SPECIAL FOCUS: NORTH AMERICAN OUTLOOK

Mexico ponders cross-border strategy for deepwater GOM fields

Mexico-US boundary treaty set no agreement for border-field development.

George Baker, Energia.com

The existence of commercial, cross-border oil and gas fields between the US and Mexico has yet to be established. Were such fields proved, the fact remains that neither the US nor the Mexican governments have done the preparatory work to make joint production feasible. Where the US has a regulatory agency (MMS), that body has no authority or mandate to deal with cross-border issues. The situation is worse in Mexico, where there is no upstream authority at all, and where a constitutional restriction prevents Pemex from operating as a partner in a joint-ventured operation. For its part, the Mexican government is aware of this situation, and, hopefully, will take steps to fill in the blanks.

In Mexico’s National Development Plan that was made public on May 31, 2007, the government of President Felipe Calderón noted that “Pemex lacks the technology to develop the yet undiscovered resources in ultra-deep water; Pemex also faces restrictions in the development of cross-border fields.”

Speaking to a forum convened by the Energy Committee of the Mexican Senate on June 18, 2007, Carlos Morales, head of Pemex’s upstream unit, noted the drainage risk from Mexican fields, if production began on the US side close to the maritime border. He called for a review of existing treaties.

The moral leader of the Left, Cuauhtémoc Cárdenas, in an address to the Mexico Chapter of the Club of Rome on May 15, 2007, insisted that efforts need to be taken by the Mexican government on the issue of transnational oil and gas fields, noting that the ten-year moratorium on drilling in the “Western Gap” will expire in the year 2010.

These three parallel observations build on the case developed in Pemex during the Fox administration. In their briefing to the Lower House of the Mexican Congress on Nov. 22, 2006, Pemex’s top executives reviewed progress since 2001 and provided an outlook for 2007-2015. The most arresting topics were the set of initiatives for addressing the development of cross-border oil and gas fields.

Until now, Pemex had said nothing in public, as, strictly speaking, it is not its job to suggest reforms in Mexico’s energy policy. As we shall see, some of Pemex’s suggestions, to be implemented, would also require changes in US-side regulatory institutions, laws and even the boundary treaty.

WHY THE CHANGE?

This 90° change arises from five causes. One reason is the possibility that lease-holders in deepwater areas of the US Gulf of Mexico (GOM) could, within a few years, begin production in reservoirs that straddle the border with Mexico.

Pemex has not carried out drilling operations in waters adjacent to the MMS’s Alaminos Canyon leasing area, which extends to the Mexican border. The existence of commercial deposits on the Mexican side of the border has not yet been established, Fig. 1. Pemex itself, however, has little doubt that such deposits exist; but, the resources are lacking for such high-budget projects.

Fig. 1. In commercial fields, development on one side of the border could drain oil and gas from the other side.

A second reason is a belated recognition by Pemex that it lacks sufficient execution capability, which, coupled with a lack of experienced managers, makes it too risky, financially and environmentally, to attempt to operate, single-handedly, a deepwater exploration and production project. Embedded in this second reason is a quiet rejection of the official line, promoted by former Pemex directors general as well as by oilfield service companies, that anything that Pemex needs for exploration and production can be bought on the open market.

Pemex proposes that it be allowed to enter into strategic alliances in which it assumes the role of partner, allowing the US-side lease-holder to be the operator in a joint development project in deepwater areas along the US-Mexican border. (In the US system, of course, the lease-holder may be of any nationality.)

A third reason for the change of tune is Pemex’s need to begin to put into production what it believes are 30 billion boe of undiscovered petroleum resources in the Mexican side of the GOM, Fig. 2. Pemex hopes, by the year 2013, to have some oil and gas flowing from deepwater wells. These volumes are needed to keep the average oil flow during the period at 3.3 MMbpd and average gas flow at 6.5 Bcfd.

Fig. 2. Pemex believes there are significant undiscovered reserves in the Gulf of Mexico.

A fourth reason is money. Pemex, for all the money it earns, lives on a shoestring budget, if judged by its financial statements, which show razor-thin net profits if not outright losses. There are two factors at fault here: a heavy tax burden and an even heavier labor burden. Pemex has proposed fiscal reform for itself for years, if not decades, but progress on fiscal reform has been slight-and on labor reform even slighter.

There is a fifth reason: In deep water, success in exploration does not automatically translate into success in reservoir development and production. In Brazil, IOCs came to have a role when production skills were needed.

WHAT CHANGES DOES PEMEX PROPOSE?

Nestled in the proposals to the Congress was language about the need for a unitization agreement that would entail a “single operator” in a joint project that would confer “shared benefits” to the operator and partners.

Following Pemex protocol, the United States is not mentioned by name. But the clear implication is that Pemex is recommending that the federal government enter into diplomatic negotiations to modify the Continental Shelf Boundary treaty with the United States.

The protocol to be negotiated should focus the need for changes in the law, regulation and institutional mandates to allow issuing of cross-border unitization permits. Such negotiations would have to be initiated and carried out by the Mexican Foreign Ministry.

Mexican law would have to be changed, and responsibility lies with the Congress. The main law to be updated is the Petroleum Act of 1958, which regulates oil and gas provisions of Article 27 of the Mexican Constitution (it is this article that reserves almost the whole of the oil industry to the state).

