COMMENT PRIVATE SECTOR FUNDS KEY TO MEXICAN ROLE AS MAJOR U.S. OIL SUPPLIER

George Baker
Oil Consultant
Berkeley, Calif.

Baker is executive secretary of ProfMex, an international group of academic research programs concerning Mexico sponsored in part by the University of California at Los Angeles. The author of Mexico's Petroleum Sector (PennWell Books, 1984), he previously was an analyst and editor at Lundberg Survey Inc.

Mexico's return to the world oil market as a major player is unlikely but should not be ruled out.

Mexico's ability to profit from rising oil prices is severely constrained by the cumulative effect of 5 years of underinvestment in exploration and production.

The crisis provoked by the Iraqi invasion and takeover of Kuwait brings to mind Mexico's basic argument since the late 1970s that it is the West's best source of crude oil outside the Organization of Petroleum Exporting Countries.

INITIAL BENEFITS

In a more perfect world, Mexico would benefit from the crisis in four ways.

Petroleos Mexicanos, the state oil company, benefits in the first instance because the export price formula in its long term contracts is sensitive to changes.

Pemex bills its crude export clients retroactively based on average daily prices for the billing period, according to an agreed price weighing formula.

Rising export prices, therefore, will bring up the average monthly price on existing, long term contracts.

Second, during the last oil boom, the first commandment of Mexico's crude export policy was: Thou shalt not sell on the spot market.

Along with other sweeping changes such as the shakeup of the oil union leadership in early 1989, the administration of Carlos Salinas de Gotari has dropped this commandment.

In 1989, a new subsidiary, Petroleos Mexicanos International (PMI) was formed for reasons that at the time were not clear.

The current international crisis has brought forth what may have been the underlying reason: the administrative ability to sell crude oil on the spot market. If crude supplies are available, PMI could take advantage of spikes in oil prices.

CAPITAL NEEDS

In the third place, Pemex's ability to raise money abroad for capital projects will be enhanced by a sustained increase in world oil prices.

The main item needing outside funding is the Cantarell Project, which needs a benefactor with about $800 million in his pocket.

The Cantarell Project is one that indirectly addresses the cumulative effect of a government policy of austerity that includes exploration and production.

Without the Cantarell Project, which was conceived as an investment package that might be attractive to funding agencies such as the Ex-Im Bank of Japan, Mexico's ability to hold onto its present share of the oil market is in jeopardy.

Increasing internal demand and falling crude production undermine Mexico's ability to assume its former prestigious role as a crude supplier to the U.S.

SOARING DOMESTIC DEMAND

While Pemex's production of refined products in 1989 was only 4.29% above that of 1988, Mexican imports told another story:

Fuel oil imports rose 17.7% to 69,500 b/d in 1989 from the year before.
Gasoline imports last year shot up almost 1,500% to 28,200 b/d from 1988's 2,100 b/d.
Natural gas imports in 1989 soared to an average 36.4 MMcfd from 6.3 MMcfd in 1988.
Petrochemical imports jumped to 55,498 metric tons in 1989 from 34,433 metric tons in 1988.

In the absence of increased production, such increases in internal demand must come at the expense of exports. In 1989, Mexican gasoline exports fell to 394 b/d from 16,298 b/d in 1988. Overall petroleum product exports in 1989 were down 30.9% from the year before. Further, Pemex's petrochemical exports fell 14% in the year to year comparison.

While all of Pemex's internal forecasts are pessimistic, some are more pessimistic than others.

Meanwhile, hiking production through greater investment in E&P faces an increasing cost environment.

CANTARELL PROJECT

This shadow over Mexico's future role as an oil exporter helps explain the origin of the Cantarell Project (see map), which Pemex's E&P department proposed in late 1989.

It calls for investment of $807 million in a program intended to maintain production of heavy Maya crude in the Cantarell complex of fields in Campeche Sound at more than 1 million b/d through 1996.

In addition to boosting flow from existing wells, an infill program would stem a decline in field production currently estimated at 11%/year.

The Cantarell complex is projected to produce an average 1.153 million b/d in 1990. If the project is implemented immediately, flow could rise to an average 1.225 million b/d for 1990 and peak at about 1.4 million b/d by 1994.

