Mexico Oil Importer By 2020

Jim Brown
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In 2004 Mexico's oil production peaked at 3.9 million barrels per day. Since 2005 that output has been falling and is now down -25% to 2.98 mbpd in 2010. Since Mexico is one of our biggest sources for oil the possibility they will switch from exporter to importer is a chilling thought.

Mexico produces oil in the Gulf of Mexico and in areas just a short distance from the U.S. where there is no threat of supply disruption due to external events other than the occasional hurricane. Mexico, like Canada, represents supplies safe from geopolitical turmoil, wars, terrorist attacks, etc. If Mexico is forced to terminate exports if would be a sad day for the U.S. because it would make us more reliant on OPEC suppliers. The money we pay for oil would no longer go to support a close neighbor but to line the pockets of countries that hate us.

Mexico not only faces declining supplies but increasing demand. Oil demand in Mexico has grown from 500,000 bpd in 1971 to 2.15 mbpd in 2010. Currently Mexico is still a net exporter of more than 1.0 mbpd to the USA.

As the twin problems of rising demand and falling production reduce the amount of money going to support the government they are forced to cut back on infrastructure and services. Five years ago more than 40% of Mexico's budget came from oil revenues. Oil was $60 back then. Fast forward to today and oil prices are nearly double but exports have been cut by more than half. Fortunately for Mexico those rising prices are filling in the budget gap from falling production.

Unfortunately this solution will not last forever. Mexico is struggling with a major program to increase exploration and increase production. Mexico will not allow foreign companies to lease blocks and drill for oil on their own. Mexico prohibits private ownership of oil. They just passed a new oil law after several years of wrangling that permits the government through Pemex to hire foreign firms like Exxon or Conoco on a contract basis. Essentially we will let you drill but Pemex will supervise and you can keep $5 a barrel on anything you find.

The problem with this kind of relationship is the lack of reward. Oil companies don't want to spend hundreds of millions of dollars exploring for oil and then reap only $5 a barrel for their trouble. They would rather drill elsewhere so they can share in the profits from what they find rather than be paid a nominal fee for drilling.

However, analysts believe there are enough smaller companies willing to take a chance and enough low hanging fruit in the Mexican oil fields to stave off disaster for a few more years. Mexico is negotiating with several firms now so it could be 5-7 years before any meaningful production is achieved. Once deals are struck it takes a year or more to run seismic, another year in the planning stages. Rigs have to be leased and wells drilled. If they find oil, platforms have to be built and new infrastructure put in place to pipe the oil to shore. It will take a lot of money and a long time. Meanwhile Mexican production will continue to decline and the cash flow from that production that would be available to fund additional exploration.

It is going to be a race between now and 2020 to see if they can reverse the decline rate with new production and in enough quantities to offset growing demand from Mexico. If demand is growing by 100,000 bpd every year and deletion is -203,000 bpd (7%) then new production must be higher than 300,000 bpd every year just to remain level on exports. Otherwise cash flow is going to suffer significantly.

A little farther south in Venezuela, Hugo Chavez ha come up with a new method of decreasing production. Venezuela already taxes oil companies more than any other country on the planet. Over the last five years Venezuela has recovered 50% of the revenue from every barrel sold. In the new oil law he just passed there is a windfall profit tax that gives the government more than 95% of revenue when oil prices exceed $100. Already on average 90% of the profit of an oil company in Venezuela is transferred to the state. This will raise that total.

Oil companies are not going to spend millions and develop new production when the government received 95% of the revenue. This is why most majors either left Venezuela or were kicked out over the last five years and their facilities nationalized. Even those that initially stayed eventually left because PDVSA would not pay the bills. Companies like Helmerich & Payne (HP) were forces to leave and abandon rigs when tens of millions in drilling fees were never paid by PDVSA or Venezuela. HP told Venezuelan workers they could no longer pay salaries and laid them off because PDVSA had accumulated a $35 million bill for services and never paid. Chavez told HP to rehire the workers and pay them for back wages and HP refused until HP was paid. Instead Chavez nationalized HP's rigs and kicked the company out of the country.

Venezuelan production has been on a steady decline for the years since Chavez too office. With this last windfall profits tax it is likely to accelerate that decline. Believe it or not but Venezuela is a major importer to the USA where it has refineries and previously had a chain of thousands of service stations. With Venezuelan and Mexican oil in danger of drying up we had better hope Brazil's offshore fields come online quickly or we will be even more at the mercy of OPEC nations.

There is a fuel recession headed our way and every one of these minor data points is simply another straw on the back of U.S. drivers. 100,000 barrel shortfall here, 100,000 there, 250,000 shortfall from the Gulf and pretty soon you have $4.50 gasoline and that bill will come to rest not only on the consumer but on the President's desk. That challenge will not be as simple to solve as finding bin Laden and it will make for far more hostile press conferences.

Jim Brown

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The OilSlick Newsletter is based on the expectations for global oil production of light sweet crude to peak and begin to decline in the 2012-2014 timeframe. I am calling this "Peak Sweet™" instead of Peak Oil. This is the point where global production of conventional light sweet crude supplies can no longer be supplemented by enough oil sands production, deepwater oil production, biofuels and natural gas liquids to offset the decline in existing fields. The roughly 6% annual decline of existing production due to depletion is larger than the rate of new discoveries and new production being added each year. The Peak Sweet™ countdown clock is ticking and time is growing short. Peak Oil will arrive shortly thereafter. Are you prepared?