MEXICO: Output Falling in Oil-Rich Mexico, and Politics Gets the Blame

by ELISABETH MALKIN
The KU-S oil production platform off the coast of Ciudad del Carmen, with its 10,000-ton tangle of yellow and red tanks and pipes, would seem the natural product of three years of soaring energy prices. The newly installed platform certainly is the face that Mexico’s state oil monopoly, Pemex, would like to show off.

But Pemex is in trouble. Its production and proven reserves are falling, and it has no money to reverse the slide. Mexico is the second-largest supplier of imported oil to the United States, after Canada, but its total exports are slipping. If the company continues on its current course, Mexico may one day have trouble just keeping up with rising demand at home.

The evidence of its predicament is clear not far from the KU-S platform. On the horizon, some 50 to 60 miles into the southern Gulf of Mexico, aging rigs billow flames and black smoke over the waters as they burn off the natural gas they are unable to process.

The major reason that Pemex’s prospects are so poor, energy experts agree, is government interference. The Mexican government, which expropriated the oil industry in 1938, depends on Pemex to finance its budget. Last year, sales at Pemex (its full name is Petróleos Mexicanos) reached $97 billion. But $79 billion of that went to the government, Pemex’s chief, Jesús Reyes Heróles, said last month. That accounted for almost 40 percent of the federal budget.

Government interference is only part of the story. Pemex has been hamstrung by years of short-sighted management aimed at extracting the most cash for the government treasury — Mexico’s president and Congress must approve the company’s budget, its output, investments and exports each year. By law, Pemex is closed to any outside investment, shutting it off from private capital and expertise.

In addition, Pemex has not reinvested enough for decades and, because it faces no competition at home, has lagged behind many of the industry’s technical advances. Its labor union has locked it into rigid work rules and siphoned off hundreds of millions of dollars for unexplained benefits. And that does not even touch on the widespread corruption and waste.

“Inside Pemex, I think they have creative solutions,” said Amy Myers Jaffe, an energy analyst at the James A. Baker III Institute at Rice University. “They know what they want to do. How do you get that solved within the politics of Mexico?”

President Bush is scheduled to visit Mexico Monday and Tuesday, and oil is likely to be on the agenda. In comments to Latin American reporters this week, Mr. Bush mused that Mexico’s president, Felipe Calderón, should consider private capital to expand Pemex production. The comments ruffled Mexican sensitivities over national sovereignty of its oil resources.

Over the last five years, Pemex has spent about $50 billion, mostly borrowed, to pump more and more oil and gas. “It should have spent much more on exploration so that it wouldn’t be in the situation it is in today,” said Adrian Lajous, who led Pemex in the 1990s. “It was a drive to generate short-term revenue for the government.”

For all that spending, said George Baker, a Houston analyst who publishes a newsletter covering the Mexican oil industry, Pemex did not get much. “In the end, the results were very weak. You didn’t build a new refinery. You didn’t find more oil.”

Mexico, the fifth-largest oil producer in the world in 2005, is sitting on tens of billions of barrels of untapped oil reserves. But much of that is in the deep waters of the gulf, not far from where American companies have announced discoveries. Pemex has neither the money nor the expertise to get at the oil.

Its biggest field, Cantarell, in the shallow waters of the gulf, is one of the world’s richest. That field used to account for about 60 percent of Mexico’s oil production, but has gone into a sharp decline. Production at Cantarell fell 13.5 percent last year, and it will fall another 15 percent this year, Mr. Reyes Heróles said recently.

The decline at Cantarell pushed Pemex’s output down from its peak of 3.4 million barrels a day in 2004 to 3.26 million last year.

At the same time, Pemex’s proven reserves of crude oil have fallen to 11.8 billion barrels at the end of 2005 from 15.1 billion barrels at the end of 2002. Mexico’s nationalist energy policy has closed off the option that most cash-starved national oil companies have used — opening up some production to joint ventures with foreign companies.

Any debate about how to fix the industry quickly becomes snarled in Mexico’s passionate oil politics. The official history celebrates the government’s expropriation of the oil industry as a heroic act and recalls how ordinary Mexicans donated their jewelry to pay for “their” oil. In fact, state control of the industry is enshrined in Mexico’s Constitution.

Even so, there is more agreement than ever before that the government has to rethink the way Pemex is run.

President Calderón has been vague about his government’s plans three months into his presidency. His conservative National Action Party favors private investment.

