Oil in Mexico and United States energy security: A tale of symbiosis

by Jeremy Martin

On the outskirts of Houston, along the industrial ship canal, is a refinery known as Deer Park. It is the sixth largest refinery in the United States. Its 340,000 bpd capacity makes it a critical refinery for the greater Houston fuels market. But what really sets the facility apart is that it is partially owned by Mexico's national oil company, Petroleos Mexicanos, (Pemex).
The Deer Park refinery dates back to 1929, but in 1993 Pemex acquired a 50 % stake from Shell and the two firms have run it as a joint venture since. The facility -- which receives roughly 240,000 bpd from Pemex oil fields in Mexico -- has continuously served the United States market for many years. This has greatly contributed to US energy security of supply. While a significant amount of the refinery's product is for US consumption, a portion of the output returns to Mexico.

Deer Park is a remarkable two-way street of oil connections between the United States and Mexico -- and a microcosm of a largersymbiotic relationship. The refinery offers superb insight into a key international piece of the broader energy security discussion in the United States.
Indeed, for over 15 years Mexico's Pemex has operated a critical piece of the United States' energy matrix -- both in terms of crude oil supply and refined products. Yet it is likely that few Americans outside of the energy business have ever heard of Deer Park or fully grasp the larger linkage between the United States and Mexico that Dee Park underscores.

Symbiosis
In terms of the US-Mexico energy relationship, Deer Park is in some ways an anomaly. It does, however, serve as an excellent example of the symbiotic relationship that has developed between the United States and Mexico when it comes to oil, national budgets and energy security.
Scientists define symbiosis as a mutually beneficial relationship that evolves between two species. Symbiotic relationships often feature complex co-dependencies. For Mexico and the United States, symbiosis speaks to the direct relationship between Mexican oil production, its related fiscal dependency for the nation, and the United States' "addiction to oil."

Mexico is the United States' third largest supplier of oil and the United States is by far Mexico's largest export market for oil, accounting for over 80 % of its oil exports each year. Mexico's budgetary dependency on oil export revenues and, more specifically, Pemex is another important element of the symbiosis that has evolved.
Dating back to the early days of the oil industry in both countries, the physical neighbours have slowly and steadily marched into an oil co-dependency that has contributed significantly to both countries' recent economic development and geopolitical relationship.

March 1938, the creation of Pemex and oil nationalism in Mexico
No discussion of oil in Mexico is complete without at least a cursory review of the historical and geopolitical developments crucial to understanding the oil business in Mexicotoday and there is no better temporal starting point than the March 18, 1938 nationalization of the oil industry in Mexico.
On that momentous day, Mexican President Lazaro Cardenas -- responding to a crippling oil strike that pitted Mexican workers against United States and British/Dutch oil companies -- expropriated the assets of international oil firms operating in Mexico. In choosing to expropriate the foreign concerns, President Cardenas cited Article 27 from Mexico's 1917 Constitution and declared that all oil reserves within Mexico belong to the state.

These developments led to the creation of the national oil company Pemex in June of that year and effectively restricted the participation of private and foreign concerns in Mexico's oil industry; limited access remains the case almost 72 years later.
That March 18 is a federal holiday in Mexico and that school books include descriptions of these events speaks volumes. It is clearly one of the most important historical dates for Mexico in the Twentieth Century. And Pemex literally embodies that nationalistic fervour. It is not uncommon to hear tales in Mexico of how families responded to President Cardenas' effort by donating family heirlooms, livestock, savings and other contributions to help fund the early days of the company.

Pemex and national sovereignty interconnected
It has been said that in Mexico oil is not merely a chemical compound but rather a fundamental element of sovereignty. Simply put, in Mexico, oil is part of the national DNA. This fundamental political truism continues to affect development of the nation's huge oil resource potential by restricting private -- particularly foreign - investment.
President Cardenas's historic decision has imbued citizens of Mexico with a sense of ownership of the nation's oil and a fervent desire shared by many to keep Pemex in state hands and to keep private firms out. The legacy of nationalism in Mexico vis-à-vis oil has perhaps most importantly denied Pemex partnership opportunities with international firms which would have greatly benefitted it by access to technology, know-how, fiscal- and-management efficiencies.

Given the potential of the deep water Gulf, these hindrances are routinely exposed when multinational partnerships from across the world (including several national oil companies) drill and discover significant oil reserves just across the maritime border in US waters. To wit, in September 2009, BP announced that it had made a "giant discovery" at its Tiber prospect in the Gulf of Mexico; BP operates Tiber in partnership with Brazil's national oil company, Petrobras, and ConocoPhillips.
Meanwhile, given the constraints of the Mexican Constitution, Pemex is barred from entering into such partnerships in the deep waters on its side of the Gulf of Mexico. Mexico's deep waters continue to go almost completely un-explored and un-produced.

