March 31, 2008 at 2:00 pm #3729
Pemex Missteps Pare Oil Revenues, Pave Way for Petrobras Entry
By Thomas Black and Andres R. Martinez
March 31, 2008 (Bloomberg) — Guillermo Najera, a 42-year-old machine operator at Mexican state-controlled oil company Petroleos Mexicanos, gets paid to do nothing all day. Pemex management can’t fire the union worker or transfer him from the ammonia plant in Ciudad Camargo, where he still shows up for work even though the plant stopped production in 2002.
“We don’t have anything else to do except keep our areas clean,” Najera says as he and dozens of other idle workers enter the gates of the plant for the 7 a.m. shift. “I want to go back to work.”
Pemex’s lack of control over its 110,000 union workers is just one symptom of a deeper malaise at Mexico’s largest company. Pemex, which produces more crude oil every year than Exxon Mobil Corp., suffers from too little investment, high taxes, laws that forbid competition, corruption and corroding and exploding pipelines. An accident at an offshore platform killed 21 in October.
The Pemex crisis that critics have warned about for the past decade has arrived: Production at the company’s largest oil field, Cantarell, fell 18 percent last year, and Pemex has little petroleum lined up to replace it. Yet the government of President Felipe Calderon finds itself unable to act to prevent what could be a disaster for both Pemex and the country, whose budget relies heavily on Pemex sales.
Masking a Decline
The price of oil, which jumped 57 percent last year, has kept revenue at the oil giant from falling, masking a production decline, massive inefficiency and overstaffing, says John Padilla, managing director of IPD Latin America, an energy consulting firm with offices in Caracas, Mexico City and New York.
The Mexican Energy Ministry estimates 30 billion barrels of oil and gas are sitting below deep water on the Mexican side of the Gulf of Mexico. Yet it’s unclear whether Pemex, which hasn’t been permitted to form partnerships with foreign oil companies, has the technology, money or competence to drill successfully in waters as deep as 10,000 feet (3,000 meters), says Matthew Shaw, an energy analyst at Wood Mackenzie Consultants Ltd. in Edinburgh.
Calderon, who took office in December 2006, wants Pemex to have more autonomy from the government and the right to form partnerships with other companies to gain access to deep-water drilling technology.
“To reach this oil, we need to strengthen Pemex,” Calderon said at a Feb. 14 news conference in Los Angeles. “I’m convinced that we Mexicans should go for this oil, so it becomes an instrument with which we make Mexico a fully developed and powerful country in the next decades.”
Production at Pemex, the world’s third-largest oil producer began to fall in 2005 and in 2007 averaged 3.08 million barrels a day.
Mexico may have to import light crude — less viscous oil used to make gasoline — for its refineries by 2011 if Pemex is left unchanged, Energy Minister Georgina Kessel said in a Dec. 11 report. Without new production, daily oil exports may plummet to 289,000 barrels in 2016 from 1.67 million last year, the report says.
What’s bad for Pemex is bad for Mexico’s economy. Pemex last year paid the government taxes of $62.5 billion — a full 60 percent of its sales. Pemex funds about 40 percent of federal spending. Only rising oil prices have prevented Mexico from falling into a budget crisis, which could ruin its three-year record of balanced budgets, stable exchange and interest rates and a stock market that rose fourfold in the past five years.
Possible Tax Increase
When oil revenues finally fall, Mexico will have to raise other taxes or cut anti-poverty, education and road building programs, says Jorge Chabat, a political science professor at the Center for Economic Research and Teaching in Mexico City.
“The impact would be great,” Chabat says. “Pemex is the main source of foreign currency earnings for Mexico and very important for the Mexican economy.”
Mexican lawmakers have finally recognized the urgent need to give Pemex enough money for new exploration and capital improvements. They’ve reduced Pemex’s tribute to the state twice in the past two years.
Pemex’s largest tax is a 71.5 percent levy on the value of all oil and gas it produces. As a result of the tax reduction, Pemex will have $18 billion this year to spend on exploration and oil and gas production, the highest amount ever.
What lawmakers are unwilling to change is the essentially political nature of Pemex’s operation. Since Pemex was created with the expropriated assets of U.K. and U.S. oil companies in 1938, the government has enforced the clause of the federal constitution that gives the state the exclusive right to process and distribute oil and natural gas.
That’s put the company’s profits at the disposal of each new president. They’ve had little incentive to plan for Pemex’s future beyond their six-year terms. (Mexican presidents may serve only one term.)
