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

Mexico’s Crashing Oil Industry was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Pemex officials were polite. They listened to Cantarell and checked their maps and logs. The Pemex representatives assured Cantarell that he was mistaken. There was no record of any oil spill coming from a Pemex ship or facility. They sent Cantarell away.

But Cantarell would not give up. He returned with the ruined nets and showed them to the Pemex officials. Sure enough, the nets were fouled with raw crude oil. So the Pemex officials asked Cantarell to take them to the place where his nets were damaged.

Cantarell took several Pemex representatives to a spot about 50 miles offshore. Despite the distance from land, the depth was relatively shallow — about 150 feet or so. One of Cantarell’s guests noticed an oil slick on the surface. The Pemex men realized that Cantarell had stumbled upon a naturally occurring oil seep.

Natural oil and gas seeps have long provided invaluable information to oil explorers. The seeps are evidence of active petroleum systems nearby. For example, Col. Drake’s famous well at Titusville, Pa., in 1859, was nothing but a hole pounded down near a known seep in the muddy bed of a body of water called — appropriately enough — Oil Creek.

But in the early 1970s, Señor Cantarell found something the likes of which Col. Drake could not have dreamed. The offshore seeps that Cantarell located were evidence of a massive hydrocarbon system deep within the rocks below. Oil was migrating upward from a highly charged reservoir. And, oh, what a reservoir!

This reservoir set a chain of events into motion that should lead you to some great profits. Here’s how it happened…

Pemex Drills the Oil Seeps — And Finds a Freak of Geology

The offshore waters and seabed of Mexico belong to the Mexican government. So Pemex began a program to investigate Cantarell’s find.

In 1976, Pemex drilled the first exploration well in the area. The results were beyond anyone’s wildest expectations. The Cantarell oil field (named in honor of the fisherman) was simply gigantic. Today, we know that the Cantarell discovery may have held nearly 20 billion barrels of oil. Much of that oil has been extracted over the past 30 years, but Cantarell easily ranks as one of the largest oil fields in the world.

And the Cantarell oil field is also a freak of geology.

The productivity of the oil-bearing zones at Cantarell — that is, the microscopic system of pores and permeability within the rock — apparently resulted from an impact with a rock from outer space about 65 million years ago.

Many geologists believe that this impact came from an asteroid with a diameter of about six miles — the size of lower Manhattan. The asteroid hit the Earth with the power of 50,000 hydrogen bombs. The force of the collision penetrated the Earth’s crust down to the mantle. The blast dug out what is called the Chicxulub crater — more than 110 miles in diameter — underneath the Yucatán Peninsula. And this impact may have been the “extinction event” that killed off the dinosaurs.

Whatever happened to the dinosaurs 65 million years ago, in more modern geologic time, the Chicxulub crater developed into an oil-bearing region of the Earth’s crust. So there was a massive oil field to exploit in modern times.

In the late 1970s, Pemex invested heavily in drilling Cantarell. And Cantarell began to yield its oil in 1979. When the oil started flowing, there was a national celebration in Mexico. The president of Mexico declared that the future role of the government would be to “administer abundance” flowing from Cantarell. We’ll address that notion shortly.

A Giant Oil Field — Cantarell

From the early 1980s to about 1995, Cantarell produced over one million barrels of oil per day (bpd). Output was steady. One of the best customers for Pemex oil has been the U.S., which has long imported well over one million bpd from Mexico.

And then, in the 1990s, Pemex began a systematic program to increase oil output. Mexico’s government wanted to raise more revenues from oil sales. The government wanted more of that “abundance” to administer. So Pemex built the world’s largest nitrogen injection project right on top of Cantarell.

That is, a large system of air pumps strips nitrogen gas from the atmosphere to inject it into the upper parts of the Cantarell reservoir. This maintains reservoir pressure, and thus increases (at least in the beginning it increased) the oil production. Oil output from Cantarell rapidly increased to nearly two million bpd.

But by the end of 2005, oil production stopped rising. In fact, oil output dropped below two million bpd as 2005 wore on. In January 2006, Pemex announced that Cantarell had “peaked” in daily output and would begin a process of irreversible decline.

What happened was that Pemex accelerated the depletion of the Cantarell field. There is only so much oil in any oil field. You can extract it slowly over time. Or you can apply technology to extract more oil more quickly. In the case of Cantarell, the nitrogen injection squeezed the “easy” oil out of the field. One could say that the nitrogen project worked too well.

Output from Cantarell is now declining at a rate around 14% per year. Some estimates are that Mexico will cease to be an oil exporter by 2012. And this will be a disaster for Mexico.

The Mexican Politics of Oil

In 1938, President Lázaro Cárdenas nationalized the Mexican petroleum industry. Indeed, for this act alone, Cárdenas is still regarded as a national hero in Mexico. Since that time, Mexican law has forbidden foreign investment in the energy sector. So Pemex has long held a total monopoly on oil exploration and production within Mexico. Pemex also controls many of the oil services that are required by any oil company, Mexican or otherwise.

But while Pemex has an oil monopoly, the Mexican government has used Pemex as both a social welfare program and a cash cow. It has to do with that notion of “administering abundance.”

One prime example is that the Mexican government has encouraged a strong union movement in the energy sector. This has led to massive overstaffing — featherbedding, really — within the oil industry. Pemex wages and benefits are among the highest in Mexico, while Pemex’s productivity is at the low end of world standards. And Pemex has over $48 billion of unfunded future pension obligations alone.

Furthermore, Pemex pays over 60% of its profits to the state and federal coffers. And over 40% of Mexican federal revenues come from Pemex. Pemex is a goose that lays golden eggs for the Mexican government. It goes back to “administering abundance.” But without Pemex, the Mexican government would rapidly become illiquid and insolvent.

Mexican government entities, in turn, use the money for social programs. But as is the case with large government entities everywhere, the politicians always seem to want more. The effect on Pemex is one of massive and ongoing decapitalization. Thus, for many decades, Pemex has not had adequate funds to reinvest in the Mexican energy sector. Much of the Pemex energy infrastructure is old and in poor mechanical condition.

To make a long story short, Pemex is deep in debt and — despite the high oil prices of late — losing money. And now output from Cantarell is crashing. The implications of all this are strategic not just for Pemex, but for Mexico and the U.S., as well.

Regards,
Byron W. King
July 2, 2008

P.S.: While Mexico tries to reestablish itself as a major player in the oil market, some American companies are beginning to make serious investments in the Mexican oil business. One such company has put itself in perfect position to capitalize on Pemex’s new plans to step up production and modernize its infrastructure. This company has been recommended to the readers of my paid service Outstanding Investments.

Mexican Oil was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.