Mexican oil production and Cantarell
Fast forward almost forty years from Lazaro Cardenas' nationalization epoch to the sleepy fishing coast along the Bay of Campeche in the 1970's for another critical marker in Mexico's oil history: The discovery of the Cantarell field.
Named for the fisherman, Rudesindo Cantarell, who reported that his fishing nets were being ruined by oil to the local Pemex office, Cantarell proved to be the world's third largest oil field. The discovery in the shallow waters changed everything -- including the flow of oil north to the United States. Cantarell's production boom and its output oil shipped to the US is perhaps the most visible manifestation of the Mexico-US symbiotic relationship.

As the Cantarell field proved itself prolific, Pemex became one of the world's largest oil exporters. The increase in production beginning in the 1980's also saw a commensurate increase in exports to the United States. Production at Cantarell boomed until 2003 when its output peaked at 2.1 mm bpd. Of that overall production, exports to the United States reached their peak in 2004 at 1.6 mm bpd.
On the back of Cantarell, Mexico became the United States' second largest supplier of oil, but since the peak of Mexico's oil exports in 2004, it has gradually lost surplus production. Supplies to the United States have decreased. Mexico fell to third place in terms of the United States' top foreign suppliers of oil in 2008 with 1.3 mm bpd. And if international projections and outlooks for Mexico's oil production are even remotely accurate, Mexico will continue to slip down the list of top foreign oil sources serving the US market.

Recent news on Cantarell points to a slight slow-down in the production decline but the larger picture still remains bleak for the field and for Pemex's short to medium term oil production outlook. Indeed, Cantarell has now slipped to Pemex's second largest producing area, second to the Ku-Maloob-Zaap field.
Most disturbing is that with Cantarell's precipitous decline in production coupled with a lack of sufficient replacement production at other fields, many projectionsindicate that Mexico will become a net importer of oil by as soon as 2020; the International Energy Outlook 2009 indicates that net imports could reach 300,000 bpd in 2030. This obviously has serious implications for Pemex, Mexico's national treasury, and US energy security.

Cantarell's fallout
Cantarell's relevance cannot be overstated in other than less-than-positive ways. With the bonanza that the field provided, it also served as an important cover for the myriad inefficiencies at the state oil giant. Because of the nature of the Cantarell field, the Mexican government was for a time spared facing the inefficiencies embedded in Pemex, particularly in its fiscal management and its lack of access to know-how and technologies commonplace in the oil industry elsewhere.
Critics contend that because of Cantarell, Pemex and Mexico skirted challenging issues that other nations faced such as how to attract and manage international investment and collaborate with international oil companies, how to deal with bloated work forces, how to redress severe managerial inefficiencies, and how to face its most difficult issue -- corruption.

Alas the Cantarell story has become a rather tragic one.
Pemex and the Mexican Energy Ministry have regularly overlooked the steepness in the decline in Cantrell production and accordingly have exaggerated projections for output that have impacted both the company and Mexico's national treasury.

Mexico's fiscal dependency on oil
The golden goose, the cash cow, and a variety of other expressions have all been used to describe what oil and Pemex are for Mexico. Pemex oil is the economic life line for the federal budget of Mexico. As Mexico's oil industry boomed, and particularly with the enormous discovery of Cantarell, dependency on oil revenues for the federal budget developed; roughly a third of revenue come from oil exports.
Much has been written about the economic impact and "resource curse" Cantarell has caused both for Mexico's structural development and for Pemex. What is important to highlight is how resource dependency wrought by Cantarell in turn led to mismanagement at the field, as well as inefficiencies and ultimately a stifling fiscal straightjacket placed on Pemex by the federal government.

Seeking to maximize what was initially a highly pressurized field, Pemex drilled hundreds of wells in Cantarell which led to gusher-like production. As the field's production soared, pressure dropped and Pemex implemented a process known as nitrogen injection to further pressurize the reservoir allowing Pemex to continue to pump large amounts of oil.
But saltwater seeped into the reservoir and Pemex did not have the technology at its disposal to arrest the saltwater intrusion thanks largely to the fiscal constraints placed on it by the federal government.

Cantarell's development ultimately suffered from an almost perfect storm of mismanagement due to ineffective technology, insufficient capital budgets and intense pressure to produce as much oil as possible thereby maximizing its rent for the federal government. Indeed, the brunt of this rent seeking has been borne by Pemex itself.
Through onerous taxes and royalties the federal government's milking of Pemex peaked during the oil price spike of 2008. According to a report, due to the onerous fiscal demands placed on Pemex, the company has not been able to successfully manage what have been several years of pre-tax profits.

