Weekly Offshore Rig Review: Much Ado in Mexico

Worlwide offshore rig utilization dipped slightly this week to 84.3%. This decline of one contracted rig was due to a total of 5 rigs coming off contracts while 4 idle rigs started new contracts, with most of the activity occuring in the Gulf of Mexico.

Mexican Elections
With this week's nail-biting presidential election in Mexico, all eyes have been looking south of the border. As of this afternoon, conservative candidate Felipe Calderón had an official margin of victory of only 243,000 votes out of about 41 million, less then 0.5%. His leftist opponent, Andrés Manuel López Obrador, has pledged to fight the result and demand a recount. So, even though it appears that Mr. Calderón has won, the final result has yet to be decided. And that result could have serious implications for the Mexican oil and gas industry.

Both candidates have publicly expressed their desire to make sure that Pemex, Mexico's state-owned oil company, is a competitive and viable enterprise, but their visions of making that happen are somewhat murky. Mr. Calderón has openly expressed his desire to improve and open the Mexican petroleum industry, saying that he favored allowing foreign investment in the form of "strategic alliances" that would bring needed technology and financing for deepwater prospects that are currently out of Pemex's depth. Mr. López Obrador has focused his vision on reducing inefficiencies and aiming to improve productivity within Pemex, stating that foreign investment in the petroleum industry would not be palatable to the Mexican Congress.

With Mr. Calderón's apparent victory, the prospect of further opening the Mexican oil industry to outside investment is now a real, though somewhat distant, possibility.

To give some perspective on the current state of affairs within Pemex under the Fox administration, we'll take a look back at some of the key indicators over the past several years.

Ambitious Plans
In 2000, when President Vicente Fox took office, Pemex began to increase its exploration and production capital expenditures with the goal of increasing production from about 2.9 million bpd to 4 million bpd by the end of 2006. In order to facilitate this growth, the Mexican government has given Pemex a little bit more freedom in its spending, but still, the majority of Pemex revenue (60%) goes directly to the Mexican government where it accounts for 30 to 40% of government revenues. As such, Pemex has amassed nearly $50 billion in debt as it builds infrastructure and expands its drilling programs.

The graph below outlines Pemex's yearly exploration and production capital expenditures over the last 6 years for which information is available from Pemex.

Pemex E&P Capital Expenditures
1999 to 2004

Reflections in the Rig Count
With the ramping up of E&P capital expenditures came a major increase in Mexican offshore rig activity. In the summer of 2001, there were only 6 jackups and 1 semisub under contract in Mexico. One year later, in August 2002, that number had doubled to 12 jackups and 2 semisubs. Another year later, in August 2003, contracted rigs had more than doubled again, rising to 27 jackups and 7 semisubs under contract. Through the rest of 2003, 2004, and most of 2005, Mexican rig utilization hovered around 30 jackups and 10 semisubs before beginning to decline in late 2005.

That level of jackup activity has made Pemex the world's leading jackup operator. For 2003, 2004, and 2005, Pemex contracted more jackup days than any other operator in the world. Interestingly, though the company led in terms of the number of days contracted, it only led in terms of total day rates paid during 2003. In both 2004 and 2005, other companies paid out significantly more on jackup day rates than Pemex for fewer overall rig days.

Looking at 2006, Pemex has spent about $230 million on jackup contracts thru June, and is already contracted to spend another $290 million in the second half of the year. That will put Pemex total jackup expenditures for 2006 well above $500 million, its highest level in at least 10 years.

Those expenditures and rig contracts have allowed Pemex to drill a reported 74 exploratory wells and 150 development wells in the waters offshore Mexico from 1999 to 2004. More than half of those 224 wells were drilled in 2003 and 2004 as Pemex contracted more jackup days than any other company in the world.

For Their Efforts
Although the CAPEX campaign was successful in increasing production (and keeping a great many rigs working), it appears to have fallen short of its goals. The aim was to increase oil production by about 1.1 million barrels, but production increased by a little less than 500,000 bpd from 1999 to 2004. Since 2004, the most recent year for which Pemex provides official statistics, Mexico's oil production has increased only marginally, if at all. The USGS estimates 2005 production at about 3.42 million bpd, just 1% higher than 2004 output. As such, Mexican oil output is not likely to exceed 3.5 million bpd in 2006, leaving it 500,000 barrels short of the goal set at the start of the Fox administration.

The table below outlines the production of crude oil from Pemex of the 1999 to 2004 time frame. Overall, oil output increased about 16% over the 6 year time frame. The majority of the increase came from increased production in the Northeast Marine Region, which includes the supergiant Cantarell oilfield.

Pemex Crude Oil Production
1999 to 2004

Counting on Cantarell
The majority of Mexico's oil output comes from the Cantarell oilfield, which is located in the Bay of Campeche, about 85 km from Ciudad del Carmen. The Cantarell complex is actually composed of four major fields, Akal, Nohoch, Chac, and Kutz, of which Akal is the largest and most important. The field initially had an estimated 35 billion barrels of oil in place, of which about 18 billion barrels are expected to be recovered.

The Akal field was discovered in 1976, with a well that flowed 34,000 bopd. The field was put into production in 1979, and by 1981, the field was producing 1.16 million bpd from 40 wells, which is about 29,000 barrels from each well. By 1994, production had declined to about 900,000 bpd. In 1997, Pemex began a program of nitrogen injection that helped to greatly increase production from Cantarell, raising production from 1.6 mbpd in 1997 to over 2.1 mbpd in 2003.

In 2001, each of the wells in the Cantarell complex produced an average of over 9,000 barrels of oil per day. These wells are excellent producers, producing about 9 times as much as the average Mexican oil well, which averages about 1,000 bopd. As such, getting oil out of Cantarell has been very cheap for Pemex. Congressman Francisco Carrillo Soberón, a member of a legislative energy commission, said it costs between $2 and $3 to get a barrel of crude out of Cantarell.

Pemex has indicated that production from the Cantarell field has peaked and is set to decline in 2006. With rather steep declines of 14 to 16% in the next several years, it has been estimated that the Cantarell field will only be producing about 1 million bopd by the end of 2008.

A Not-so-Bright Future
Whichever candidate finally wins the Presidency, his new administration will clearly be saddled with a difficult problem in the form of Pemex's declining fortunes. Current high oil prices have helped to make Pemex the Mexican government's golden goose, but with nearly $50 billion in debt and an impending 30% decline in production over the next 2 years, the firm could turn into an albatross around the new administration's neck.

However, there is some hope for optimism with the discovery of the 10 billion barrel Noxal field in the deep waters of the Gulf, growing production in Veracruz, and the potential for more discoveries in Mexico's northern waters closer to the US border. These new developments, along with the major investments that Pemex has made over the last several years, could help to sustain the company from a precipitous decline.

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