Mexico's Crashing Oil Industry

Mexico is a critical oil supplier to the United States. But Mexico’s ‘s oil industry is in crisis. Indeed the grim numbers come from no less a source than the Mexican Energy Ministry. Production statistics make it clear that Mexico’s overall oil output is declining rapidly — with the word “crashing” coming to mind as one views the chart.

One particular oil field is central to the problem. It’s called Cantarell. It’s a super-giant, offshore oil field that was discovered in 1976 — based on a natural oil seep under about 150 feet of water, by the way.

After decades of production, Cantarell is getting long in the tooth. Oil output from Cantarell, is declining rapidly. Cantarell is depleting at an astonishing rate. Meanwhile, the yield from new Mexican oil fields is simply not making up the difference.

The Mexican government obtains about 40% of its national receipts from oil-related revenues. Yet due to falling oil output, especially from offshore, Mexico will likely cease being an oil exporting nation by 2015. This looming problem holds dire implications for the national balance sheet of Mexico, as well as — by implication — for U.S. energy and national security.

One obvious question is, Can Mexico rebuild its oil industry? Right now, there’s not nearly enough internal Mexican investment in exploration and new oil development. It’s quite evident that Mexico has under-funded what’s called “maintenance capital,” the funds necessary just to keep the day-to-day operations and equipment working.

Another problem is Mexico’s lack of success in discovering and developing new oil resources, despite its national jurisdiction over a large slice of the oil-rich Gulf of Mexico.

One major element of this lack of exploration success is that Mexico’s constitution severely restricts foreign participation in Mexico’s energy development. That is, foreign oil companies are banned from exploring for and drilling for oil in Mexico. Considering Mexico’s crashing oil output, it’s fair to ask if Mexico should change its approach to development.

Recently, I discussed these important issues with Ali Moshiri, President of Chevron Africa and Latin America Exploration and Production Company.

Here’s what I asked Mr. Moshiri about Mexican oil development, followed by his reply.

BWK: In the U.S. we’re seeing remarkable discoveries in the deepwater Gulf of Mexico (GOM). Could you share your views about what’s happening across the GOM, down in Mexico? Is there hope for deepwater oil helping Mexico reverse it’s decline rate for oil production?

AM: With Mexico, the new government reforms are in a positive direction. The fundamentals have to be decided by the Mexican government, which has to decide how they want to risk exploring their basin.

The Mexican government has to decide if they want to risk future exploration via Pemex (Petroleos Mexicanos, the Mexican national oil company — NOC), or via the private sector. They need to recognize that if the private sector is going to get involved, it has to be via a meaningful way. A meaningful way would be via sharing the risk and the upside.

BWK: Do you think we’ll ever see large, new discoveries in the Mexican GOM areas?

AM: I personally believe that Mexico is under-explored. They’re lagging behind on exploration offshore, and they underestimate the complexity and what is required. It all needs to be reassessed.

If you look at the U.S. deepwater GOM, there was a long era (to get to) where we are today. And you cannot look at today, and say you are going to take the U.S. GOM and image it into the Mexican area.

BWK: So what do you think it will take for Mexico to accomplish the exploration, and find the potential resources that are out there?

AM: Number one is that (Mexico needs to allow) the flexibility that is required for private sector, for IOCs (international oil companies). It’s IOCs that are the ones who really know how to go from phased exploration into development.

Yes, you can find companies that can explore. But when you explore, and then you find hydrocarbons in 8,000 feet of water, the next step is how you can develop it. How much money do you need? You can say, well, you need X-millions of dollars (to) develop it. But how do I finance it?

It gets into capital efficiency. Capital efficiency would be, how do I go ahead and finance this project? By production sharing? Finance it by myself? Some other way? How do you finance the development? Those are things that we think need to be addressed in Mexico.

BWK: What about contractors? Do you think Mexico could accomplish its energy goals by hiring, say, service companies, or using large oil companies as contractors, to do the exploration, the seismic, the drilling and such?

AM: The IOC has to be perceived as a partner. You cannot perceive the IOC as a contractor. This is my personal opinion.

Working with the IOC as purely a contractor will slow down the process. You have to look at the IOC as a partner, and a partner meaning sharing the risks as well as the rewards.

If Mexico gets this concept, and understands it, I think the progress and the basin is good enough to do things in the right way, and (Mexico) can be able to catch up the U.S. GOM and the U.S. sector.

So according to Chevron’s Ali Moshiri, there’s hope the Mexican energy sector. If Mexico opens up to foreign risk-sharing, and makes a good use of the expertise of international oil firms, then the nation can increase its future oil output.

But Mexico needs to permit outside, independent oil companies to participate as partners in exploration and development. That means to share the risk and rewards. In other words, Mexico should leverage foreign capital and technology, while sharing the eventual oil production in an equitable manner.

Even then, if everything goes right, it’s going to be a multi-year project to restore Mexico’s oil output to what we’ve seen in previous years. From where things are now, it won’t be easy.

The Overall Strength of Chevron

Chevron is one of the world’s largest and most capable independent oil companies. Chevron has great financial strength, and a deep pool of technical competence. Chevron’s success — certainly in deepwater development — is built upon its many highly skilled and talented people.

I can say these good things about Chevron based, in part, on my first hand knowledge. I’ve had the opportunity to visit a Chevron deepwater drilling project in the GOM. From what I’ve seen, Chevron exhibits a strong culture of safety and technical excellence.

Other Investment Opportunities in Deepwater Energy

There are, of course, other companies working on deepwater oil exploration and development projects across the world. If you’re interested in learning about another deepwater development, I can tell you about a small, Canadian company that has acquired a remarkable play offshore Africa. Just follow this link and listen to a presentation on this investment idea.

Until we meet again,
Byron W. King
Whiskey & Gunpowder

August 9, 2010

The Daily Reckoning