Despite a year of record oil prices in 2008, Pemex lost $ 8.1 bn on revenues of $ 98 bn; the company paid the federal government $ 57 bn in taxes and royalties.
While BNA's analysis emphasizes the extremely poor year in 2008 -- then-CEO Jesus Reyes Heroles publicly called it the worst year ever for the company -- it is important to note that Pemex has not had a profitable year since 2006.

Record oil prices made matters worse
For Pemex and Mexico, the atmospheric rise in prices in 2008 distracted attention from its continued downward production profile. As production at Pemex plunged in 2008, international oil prices skyrocketed to the $ 147/barrel in July. Pemex's export values and revenues were literally going through the roof as production was going through the floor.
Making matters worse, it is estimated that Pemex loses upwards to $ 2 bn per year due to corruption, mismanagement and in the theft of oil and fuels from its network; almost 400 illegal connections were detected in 2009 alone. The problems became so severe, that in mid-2009, federal law enforcement authorities raided Pemex headquarters to obtain documents and information for further investigation of the fuel theft.

The ongoing investigation and dramatic losses incurred at the company underscores that the issue of corruption while efforts to modernize and manage its oil production and fuel distribution challenges remain.
Indeed, as Mexico's Secretary of Energy conceded, fuel thieves have been more likely using technology more sophisticated than that employed by Pemex itself.

Energy reform in Mexico 2008
Mexican President Felipe Calderon, who served a stint as Secretary of Energy under his predecessor Vicente Fox, assumed office with a clear understanding of the problems and challenges for Mexico due to its oil-driven fiscal dependency and the burdensome legacy that makes inward foreign investment virtually impossible. He knew all-too-well the failed effort by President Fox on redressing those issues.
Nevertheless, in April 2008 President Calderon announced a four-point plan to reform Mexico's energy sector. If there was any doubt as to the explosiveness of the topic, huge public demonstrations erupted led by one-time presidential candidate Andres Manuel Lopez Obrador, and months of debate in Congress dispelled the notion that the reform would be approved quickly.

By October 2008, Mexico's Congress approved a fairly broad set of measures aimed at reforming the sector and in particular Pemex. Central to these measures was the need to create a more modern, agile Pemex; to give the company enhanced and increased autonomy through a major re-write of many of the statutes governing the company, including revised contractual mechanisms that would allow the company to hire outside firms to assist with the production of oil via service contracts.
Critics labelled the original proposal "energy reform light" and bemoaned the final legislation. Others concede that Calderon has inched down the road aided by incrementalism.

Perhaps not surprisingly, legislative implementation has slipped far behind schedule. The reform has also brought new oversight over Pemex in the form of a new regulatory body: the Comision Nacional de Hidrocarburos or CNH.
Recent debate over the development of another field, Chicontepec, points to the possibility that these reforms may prove a fairly important step toward the incremental modernization of Pemex and Mexico's oil industry.

Chicontepec
Chicontepec is an onshore oil formation that straddles three north eastern states in Mexico. Lately however it has become synonymous with the ills that afflict Pemex. Pemex had initially projected that production at Chicontepec would hit 700,000 bpd in 2017; critics have long noted discrepancies between these projections and actual production figures. Others have focused on the geological challenges of Chicontepec as a serious impediment to its production profile.
Experts have noted that Chicontepec's fractured formation would require a large number of wells each with small amounts of production and low rates of recovery.

So far, the numbers are indicative of the challenges: Pemex has spent approximately $ 11.1 bn dollars and earmarked over $ 2 bn in 2009 alone for Chicontepec. Production targeted 70,000 bpd but the field has only returned 30,000 bpd in Q3 2009.
This has led Pemex to announce that they will be significantly reducing spending on Chicontepec in 2010.

Robust debate
Debate is unfolding in Mexico triggered by the Chicontepec developments.Demands for accountability have been voiced by the newly created CNH. Its head, Juan Carlos Zepeda, minced no words when he declared that, "The project should be stopped and reinstated once there is a real development plan."
This may be merely be the CNH flexing its muscles but with good reason as the nation's newly established oil watchdog. Changes in Pemex's Board of Directors have also figured into the evolving Chicontepec debate. For Mexico's northern neighbour, the US should pay attention to the fact that Mexico is in the throes of a process that may ultimately redefine the energy in Mexico itself.