The left and Mexico’s old-guard nationalists oppose private investment, arguing that it is a cover-up for creeping privatization. That suspicion seems to resonate: a broad public opinion survey last year by CIDE, a university in Mexico City, and the Mexican Council on Foreign Affairs, found that 76 percent of Mexicans oppose foreign investment in oil. “It needs to hurt like hell before you can have an intelligent discussion,” said David Shields, a Mexico City energy analyst who has written a book about Pemex.

Graco Ramírez, a senator from the leftist Party of the Democratic Revolution, said Mexico was already feeling the pain. Other than the sale of any part of Pemex, he said, nearly everything else is on the table “because of the seriousness of the country’s energy situation.”

Shifting from the party’s line, Mr. Ramírez, who is the secretary of the energy commission in Mexico’s Senate, said there may be room for national oil companies — he singled out Statoil of Norway, Petrobras of Brazil and Petróleos de Venezuela, or PDVSA — to work with Pemex on deepwater exploration and a few other areas.

Mr. Calderón has mentioned two of those companies as well. In a visit to inaugurate the KU-S platform last week, the president announced the expansion of an existing technology-sharing agreement with Petrobras. Two days later, Pemex announced an emissions-reduction agreement with Statoil.

Political analysts warn that Mexico’s fractious politics could delay serious change. Another problem is that the government would have to collect more taxes elsewhere if it took less from Pemex. “Some reform of the laws governing Pemex’s operations seem almost certain to take place in the next 18 to 24 months,” Pamela K. Starr, an analyst at the Eurasia Group in Washington, wrote in a report released Wednesday. But, she added, “These reforms will be limited in scope.”

For now, Pemex is doing what it can alone to make up for lost time. In a beige-carpeted glass-walled research center that Pemex opened in Ciudad del Carmen six months ago, scientists and engineers study 3D images of the geological layers below the gulf’s deep waters to determine where they will put exploratory wells.

“I think that this is the future or at least part of the future,” said Pemex’s director of exploration and production, Carlos Morales Gil.

Even under the best of circumstances, though, Pemex cannot expect to see deepwater oil before 2014. For now Mr. Reyes Heróles has more immediate concerns. He has said that Pemex needs to spend some $8 billion to $10 billion a year over its current investment budget of about $14 billion.

He doesn’t have it.
The company’s finances are too “delicate” to keep borrowing, he said at a news conference last month.

It will cost about $15 billion a year just to enhance reserves and keep output of crude above three million barrels a day, he said. The company is developing new fields to help make up for the decline at Cantarell. One of those is the adjacent field of Ku-Maloob-Zaap, where the new KU-S oil platform will produce 250,000 barrels of crude a day.

Private analysts are cautious. “We don’t see even in the most optimistic model that they could manage to reverse the total fall in production,” said Alejandra León, an analyst at Cambridge Energy Research Associates in Mexico City.

Outside of exploration and production, the rest of Pemex — its refineries, its pipelines, its money-losing petrochemical plants — have been ignored. Mexico now imports about 30 percent of its gasoline from the United States. A series of fatal accidents a couple of years ago revealed the perilous state of its pipeline network.

For years, the natural gas that was pumped up with the Cantarell crude was flared off because Pemex was unable to process it. “It’s like lighting dollars on fire,” said Kenneth B. Medlock III, who is also at the Baker Center at Rice University.

Now Pemex is trying to make use of that natural gas and develop onshore reserves. The KU-S platform will process gas, not flare it, for example. Pemex’s debt has climbed to about $53 billion; its fast-growing pension liabilities have reached another $40 billion.

Pemex’s former chief executive, Luis Ramírez Corzo, estimated last November that Pemex could trim $2.5 billion from its operating costs. Labor costs for workers who had not enough work to do or none at all cost the company almost $1 billion of that, he said.

And in a nod to the allegations of corruption at Pemex, Mr. Calderón named a new audit committee last month. Mr. Lajous, who ran Pemex in the 1990s, said, “The union is one of the key political complexities of what you have to deal with.”

Some 100,000 of the company’s 148,000 employees are members of the union, and the union has five representatives on Pemex’s board.

The union leader in charge since 1993, Carlos Romero Deschamps, refused a request for an interview. There are bright spots, though. “Pemex people are very good,” said a foreign oil executive who asked not to be identified because of the sensitivity of the debate in Mexico. “There are professionals with lots of experience.”

Ms. Jaffe of the Baker Institute agreed. “The problems of Pemex,” she said, “are not technical. The problem is political.”

And for all its troubles, Pemex is still a great source of pride to many Mexicans. Its workers are some of the best paid in Mexico, firmly in the middle class.

“It’s one of the best companies in Mexico,” said Israel Cervantes, 28, who has been working on the rigs for three years and takes home $2,200 a month. “You can do all right by your family here.”


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