Deep-water dilemma: constitutional limitations hinder exploitation of Pemex findings.

When Luis Ramirez Corzo told El Universal newspaper recently of preliminary findings that revealed the potential for a new Mexican oil boom, he probably failed to realize the impact it would cause. But Mexico is hungry for good news from what increasingly seems like a struggling oil industry, and world markets are thirsting for new sources of supply as prices rise to their highest level in more than two decades.

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So the newspaper's interview with Ramirez Corzo, director-general of the exploration and production subsidiary of the state oil monopoly Pemex, turned into a bombshell. A bombshell, it must be said, that was not of Ramirez Corzo's making. The Pemex executive chose his words carefully, placing the emphasis on "potential" and "possible," though many such subtleties got lost in the subsequent din.

Mapping based on three-dimensional seismological studies of the deep waters of the Mexican side of the Gulf of Mexico, Ramirez Corzo said, had shown the potential for 54 billion barrels of oil and its equivalent in gas--an astounding four times as much as Mexico's current proven reserves. Warming to his theme, Ramirez Corzo told El Universal the discoveries could put Mexico on a level with the great oil powers of the Middle East, roughly doubling its current output to seven million barrels per day (bpd) of crude and eight billion cubic feet a day (Bcfd) of gas within a few years.

Ramirez Corzo said seven areas with potential had been identified in Mexican territorial waters, and two held particular promise. One lies in the southern Gulf in deep waters off the oil port of Coatzacoalcos in Veracruz. The other is on the Mexican side of the maritime border with the United States in what is known as the Perdido Fold Belt, a geological formation that has provided several prolific discoveries on the U.S. side.

It was not the first time Ramirez Corzo had made such claims. A couple of months earlier he told a business forum in Mexico City that such Arabian-style output levels would be possible "within five to eight years" of a decision being taken to open up the oil industry to private investment.

And therein lies the rub. Pemex has neither the money nor the technology to go it alone in deep-water exploration, and the handful of companies that do have these resources would insist on contracts that break Mexico's tight legal restrictions on private-sector participation in the oil industry.

THE 54-BILLION BARREL QUESTION

But do the 54 billion barrels exist? The answer seems to be yes, if only, for the moment at least, on Pemex computer screens.

"Pemex has some very bright people who've been working for some years now on the question of the deep-water resources of the Gulf," said a source at a U.S.-based exploration company that has been swapping technology with Pemex for years. "It's always been reasonable to suppose that there are likely to be considerable resources out there in the deep water. After all, there's no doubt the oil's there on the U.S. side of the maritime border, and it's certainly present in shallower water on the Mexican side."

Adds George Baker of the Houston-based consultancy Baker and Associates: "There's no reason at all to doubt the seismic findings. But that's all they are. They don't amount to any kind of reserves until drilling begins."

The limitations of seismic studies were underlined when Spain's Repsol YPF launched a deep-water hunt for oil this summer off Cuba. The studies had shown four potential drilling objectives and Repsol chose one, off the northern coast of the island, for drilling. Success would have added US$1.7 billion to the value of Repsol's stocks, according to an analysis by the Swiss-based investment bank UBS, though it warned that the chances were no more than one in 10.

Despite the odds, Repsol took the risk, hiring the world's largest and most expensive semi-submersible rig, the Norwegian-owned Eirik Raude, at almost US$200,000 a day.

Several weeks later, Repsol announced it had found oil. The only problem was that the discovery was "not commercial"--in other words it would cost more to extract the oil than it would fetch on the market. The US$50 million that Repsol invested in the venture was a write-off. Or nearly. Repsol executives say they are still mulling the possibility of a new drilling attempt in a different area of one of the six Cuban blocks on which it has acquired concessions.

THE PROOF IS IN THE DRILLING

The Cuban episode drives home the point that seismic studies are no substitute for drilling. But it also emphasizes what remains Pemex's main stumbling block. Even Communist-ruled Cuba grants rights to foreign oil companies that would be illegal in Mexico, but which the companies demand in return for the huge risks they run in deep water.

Mexico's Constitution declares hydrocarbons belong to the nation alone by inalienable right. As a result, mechanisms such as production-sharing and risk contracts--common every where else in the world--are forbidden because they imply that ownership of at least some of the oil and gas found lies with the company that discovers it.

Sergio Guaso is all too aware of the problem. Guaso is the Pemex executive who heads the project under which multiple services contracts have been awarded for the development of the natural gas fields of the Burgos basin in northern Mexico.