ARTICLE 6

Pemex correctly identifies Article 6 of the Petroleum Act as the source of the legal impediment to the joint development of cross-border fields, and proposes changes. This article, established at the very end of the presidency of Adolfo Ruiz Cortines (1952-58), reflected the anger and frustration in the Mexican Congress over a small number of risk contracts that had been assigned to a half-dozen American oil companies during 1949-51. The terms of Article 6 were devised to prevent future risks contracts in Mexico.

Article 6 allows Pemex to enter into contracts with individuals or corporations to contribute to the accomplishment of its mission. But it is the restrictions that were crafted to eliminate oil companies from operating in Mexico using the standard risk-reward business model then (and now) in common usage. By the terms of Article 6, Pemex may pay only in cash, never in kind; moreover, payment may not be linked to any “result” of the services to be contracted. In other words, there was to be no upside reward linked to any measure of performance by the contractor.

In its proposal of November 22, Pemex, without details or examples, proposes to scrap these restrictions.

OTHER LAWS

Pemex also proposes to exempt such cross-border, unitized projects from the restrictions of the Public Works Act and the Government Procurement Act. These laws put a heavy burden on Pemex. But, as Pemex recognizes, their enforcement would make any joint development project impossible.

WHAT DOES PEMEX NOT PROPOSE?

Pemex is silent on the subject of the means or methodology by which it might come to have “strategic partners.” In the North Sea, it was the state oil companies, BP, Statoil and Norsk Hydro, who, operating within a competitive lease system, took on the role of “partner” with companies who, for them, were the giants: Phillips in Norway, Shell in the UK.

Pemex during 2002-2005 learned a lot about how lease systems work-and don’t work. What Pemex mainly learned is that a public tender of petroleum leases does not work without offering a meaningful upside potential based on market values for production and the right to post discoveries as reserves.

The awards issued for the Multiple Service Contracts for gas E&P in blocks in the Burgos basin were under the Public Works Act, and the oil company that won the tender would operate under Pemex supervision. In these tenders, Pemex designed scope and terms of work, method of payment, received bids and awarded the contracts. Pemex, in other words, made the laws, and subsequently served as both the judge and jury.

Five years later, Pemex understands that none of these conditions and constraints will have any place in future strategic alliances in the deepwater GOM.

The solution to this insider dealing is the legal figure of an independent upstream regulator. This agency exists in Norway in the Petroleum Directorate, but it also exists in the United States in the Minerals Management Service.

Pemex here also is silent. For the past six years officials from the Energy Ministry and the Congress have been flying off to Norway, Brazil, Canada and other destinations for a look-see at the offices and operations of upstream regulators; but Pemex has never supported the idea. How Pemex’s strategic partners are to be chosen remains unaddressed.

Pemex proposes that it be allowed to enter into unitization agreements, but there are two awkward points: 1) on the US side there are blocks and leases, but in the Mexican federal waters, there is nothing similar; 2), both sides need to document proved reserves, but on the Mexican side with Pemex’s expertise alone, this cannot be done.

WHAT PEMEX DID (OR DOES) NOT KNOW

Another awkward detail that Pemex did not tell the congressmen is that on the US side the MMS does not have authority to issue cross-border unitization agreements, and that the topic is not even being addressed. On land, the Texas Railroad Commission also lacks authority to issue such permits.

OBSERVATIONS

It is a peculiar choice of words for the Mexican government to say that Pemex has shortcomings in ultra-deepwater, when, more basically, it has not put into production any oil or gas field in water depths beyond 300 ft.

Pemex’s solution for cross-border fields and the need for strategic associations are relevant to all Pemex’s shallow- and deepwater operations in Mexico. Such associations, if authorized for cross-border fields, could subsequently be applied to other areas inside Mexico; and, in this way, serve Pemex as a safety net in case its development plans for KMZ and Chicontepec do not materialize as advertised.

The need for diplomatic savoir faire in oil matters may help explain the choice of Jesús Reyes Heroles as the head of Pemex. Dr. Reyes Heroles, an MIT-trained economist, is a former official in the Foreign Ministry, who in the late 1990s, served as Mexico’s ambassador to the United States. Also working in the background is his prior service as energy minister during 1996-1997. Another factor of possibly even greater weight is that his father-35 yr before-was director general of Pemex, and the one who bought out the last of the controversial, 25-yr risk contracts that were awarded in the early 1950s.

NEWBUILDS

Pemex recently secured a contract with SeaDragon Offshore for the SeaDragon Offshore I (SDO I “Oban B”). The $958 million, 5-yr project will produce a deepwater, harsh-environment semisubmersible capable of drilling in up to 10,000 ft of water. SDO I’s first well will be in GOM field NEN-1 in 5,000 ft of water. Drilling should begin in January 2010.

Construction has begun with the first hull being built in Sevmash yard, Russia, with completion expected in 2008. SeaDragon will build the vessel’s topsides in Teesside, UK, at the Haverton Hill yard used by the Tees Alliance Group. Module construction will begin in October 2007.

CONCLUSIONS

The Maritime Boundary Treaty of 2000 has a mechanism for bilateral consultations that can be activated with only a 60-day lead time, so cross-border fields could become active quickly.

But before very much can be done on the Mexican side, the US side needs to be prepared, legally and institutionally. At present, boundary treaties, laws and the institutional mandates of regulators all fail to provide for the legal and fiscal figure of a cross-border mineral deposit. The US side, in short, is not yet ready for Pemex’s proposals.

The Mexican side is far from ready for joint-ventured associations in which Pemex would be a partner, but not the operator.

Pemex has rightly called for a policy review.