, contractors, high ranking officers and certain legislators for whom such a move would endanger the country’s sovereignty. Ironically, their voices have been strengthened by the successful deep-water drilling, which will arguably hinder any future negotiations for the much needed energy reform. On the one hand, it decreases the sense of urgency brought upon by the decline in oil production and Chicontepec’s low recovery rate. On the other, the drillings of “Supremus-1” and “Trion-1” were done with Pemex’s own technology, so why would it need to cooperate with other companies?

We will have to wait to see if elected-President Peña Nieto is be able to advance the much needed energy reform to improve the country’s hydrocarbons industry and enable Pemex to increase the efficiency of its operations. Will he be able to negotiate and/or bend the arms of any interest group opposed to this?

*Alfredo Montufar-Helu is a guest blogger to AQ Online. His expertise is in the analysis of global affairs including political risk, emerging markets, international security, energy security, Land atin American geopolitics as well as Mexico and China.

Tags: energy, Mexico

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