Pemex has changed chief executive officers four times in the past eight years and chairmen five times. “It’s effectively a government department at the moment,” Wood Mackenzie’s Shaw says. Pemex’s board of directors consists of six of Calderon’s cabinet members and five union leaders. Without amendments to the constitution, not much change is expected, Shaw says.
“The Big One that everyone is waiting for is some kind of an opening up of the upstream sector, and that doesn’t seem to be on the agenda,’‘ Shaw says, referring to exploration and production. The company needs to form partnerships with foreign oil companies to gain the technology and expertise required to drill in deep water, he says.
Reyes Heroles Speaks
Shaw and other analysts are convinced that the Mexican government could greatly increase private participation in the oil sector without violating the constitution. However, Pemex CEO Jesus Reyes Heroles, a former energy minister and ambassador to the U.S., only began publicly pushing to loosen the state’s monopoly on the oil industry in March, 16 months after his appointment.
Reyes Heroles gave interviews to the Mexican press advocating partnerships to explore for Gulf oil, while at the same time Pemex started a television and radio advertising campaign saying there is a “treasure” buried in the deep ocean that it needs help to recover.
While officials argue over how much private investment is legal, fuel imports jumped to $15.8 billion in 2007 from $2.4 billion four years earlier, Pemex’s 60,000-kilometer (37,000- mile) pipeline system continued to decay and its debt and unfunded pension liabilities more than doubled to $122.5 billion as of the end of December from $59.1 billion in 2002.
The argument over how to fix Pemex has become a political standoff that will determine the future pace of Mexico’s unfinished economic opening, Chabat says. Since Carlos Salinas de Gortari, who was president from 1988 to ’94, began selling banks, steel companies, ports and other government assets to private companies, the pace of economic change has slowed.
Former President Vicente Fox, a businessman turned politician who ended seven decades of rule by the Institutional Revolutionary Party, or PRI, in 2000, failed to live up to his promise of change, Chabat says. Fox’s attempts to modernize Pemex by bringing in more private investment, increasing non- Pemex tax assessments and modifying labor laws were all blocked by Congress.
“Fox never understood what politics was all about,” Chabat says. “He never could negotiate anything because he didn’t know how to do it.”
Opposition Stalls Change
Fox, a former Coca-Cola Co. executive, appointed Raul Munoz Leos, then the president of DuPont Co.’s Mexican operations, as CEO of Pemex, with orders to run it like a private company. Munoz Leos’s efforts couldn’t overcome opposition by Pemex’s union, the company bureaucracy, Congress and the Finance Ministry, which sets Pemex’s prices and budget and tells the company when it can sell debt.
Calderon, a former legislator and energy minister in Fox’s National Action Party government, has more experience cutting deals in Congress. Last year, he won plaudits when he pushed through a bill that raised taxes and cut the cost of civil service pensions.
The PRI, which is now the second-largest party in the Senate and the third largest in the House, holds the key to any change. With its votes, Calderon’s National Action Party, the largest in Congress, can push through a new energy law. The PRI last year helped Calderon pass the pension and tax bills. Its legislators are divided on the question of opening up Pemex to more private investment, Chabat says.
Brazil Sets Example
Calderon has exhorted Congress to follow the examples of Brazil’s Petroleo Brasileiro SA and Norway’s StatoilHydro ASA, two state-controlled companies that have sold shares publicly, developed deep-water technology and increased production through international exploration.
During the legislative session scheduled to end on April 30, Calderon planned to introduce a bill allowing partnerships for deep-water drilling and giving Pemex management autonomy from the government.
“We don’t have much time,” Calderon says. “We have to decide this.”
The political opposition is doing all it can to prevent a decision. “Oil profit belongs to the Mexican people, and there’s no reason to privatize it,” Andres Manuel Lopez Obrador, the former mayor of Mexico City whom Calderon defeated in the 2006 presidential race, said in a Feb. 11 press conference. Lopez Obrador, a top leader of the Party of the Democratic Revolution, instead advocates increasing the company’s budget and reducing corruption.
Into the Streets
At a rally in front of Pemex headquarters on Feb. 24 that drew a crowd of thousands, Lopez Obrador warned that opening Pemex to private investment could lead to violence.
He pledged to call on his supporters to block entry to Congress, airports and financial institutions if legislators push forward on Calderon’s bill. Lopez Obrador has led a series of anti-government demonstrations since he lost the presidency by a narrow margin in a vote he says was fraudulent.