The project caused what Guaso describes as "political noise" from critics who claimed the contracts are concessions in breach of the Constitution, and--led by Senator Manuel Bartlett of the opposition Institutional Revolutionary Party (PRI)--they continue to pursue the issue in the courts.

In efforts to keep within the Constitution, Pemex bent over backwards to produce contracts that could be regarded as rewarding, though ensuring that all the gas found and produced remains Pemex property. Even so, last year's first round of tenders for the contracts produced a lukewarm response, with major companies staying away from the bidding. The future of this year's second round remains uncertain.

Guaso agrees his hands are tied. "It's very difficult to compete for investment when the companies can find more attractive terms elsewhere," he says. And there seems little doubt that the concept has no hope of attracting investment for deep-water exploration where the risks, and the level of investment that is necessary, are infinitely greater.

Industry sources say Pemex has sounded out all the international companies that have deep-water capability. But while all would undoubtedly be interested in exploring Mexican waters, Pemex has been unable to make them the kind of offer they would be prepared to contemplate.

Brazil's Petrobras was one of the companies consulted. Petrobras is controlled by the Brazilian government but private investors have a large stake acquired through stock market flotation. The company is a world leader in deep-water technology with several successes to its name in U.S. waters of the Gulf and elsewhere in the world.

"We had talks with Pemex officials," confirmed Roberto de Toledo, who heads the Mexico office of Petrobras. "But they had nothing concrete to offer, so it only came down to an exchange of views."

Petrobras has two of the multiple services contracts in Burgos, but Toledo admits a similar formula would be "most unlikely" to attract his company, or any other in a similar position, to deep-water exploration.

PEMEX AT A CROSSROADS

Yet the prospects of a change in the law seem remote, at least for the moment. President Vicente Fox faces a hostile Congress that has blocked even his mild proposal for electricity reform, while the timid initiative of the multiple service contracts has attracted virulent opposition.

Matters have been further complicated by a 2006 presidential campaign which--at least in some segments of the political spectrum--is already in full swing, apparently precluding the possibilities of radical change in any area for what remains of the current administration.

Yet the clock is ticking on what remains an uncertain future for Pemex. Raul Munoz Leos, Pemex's director, has set a target of producing four million bpd of crude and seven Bcfd of gas by the end of 2006. But Pemex production, after rising sharply in the early years of the administration, has been stuck at 3.4 million bpd of crude for the last 12 months. Gas output is even further off-target, at less than 4.6 Bcfd.

Further progress may be made, but a huge question mark remains. Two-thirds of the crude, and a substantial proportion of the gas, come from just one huge field--Cantarell, in the Sound of Campeche, Cantarell, the largest offshore field in production in the world, is a discovery that dates back to the 1976-82 oil boom when Jose Lopez Portillo was president. Since then, some US$20 billion has been sunk into boosting Cantarell's output, largely through the injection of nitrogen from a US$1 billion plant built by a consortium led by Britain's BOC Group on the Atasta Peninsula in Campeche.

Cantarell, however, is due to go into decline soon. How soon is anyone's guess--or at least those in the know are not saying. And, with no other major discoveries in sight, apart from the deep-water seismic findings, that date could be crucial. "Just when Cantarell is going to go into decline is probably Mexico's most important state secret," says Baker, the Houston-based analyst. "On that one fact hangs Pemex's debt rating, Mexico's sovereign debt rating and the whole multiplier effect on the economy of the oil industry."

OIL INDUSTRY NEEDS SHOT IN THE ARM

The point has not been lost on Munoz Leos and Ramirez Corzo. At the same forum in which he spoke of the possibility of doubling Pemex's production, Ramirez Corzo revealed the other side of the coin. Without the huge injection of capital that only the private sector can provide, he said, Mexico's oil industry--like Cantarell itself--will move into decline. A decline, Munoz Leos has warned, that would eventually lead to imports.

The prospect could hardly be bleaker for a nation whose federal government--thus far unable to increase its meager tax haul--now depends on oil for more than one-third of its income.

Nor are world oil prices likely to decline in the future. Prices currently hover around US$40 a barrel. Even so, these prices pale by comparison with those of the 1973 "oil shock" which would be equivalent to almost US$80 in today's money, and the current prices have been partly boosted by temporary factors such as the conflict in Iraq.