Mexico's current total oil production is about 2.6 million b/d.

Having the Cantarell project in operation will mean a net difference of another 380,000 b/d of heavy crude production in 1994. This volume, at $20/bbl, would produce incremental income of $2.8 billion/year.

The Cantarell project in part involves boosting field flow by solving a problem of excess backpressures in the offshore gathering lines that is affecting well production.

It calls for a two step cut in average backpressure to 114 psi and then to 28 psi from 185-284 psi. That would be accomplished by reconfiguring the layout of the pipeline system connecting Cantarell platforms, replacing existing pipe with larger diameter pipe, and, in a second stage, installing gas separation equipment on production platforms and laying separate oil and gas lines from the platforms to the main gathering centers.

Pemex plans to drill another 30 infill/development wells in the complex in addition to the existing 100. Some of that added drilling is in Pemex's 1990 budget.

FUNDING SOURCES?

Pemex analysts conceived the Cantarell project as one that could be funded by outside financing because the payback period is short-unrealistically put at 1 year-and the internal rate of return is high at 200%.

Japanese funding sources, who were initially approached for this project, have not been encouraging in their response.

Where, then, are funding sources to be found?

The obvious answer is not one Mexico's leaders want to hear: risk contracts with private corporate investors.

Mexico's Constitutional Article 27 requires the state to be sole owner and operator of upstream and downstream activities. An exception is made for private participation in the petrochemical industry.

The hard truth is that no one seems to be interested in being an indirect, equityless investor in Mexico's oil industry.

MEXICO'S POTENTIAL

Most U.S. observers believe Pemex is not developing the full potential of Mexico's undiscovered petroleum resources.

Two issues are at stake: the recovery factor for known fields and the question of undiscovered resources.

The word at Pemex is that the official 1981 figure of 70 billion bbl of oil equivalent (BOE) of proved reserves was first arrived at using a 40% recovery factor. Recent estimates have reduced this figure to 20-30%.

However, that original reserves number includes an estimate of reserves in the Chicontepec complex of fields of 10 billion bbl of oil, 26 tcf of gas, and 1.3 billion bbl of condensate.

Pemex first estimated a recovery factor for Chicontepec at 20% but has cut that to 5%. Chicontepec production is likely to average only about 100 b/d/well, and full development would involve 10,000 wells.

U.S. private investor groups have sounded out Pemex on the possibility of a risk contract agreement to help develop Chicontepec. Pemex has rebuff ed those efforts so far, and Chicontepec still is not producing.

As for undiscovered resources, Pemex emphasizes that only a small percentage of hydrocarbon potential areas have been explored. Bernardo F. Grossling, a petroleum geologist with the U.S. Geological Survey, believes there is a minimum reserves potential of 100 billion BOE in the Reforma-Campeche region out of a potential resource base of 260 billion BOE at 80% probability, with an upper limit estimate of 700 billion BOE at 10% probability.

Pemex's published figures place onshore Reforma reserves at 13.7 billion BOE and offshore Campeche reserves at 30.7 billion BOE.

In spite of all these constraints, Pemex engineers in the past have shown that the impossible took only a little longer than the difficult, especially with the barely visible but profoundly important moral, political, and financial support from Washington.

U.S.-MEXICO RELATIONS

The fourth way Mexico stands to gain from higher oil prices stemming from an extended crisis in the Middle East lies in gaining leverage in U.S.-Mexican government relations.

Mexico might propose, for example, that for every $1 less of international debt servicing expense Pemex will invest an additional 500 in exploration/production. The other 500 would be set aside for other urgent programs such as public health, education, and agriculture.

Mexico's proposal on Aug. 9 to increase crude production in the Bay of Campeche by 100,000 b/d for 60 days was an appreciated symbolic gesture, said U.S.,Treasury Sec. Nicholas Brady.

In Mexico, however, government critics insisted that such output, if achieved, would be at a net loss to Mexico:

"The cost of the damage to oil fields from overproduction and the waste of flared natural gas will easily offset the additional revenues that Pemex may receive," one critic said.

While a resurgent response on the part of Mexico to an international oil crisis should not be ruled out, it cannot be funded on a short term basis.