Pemex won’t be able to reverse its slide in production and reserves without overhauling laws that saddle the company with bureaucracy, says Samir Awad, manager of Petrobras’s operations in the Americas, Africa and Eurasia. Before Brazil opened its oil industry to competition, Petrobras was inefficient and had little incentive to grow, he says. The company now has a market capitalization of $235 billion and has more than doubled daily oil production to 1.92 million barrels from 869,000 in 1997 by drilling off the coasts of Algeria and Nigeria and in an area of the Gulf of Mexico controlled by the U.S.
Price of Modernization
Pemex suffers from the same government bureaucracy and civil-servant mentality as Petrobras did before it gained autonomy, Awad says. Petrobras in 2005 produced three times as much oil as it did in 1992 with the same number of workers.
Mexico treats Pemex like an “untouchable goddess,” Brazilian President Luiz Inacio Lula da Silva told the press March 27. Lula says he told Calderon in a private conversation the same day that Pemex and Petrobras should create a joint company to explore new areas in the Gulf of Mexico.
Petrobras and Pemex have already signed a technology- sharing accord, and the Brazilian company has invited Pemex to share in a venture to drill on the U.S. side of the Gulf of Mexico near Mexico’s border.
Petrobras is also drilling for gas on Pemex’s behalf in northern Mexico in an experimental program designed to prove the value of private contracting.
Decisions and Consequences
Petrobras has hosted tours of its Brazilian facilities by Mexican legislators to show how the company has been transformed since it opened to private investment.
“They really need to do some sort of reforms in the oil sector,” Awad says. “I would say this is urgent. It’s a question of when they are really mature enough to promote the changes and make the decisions and face the consequences.”
Mexican lawmakers have also traveled to Norway to study StatoilHydro, which sold shares to the public in 2001. StatoilHydro expects to get 30 percent of its production outside Norway’s continental shelf by 2012, as it scours the world to make up for a potential oil decline at home.
“We have done the journey from privilege to performance, from domestic to international and from public to private,” StatoilHydro CEO Helge Lund said in a Feb. 12 speech at an energy conference in Houston.
Seeking Past Glory
Victor Lopez doesn’t believe in private solutions to Pemex’s problems. The company should shun partnerships and private investment and instead regain its past glory, says Lopez, an engineer and 27-year Pemex veteran who’s helping oversee a $3.1 billion expansion of Pemex’s refinery at Minatitlan.
In the 1950s, ’60s and ’70s, Pemex built its own refineries and petrochemical plants and developed its own offshore drilling technology, he says. Most of the money being spent at Minatitlan is going to private companies, including Mexico City-based ICA Fluor and Seoul-based Samsung Engineering Co. ICA Fluor is a joint venture of Mexico City-based Empresas ICA SAB and Irving, Texas-based Fluor Corp.
When the project is finished, the refinery will produce 40,000 more barrels of gasoline a day. “This is technology that Pemex should be creating,” Lopez says. “This money could stay in Pemex and create jobs for Mexican engineers.”
Pemex focuses most of its spending on oil, which the company says it produces for $4.36 a barrel and sells for $90 — the going price for Mexican heavy crude. Those costs will rise as the company shifts production to the southern mountains and the deep waters of the Gulf.
In Deep Water
The company began last year to hire drilling companies to tap reserves at Chicontepec, a vast field dotted with thousands of small oil pockets that cut across the states of Hidalgo, Puebla and Veracruz. Pemex is counting on Chicontepec as its medium-term answer to the Cantarell decline.
The long-term solution lies below the waters of the Gulf of Mexico, where the company has little experience. Pemex has sunk six exploratory wells in deep Gulf waters, in contrast to the hundreds that pepper the U.S. side of the Gulf.
Private companies aren’t necessarily itching to partner with Pemex under the current law. “We are not interested in working as a service company in a deep-water project,” Awad says. “The financial exposure is too much.”
What companies such as Petrobras, Royal Dutch Shell Plc and Exxon Mobil want is to form equity partnerships with Pemex or gain the right to drill on their own, then share the riches with Mexico through taxes and job creation. They are watching developments in Mexico City closely in hopes the government will see the light.
“Exxon’s there, Chevron’s there, Statoil’s there, Total’s there,” Awad says. “Everybody’s waiting for the change. The change may happen tomorrow. Or it may never happen.”
To contact the reporters on this story: Thomas Black in Monterrey at firstname.lastname@example.org; Andres R. Martinez in Mexico City at email@example.com. Last Updated: March 31, 2008 00:01 EDT
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