And though, as always, specialists are divided in their opinions, most of them see the current scenario as being qualitatively different. Within a few years of the 1970s shock, prices slumped as new fields came into production--as Mexico found to its detriment at the beginning of the following decade.

This time round, however, the international oil industry is running out of new fields to exploit, at least at current production prices. And demand is being driven by the Far East's industrial growth, where China alone is sucking up an additional 2.7 million bpd, much more than current surplus capacity. Mexico needs more oil, and so does the world.

RELATED ARTICLE: 'Proven' Reserves Slip

Pemex's most recent estimate of its proven reserves puts them at 18.9 billion barrels of crude oil and its equivalent in gas. That figure causes heart palpitations among Mexicans, who recall that only two decades ago it stood at 72 billion.

But don't press the panic button yet. The oil hasn't all disappeared. What has happened is that, over the years, the concept of what constitutes a "proven" reserve has changed radically, with much stricter criteria now applied.

Compared internationally, Pemex doesn't do badly at all. Take, for example, ExxonMobil, whose proven reserves of 22 billion barrels are the highest of all the private-sector oil giants and enough for 14 years of production. Pemex has enough for 12 years, putting it not far behind.

Where there is a big difference is in exploration success. Last year, for the 10th straight year, ExxonMobil added to its proven reserves more than 100 percent of what it extracted. Pemex has improved recently, but its comparable rate is still only 44 percent. In other words, each year while ExxonMobil's reserves creep up, those of Pemex slip down, and much faster.

In contrast to two decades ago, drilling to reveal the physical existence of oil and gas is not now sufficient for it to be classified as a "proven" reserve. For that you also have to show that it would be profitable to extract it at current prices.

--Ronald Buchanan

RELATED ARTICLE: Comparative Failure

The debate over the future of Pemex has become bogged down by politics. Ideology has clouded what is an eminently practical matter. Among state oil industries, Pemex cuts a lonely figure. There appears to be no reason why it cannot be like the private-sector giants of the industry--returning billions of dollars in profits as they scour the world, bringing cutting-edge technology to the quest for new resources.

Nor does the political ideology of the country present any barrier. Even communist China is getting in on the act--right here in Mexico, where its GreatWall Drilling Company is fulfilling two contracts in Tabasco that it won last year in a Pemex tender. And Great Wall, which operates in 18 countries, is hungry for more. "Now we've made a start in Mexico, we're looking for additional contracts," said country manager Zhang Xun.

By contrast, Pemex's business horizons stretch no further than the nation's maritime frontiers. Meanwhile, Petroleos de Venezuela sells gasoline in the United States and Saudi Basic Industries Corporation is one of the possible participants in the upcoming Phoenix Project to revive Mexico's ailing petrochemicals industry.

Brazil's Petroleo Brasileiro (Petrobras) and Norway's Statoil come from countries with very different socio-economic backgrounds. While Brazil shares many of Mexico's problems (poverty and lack of social provision), Norway has a per capita income of US$42,000 a year, one of the highest in the world.

Yet the business profiles of Petrobras and Statoil are very similar. Both are state-controlled, but each has a substantial element of private equity channeled through the stock markets. Both operate in their own countries, but only where they see the most lucrative opportunities. And in their search for profits, they are prepared to go anywhere in the world where their advanced technology in gas and deep-water exploration attract the highest potential for profit.

Statoil has all but given up on exploration in Norway, where potential has been exhausted, but it has operations or offices in 28 nations. Petrobras recently announced another deep-water discovery in the Gulf of Mexico--on the U.S. side of the maritime border, of course--and it has just opened offices in China and Tanzania, as well as launching a lubricants joint venture with Cuba.

Unlike Petrobras and Statoil, Pemex bears on its shoulders the huge burden of propping up the nation's finances. For at least two decades, Mexican politicians have talked about "de-petrolizing" the economy, yet Pemex already provides one-third of the federal government's income and the proportion is growing.

The results are there for all to see. Last year, Petrobras recorded revenue of more than US$37 billion for a net profit of some US$6 billion. Statoil turned a net profit of US$643 million on revenue of US$9.8 billion. Pemex, whose reserves are about equal to those of Petrobras and Statoil combined and whose production exceeds their joint efforts by almost 1 million bpd, reported revenue of US$55.7 billion and--yet again--a net loss, this time of US$3.6 billion.

--Ronald Buchanan

Ronald Buchanan is a freelance journalist and the correspondent in Mexico for Platts energy news service.