Mexico’s Oil:Mexico’s Oil:

Who needs it?Who needs it?

José AlberroJosé AlberroJuly 2007July 2007

Outline.

1. Declining reserves, declining production

2. PEMEX’s shortcomings

3. Inauspicious political environments

4. Designing alternatives

Axes

Leading supplier of oil to the US Are Mexico's reserves on the decline? Why/how do countries grow? Is oil a strategic

resource to address development needs? In Mexico the debate has centered on:

• privatization vs sovereignty

• PEMEX modernization vs government revenues

Venezuela or Brazil Solutions “in times of colera”, not

remembrances.

9 or 28 years of reserves?

Declining reserves, for a decade.

Is PEMEX’s exploration strategy

paying off? Proved (P90) reserves halved

between 1995 and 2006.BUT

Possible (P10) reserves have grown at 7% since 2001.

Total: rate went from -1.6% (1995-1999) to -3.5% (1999-2006).

We don’t know yet what the offshore may

yield.

A decade of PEMEX performance:

Falling oil production; stagnant refinery runs and 40% decrease in

petrochemical production.

Oil revenues and development needs

Economic Growth is NOT about factor accumulation.

It is NOT about more roads; more education; more…

It IS about Total Factor Productivity (TFP). Biggest obstacles to TFP growth are:

• Government overregulation• Inflexible labor laws• Weak rule of Law• Monopoly pricing in electricity, natural gas, liquid

hydrocarbons, telecommunications? Is Mexico ceasing to be perceived as asset rich? How much will this impair its growth

performance?.

Three Scenarios

I Proved reserves are halved within a decade; Production collapses;Exports grind to a halt

Fiscal imbalanceExchange rate deteriorationLower GDP growthPressures emigration

II PEMEX maintains productionPEMEX finds new reserves (luck?)

Macroeconomic balance2.5-3.5% growth

III Regulatory Reform opens the sector to private investment

Private sector investment in:

•Transformation•Exploration and Production

Three Scenarios Some believe that what stands between

the current situation and Scenario II is the unreasonable tax burden on PEMEX.

Some believe Scenario I is likely and that it will lead to Scenario III.

Mexico’s fears have been close to the political surface for a century:

El Niño Dios te escrituró un establo y los veneros del petróleo el diablo.

…..Patria: un mutilado territorio

se viste de percal y de abalorioRamón Lopez Velarde, Suave Patria (1920)

Political Environment: interlocking questions

Mexico: Is the time ripe for a new political compact that will entail changes? If not, little will change in the oil sector.

USA: Will the US face up to geopolitical events in Latin America? Little good will capital to be leveraged to foster liberalization.

The Latin American Example: how will the confrontation between oil-rich populism and a market oriented economy resolve itself? AMLO.

Governments may not be the ideal agents of change in the current environment.

Private investors may consider doing so.

An example: the Gulf of Mexico Doughnut

Hole. The Western Gap was apportioned between the US and Mexico in 2000.

10 year moratorium on production. The US has leased significant portions of the

Western Gap, north of the buffer zone Chevron (2006), among others, made

discoveries under more than 7000 feet of water.

Estimates range from 3-20 billion barrels of oil and from 6-45 trillion cubic feet of gas.

Significant Transboundary issues. The Mexican Legal Framework is inadequate

to deal with “unitization”. A private arrangement?

Oil Investment in the risky Gulf of Mexico.

Venezuela’s and Bolivia’s dealings with oil companies.

Neo Ricardian rents, operational control and sovereign claims.

Will Shell or Chevron invest in the doughnut with Transboundary risk?

Can Shell and Chevron afford to wait for the US government?

The NAFTA Chapter 6 precedent: opportunities

for change? Article 601: Principles

1. The Parties confirm their full respect for their Constitutions.

2. The Parties recognize that it is desirable to strengthen the important role that trade in energy and basic petrochemical goods plays in the free trade area and to enhance this role through sustained and gradual liberalization.

3. The Parties recognize the importance of having viable and internationally competitive energy and petrochemical sectors to further their individual national interests.

Annex 602.3 Each Party shall allow its state enterprises to

negotiate performance clauses in their service contracts.

Wait for Diplomacy ? The Doughnut Hole

The head of PEMEX Exploration and Producción (PEP) is aware of the issue.

Can oil companies craft a “service contract with performance clauses” to their liking instead of lobbying to change the Mexican Constitution?

THANKS

José AlberroJosé Alberro