Where will the United States turn?
Mexico's role as a critical oil supplier to the United States is ebbing. This is coupled with falling production in Venezuela and through Canadian reflection on trying to find the right balance in producing oil from its vast oil sands. While the proximity of these nations to the United States market makes them natural suppliers, oil is a global commodity that is fungible.
Oil from democratic states however is not fungible and this should be something of deep concern to US policy makers.

Brazil may provide one option for future US oil imports. Over the last 50 years, Brazil has evolved from an oil importer to a self-sufficient nation with the near-term potential to be a significant net oil exporter. The primary catalyst for Brazil's stratospheric rise was its strategic decision regarding offshore oil and gas exploration and production in the 1990's that eliminated national oil company Petrobras's monopoly and partially privatized the company.
But it has been this nation's lack of onshore and easy-to-get-to oil reserves that surprisingly have proven most fortunate. With no choice but to explore for oil and gas offshore, Brazil turned its Atlantic Coast into one of the world's largest oil and gas research and development laboratories.

Years of efforts paid off as Petrobras has set a string of records for offshore and deep-sea drilling. And since late 2007 an almost never ending series of discoveries have continued to stun the energy world.
First, the Tupi field was discovered with an estimated 5 bn to 8 bn barrels of oil and the potential to be the largest offshore field ever. Immediately following were announcements regarding the Jupiter gas field and the Carioca field, which analysts believe could equal the potential of the Tupi field. Each day seems to bring a new announcement of oil discovery in Brazil's so called Pre-Salt deep sea reserves.

But there are some wrinkles emerging that may hamper the potential in Brazil. At the end of August 2009, Brazilian President Lula announced a four-bill proposal to overhaul the fiscal and regulatory framework for the Pre-Salt reserves.
"To allow the government to become the owner of the petroleum," President Lula said during the ceremony in Brasilia. How the new framework will impact access and ultimately oil production is not entirely clear.

Iraq's oil potential may provide the US another option. With an estimated 115 bn barrels of proven reserves this nation is already a top-ten supplier of oil to the US market. While serious security issues remain, oil auctions conducted in 2009 by the government may prove insightful as the country aims to monetize its tremendous oil potential.
Major oil companies including BP, ExxonMobil, Shell and firms from Russia and China gained contracts under new terms in Iraq and according to the government, the projects and injection of foreign participation will allow the country to produce about 12 mm bpd by 2017. One cannot dismiss the possibility that Iraq may drive a reconfiguration in the current top US foreign supplier list by displacing Mexico or Venezuela in the top three over the next decade.

Symbiotic redefinition
After many years of intricate connections, there are recent signs that the symbiotic relationship between the United States and Mexico may be evolving. The relationship based on oil surely will not unravel overnight, but the cracks in the façade bear discussing.
There are two medium term issues which may serve as the most important bellwethers for redefining this relationship.

First, as noted Mexico's Cantarell oil field is in severe decline. If new fields are not discovered to adequately replace lost production, Mexico's oil surplus may dry up as early as 2020 with it exports to the United States.
Second, there has been an increasing shift in attitudes and perceptions to strongly embrace an energy transition that moves away from a dependency on fossil fuels to one that further incorporates renewable sources, reduced consumption and an eye on carbon emissions. Look no further than to the leaders of both countries for a sense of this change.

President Felipe Calderon, elected in 2006, has sought in a variety of ways to exert a leadership role for Mexico in climate change talks and at home by incorporating renewable sources into his country's energy matrix. Mexico City will also host the next United Nations Climate Change conference.
President Barack Obama, while still early in his presidency, has pushed hard for a new international profile for the United States on energy and climate issues. Moreover, the $ 787 bn stimulus package in the United States includes a heavy bet on efficiency measures and renewables to revive the economy.

In the short term, for at least the next several years, the relationship will amble along its well worn path of oil co-dependency. But we are clearly thinking and talking about energy differently now and a new generation is being schooled in a completely different milieu -- both in Mexico and the United States.
History aside, the recent developments across both countries -- and the world's energy industry -- may foretell a slow motion break up of the symbiotic relationship based upon oil. If that is the case, what is unclear is whether a redefined energy outlook in both nations will allow for the relationship to persist albeit along a different energy path.

Fifty years from now we may look back and strain to recall the role of Pemex and why its ebbs and flows so concerned the US as we remark to ourselves, "Didn't we always have such massive renewable electricity integration with Mexico to power our electric cars?"

Jeremy M. Martin is the director of the Energy Program at the Institute of the Americas at the University of California, San Diego. The Institute is a non-profit inter-American organization focused on economic development in the Western Hemisphere. Martin can be reached at jermartin@ucsd.edu