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Production form Mexico's Largest Oil Field Could Plummet

The worst two scenarios suggest a drastic decline in output to 875,000 barrels a day by the end of 2007 and to just 520,000 a day by the end of 2008.

Published: 11-Feb-2006

lass=times>MEXICO CITY – Mexico's huge state-owned oil company may be facing a steep decline in output that would further tighten global oil supply and add to global woes over high oil prices.

The potential decline faced by Petroleos Mexicanos, or Pemex, also could undermine U.S. efforts to reduce dependence on Middle East oil, and complicate Mexican politics and financial stability.

An internal study reviewed by The Wall Street Journal shows water and gas are encroaching more quickly than expected in Cantarell, Mexico's biggest oil field, and might cause output to drop precipitously over the next few years. Currently, Cantarell produces two million barrels of oil a day, or six of every 10 barrels produced by Mexico. It is the world's second-biggest-producing field after Saudi Arabia's Ghawar.

Pemex, Latin America's biggest company by assets and employees, says it is confident it can make up for any decline at Cantarell by squeezing more output from other fields, but some analysts outside the company are far less sanguine.

The study, carried out last year by Pemex experts, offers a rare glimpse inside the traditionally secretive oil company. It outlines five scenarios for a decline at Cantarell, four of which are more pessimistic than the company's current public forecasts.

The worst two scenarios suggest a drastic decline in output to 875,000 barrels a day by the end of 2007 and to just 520,000 a day by the end of 2008. If such projections turn out to be correct, Mexico's overall oil exports would decline by about one million barrels a day -- equal to about 63% of its daily crude exports to the U.S. -- from its current 1.8 million.

Pemex says the study's most pessimistic scenarios represent a "do nothing" approach and are highly unlikely as long as the company carries out the right maintenance work on the field to work around the spreading gas and water, which make extracting oil much more difficult. Pemex officials privately say the report was intended by senior engineers at the company as a wake-up call to management and Mexico's Congress, which approves Pemex's budget each year, to act quickly to prevent a steep decline.

"I am confident in Pemex's portfolio of assets. Other fields will be able to substitute [Cantarell's output] and increase production," Juan Jose Suarez Coppel, the company's chief financial officer, said in an interview. Pemex predicts Mexico's output will actually grow this year to 3.42 million barrels a day from 3.33 million barrels last year.

But the study already prompted the company in December to predict a slightly sharper decline at Cantarell than its previous forecasts -- with output down 6% this year to an average rate of 1.9 million barrels a day and off to 1.43 million barrels as an average for 2008. That prediction now roughly matches the study's most optimistic scenario.

A significant decline in Mexican output would put further pressure on global oil prices. A refining bottleneck and surging demand, especially in China and India, have driven up oil prices substantially over the past two years; yesterday, the March crude contract on the New York Mercantile Exchange fell 54 cents to $62.55 a barrel.

A supply shortfall would also be bad news for the U.S., which relies on its southern neighbor as its No. 2 source of oil, behind Canada. In his State of the Union address, President Bush said the U.S. must reduce its imports from the politically volatile Middle East.

In Mexico, an oil decline would have significant political and economic fallout. Mexico's oil-export earnings as a percentage of government revenue have risen from 32% to 40% in the past five years, making the country's public finances more vulnerable to a downturn in production or global oil prices. A shortage in the coming months could play into this year's presidential race by raising the issue of whether the country needs to open its traditionally closed oil market to private investment.

Mexico has been bracing for a decline in Cantarell for years, and previous predictions of imminent decline have turned out to be wrong. But the internal study is the most complete look at the field to date. It says the difference between the layer of gas that sits atop the oil and the water that is creeping into the rocks below is now just 825 feet and is diminishing at a rate of between 248 and 363 feet a year. The report, which recommends that Pemex scrap 26 of 30 new wells planned for the northern part of the field due to gas encroachment, concludes that the "window of exploiting the reserve is closing fast."

"In my mind, this report suggests a collapse scenario is the most likely," says David Shields, an energy consultant in Mexico who first published the study's findings. Mr. Shields doubts Pemex can make up for lost output at Cantarell because it only discovers one new barrel of oil for every 14 it extracts at the moment, leading to falling reserves.

Other analysts agree with Pemex's official assessment, however. Matthew Shaw, head of Latin America research for Scotland-based oil consultancy Wood MacKenzie, says he has never heard of a major field declining as fast as the worst-case outcomes outlined in the study.

Even if Cantarell declines as gradually as Pemex says, the best-case outlook for the company is a slight increase in production but a gradual decline in current exports of 1.8 million barrels a day as domestic demand for gasoline grows. That demand grew nearly 6% last year, with low interest rates creating a boom in car loans and sales. Government-controlled gasoline prices are adding fuel to the fire by keeping prices below international levels.

The study's different scenarios depend on how well Pemex extracts the oil remaining in the field by getting around the gas and water, with recovery rates varying from 55% of the remaining oil to just 25%. Pemex says its official forecast is based on a 52% recovery rate by investing in water-handling facilities to keep out excess water and will modify existing wells to make sure they hit oil and not gas.

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