Trouble Brewing South Of the Border

Jim Brown
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Mexico's state owned oil company Pemex is under fire for falling crude production and lack of a plan to correct the decline. The sharp drop in Mexican oil exports has put a crimp in Mexico's budget and Fitch downgraded the country's debt to BBB on Nov-23rd. As the problems mount there are dark clouds forming over Mexico's future.

Oil production in Mexico averages 2.61 mbpd in 2009 and that was 22% below the production peak in 2004 and -7% below 2008 levels. Mexico prohibits exploration by foreign companies and they are struggling to find enough money to fund their own exploration. Pemex budget $19 billion for deep water exploration in 2009 and failed to find any new fields of decent size. Pemex is now $50 billion in debt and in the current financial environment it will be difficult to find additional funds.

The cause of the Pemex financial slide and Mexico's budget shortfalls is the drop in exports. In 2009 exports of crude fell -13% and they are down -35% from 2004 levels. Add in the drop in oil prices and it gets worse. Oil they were exporting for $125 in 2008 they are selling for $70 in 2009. They are exporting less oil and getting paid less for the oil they export. This is a serious problem for the Mexican government.

In a few years ? or earlier if oil prices decline ? Mexico faces a serious fiscal crunch. The combination of unequal income distribution and high tax evasion limit the government's non-oil revenue to 10.8% of GDP, well below the average for middle-income countries. The national economy has the same sort of problem as government. Mexican productivity remains below its 1980 level.

Pemex needs new management and a new plan. President Calderon tried to get the oil law changed in early 2009 to allow involvement by foreign firms and was unsuccessful. Now Pemex has to go it alone and they are not succeeding. For instance they budgeted $11.1 billion for development of Chicontepec in 2009. They set a 70,000 bpd target. By the end of September they only hit 30,000 bpd. Legislators were up in arms and waned the project stopped until a better plan could be developed. The newly constituted board of Pemex came immediately under fire. Fluvio Ruiz, who joined the board this year said Pemex estimates were far too optimistic about existing projects. Pemex has proven that simply throwing money at a problem does not always fix it.

If the giant Cantarell field continues to decline at 12-14% per year Mexico could gradually turn into a oil importer rather than an exporter by 2015. Instead of funding a major portion of Mexico's budget with oil export revenue they will be forced to spend money to import oil. This is a disaster in progress and there is no light on the horizon. Mexico is already seeing increasing problems from their lack of funds for social programs and the infrastructure is breaking down from lack of maintenance. Gangs of drug dealers fight openly in the street for control. Nearly 7,000 people have been murdered so far in 2009. 37 people were murdered in Juarez in a single day. The Mexican government has lost control. Shrinking revenue from oil exports along with tens of billions spent by Pemex is only making governmental matters worse.

The U.S. imports 1.057 mbpd from Mexico. They are our second largest source of crude oil. This is down from 1.292 mbpd in Aug-2008, nearly a 250,000 bpd shortfall. Fortunately the falling demand in the U.S. kept this from being a problem but once demand increases it means we will have to import that oil from somewhere else. Those imports from Mexico are expected to fall another 250,000 bpd over the next 3 years due to declining production at their major fields.

This is a two pronged problem for the USA. Not only will we have to get our oil elsewhere but we are also going to see a rise in the number of illegal border crossings as Mexicans flee the gangs, murder and rising poverty in hopes of a better life in the USA. I have written about this problem for the last three years and the expected out of control influx of refugees when Mexico goes bankrupt. The recent problems listed above are just another chapter in the story and we already know the ending.

Tu hablas espanol? If you don't it might be a good time to start learning.

Jim Brown