As wells dry up, Mexico could be forced to privatize oil

Even as popular pressure grows around Latin America for a stronger state hand in developing natural resources such as oil and gas, Mexico's president-elect Felipe Calderón may be forced to consider putting more power in private hands.

The country's flagship oil company Pemex, has been a point of pride since the industry was wrenched from foreign hands and nationalized in 1938. Its revenues alone cover one-third of Mexico's budget.

But prosperity from years of record oil prices has allowed Mexico to postpone what most agree are much-needed reforms. And now, as production at Pemex's top oil field declines, pressure to find new fields is mounting. But industry analysts say Mexico's constitutional restriction on foreign direct investment will hamstring costly exploration efforts, and possibly disrupt the flow of oil, 80 percent of which heads to the US.

Indeed, with his fragile political mandate, Mr. Calderón may find that oil becomes the issue that will define his presidency.

"This is an important first battle," says Benito Nacif, a political scientist at the Center for Research and Teaching in Economics (CRTE), a Mexico City think tank. "In the industry sector, there is a consensus that this reform is necessary, that you have to open it up [to the private sector]. The question is: 'Will [Calderón] be able to build sufficient [political] consensus?' "

Many industry analysts had hoped that outgoing President Vicente Fox would be able to push through energy-sector reforms to open up Pemex to more private direct investment, in order to boost exploration and production.

Mexico is the second-biggest supplier of oil to the US, favored because of its proximity and relative political stability.

In the end, Mr. Fox didn't push through a consitutional change, largely because trying to privative Pemex, even partially, is so politically unpopular.

Also, when Fox came to office in 2000, capacity at Cantarell, the world's second-largest field and Mexico's most important, was not in question. The complex, located in southern Gulf waters, actually increased production during Fox's term, peaking in 2004 with 2.1 million barrels a day.

But since then, production has been dropping off at Cantarell. David Shields, an independent energy expert in Mexico City, says production declined by 10 percent in the first six months of 2006. He contends that Pemex is in much worse shape than is publicly expressed. "Pemex says everything is great," he says. "But [Cantarell] is going to run out, and they [in the long-term] don't have other things to replace it."

Earlier this month, the state monopoly announced that crude output from another offshore field, Ku-Maloob-Zaap, was expected to double in 2009. That, Pemex officials said at a press conference, would help maintain oil production at an average 3.2 million barrels a day, and offset losses from Cantarell.

George Baker, an energy analyst at the consulting firm Energia.com in Houston, says he is not surprised by Pemex's announcement. "Pemex has a way of making magic," he says. Still, he says that potential finds in the Gulf of Mexico, similar to Chevron's recent announcement of a big discovery in US waters, are currently out of reach because Pemex does not have the technical know-how or money to undertake such exploration. The issues have been here all along, says Baker, but now that Cantarell is facing declines, "the slope downward is slipperier."

Experts say that American companies are watching oil production in Mexico, but because of politics, cannot interfere by pushing for more foreign participation. If the US needed to purchase oil from more-distant countries, additional transportation costs would be passed onto the consumer, Baker says.

So far, Calderón has reiterated that he will not consider private direct investment. "There will be deliberations that we Mexicans will have in Congress to find the means by which Pemex can access the probable reserves, particularly in the deep waters of the Gulf of Mexico," he said at a September press conference. "But, for now, I will be very respectful of national legislation on the matter, which doesn't permit foreign investment in petroleum extraction...."

In its legislative agenda, his incoming administration has also remained unclear when it comes to its energy plans, focusing on the need to "modernize" and increase investment in Pemex.

"These things are very vague, one could interpret them as minor fiscal reforms, or ... major constitutional reforms," says Allyson Benton, an expert on economics and politics at the CRTE in Mexico City. "They want to wait to see what kinds of coalitions can be built around these things."

When it comes to obtaining gasoline here, drivers have only one, decidedly Mexican, choice: the green and red pumps at Pemex. That's the way many want it. Calderón barely squeaked out a victory in the July 2 election, winning by just half a percentage point. While his rival, Andrés Manuel López Obrador, disputed the race this summer, López Obrador used many of his protest gatherings to rally supporters about keeping foreigners out of the energy sector. Each appeal brought wild applause.

Indeed, the divided electorate means that Calderón is unlikely to find the political capital to challenge nationalization, even partially. "It is too much of a political danger for them under the conditions they won," says Miguel Tinker-Salas, an oil and politics expert at Pomona College in California.

Mr. Shields puts it more starkly, saying that allowing international companies back into Mexico is tantamount to letting "the invader back in," he says. "There will be a revolution before there is foreign direct investment."

Those against foreign investment received a boost this month when businessman Carlos Slim, the third-richest man in the world according to Forbes magazine, announced that Mexico did not need foreign help to reach deep-sea oil.

Some analysts say that more foreign investment is not the only solution for Pemex. Mr. Tinker-Salas, for example, says that with more oversight, Pemex could become more efficient.

Ms. Benton says that Calderón might have the most room for change by addressing fiscal reform. One option would be to lift the heavy tax burden from Pemex, which sees nearly half of its earnings go to government coffers, so that Pemex can focus on daily operations. The budget is so stripped, she says, that Pemex has to import a significant portion of its refined products.

But some still hope that Calderón will be able to open the industry to more private participation, beyond the current flat-fee subcontracts that foreign companies can participate in. The long-ruling Institutional Revolutionary Party (PRI), for example, moved to the right of the spectrum on the issue this election, says Mr. Nacif. The PRI is also more likely to cooperate with the Calderón administration because it is in a weaker position, having dropped to the third-largest party in Congress.

But more than anything, the reality of dwindling oil production may help to change sentiments. "One of the factors that drives policy change everywhere is the deterioration of the status quo," says Nacif, "and the perception is that the status quo is worsening. It's going to help [Calderón]" move toward opening the industry up to private firms.

• Ms. Llana is Latin America correspondent for the Monitor and USA Today.