MEXICO CITY (Dow Jones Newswires), August 6, 2008

Faced with declining production, Mexico has increased both the number of oil rigs in operation and its investment budget, benefitting firms that supply equipment to Petroleos Mexicanos, or Pemex, as the state oil firm struggles to make up for lost time.

A shortfall in exploration and production spending over the past decade has caught up with Pemex. Output is down 20% from peak production of 3.4 million barrels a day in 2004.

The production shock sent Pemex into action, benefitting oil services firms such as Halliburton (HAL) and Baker Hughes (BHI), which provide Pemex with equipment, services and know-how. Pemex has boosted its yearly investment budget and is marching into more high-cost production zones that it overlooked for the past 70 years.

Pemex, legally barred from sharing oil production and reserves with outside oil firms, has relied heavily on service firms, which are now well positioned for the rise in spending.

Oil accounts for a third of Mexico's government revenue. With output in decline, Mexico is more exposed to a drop in oil prices than other producers such as Petroleo Brasileiro (PBR), or Petrobras, which ramped up output during the recent price boom.

Pemex has repeatedly downgraded its output target for 2008. Last year it anticipated an average 3.1 million barrels a day, but Pemex now hopes to pump just 2.85 million barrels a day.

Last month, an Energy Ministry director said Mexico won't get back to producing 3 million barrels a day until 2020, even with the increased spending.

That's because it takes years to get new oil projects up to peak production. More than 80% of Mexico's active oil fields are already past peak output, and the country has failed to replace the lost barrels with output from new fields.

It will take years for Mexico to reverse current production trends. But oil services firms which get paid to drill wells instead of selling oil are heading into Mexico's golden years. President Felipe Calderon is pushing an energy reform through Congress that would allow Pemex to offer these firms incentive-based contracts and streamline the contracting process.

Pemex's investment budget has doubled since 2002 to $21 billion this year. During the second quarter Pemex drilled 176 exploration and development wells, up 4.1% from the year-ago period.

The number of oil and natural gas rigs increased by 120% to 241 in the second quarter, Pemex said in an earnings statement. Pemex owns 123 rigs and it leases the remaining 118 from independent contractors.

Baker Hughes, an oil services firm that tallies the number of drilling rigs around the globe, put Pemex at 80 oil rigs in June, up 16 on year and the most since it began collecting data in 1995. Baker Hughes excludes smaller maintenance and workover rigs from its survey, accounting for the large difference between its numbers and those provided by state-run oil firms.

During recent conference calls, oil service executives said Mexico activity is busy.

Ensco International (ESV) said it placed the lowest bids for two recent Pemex rig tenders, and expects Pemex to finalize approval of the deal by Aug. 12.

Hercules Offshore (HERO) expects Pemex to put out tenders for another four to six new jackup rigs before the year's end. Jackup rigs are suitable for the shallow waters of the Gulf of Mexico, where Pemex produces most of its oil.

During the second quarter, Baker Hughes said it won a $460 million, 15-well marine drilling contract that will start up in the third and fourth quarters of this year.

Halliburton said Latin America revenue rose 27% in the second quarter, driven by higher Mexico activity after taking on the large Alliance project in southern Mexico. Halliburton operates four Pemex-owned rigs in the area and expects to have six more by the end of the third quarter.

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