The drop in oil production experienced for several years has meant that oil is no longer such a decisive source of income for the Mexican economy in general. In its best production period Mexico reached 3.5MMBoed; at today’s rate, we will hardly reach the goal of 2MMBoed by 2024. The objectives of achieving energy sovereignty proposed by the current administration are difficult to achieve, clearly from the point of view of production versus internal consumption and self-sufficiency, which is not the same as the narrative used for the general population.
The production capacity for gasoline, for example, is currently one-third of what the market demands, and the remodeling of the refining system plus the start-up of the new Dos Bocas refinery will hardly match the daily demand for this fuel, even adding the production of Deer Park. Therefore, we will most likely continue importing part of it from the US. In order to be able to satisfy the demand with autonomy, the existing refineries and the new Dos Bocas refinery will need to sustain an operating level above 80%. Historically, they have been below 50%, with periodic variations. Besides current demand, we will need to also consider the expected future increase in demand given the incipient electrification of the automotive sector.
Investment in the Energy Sector vs. Direct Investment in Mexico
The situation of direct investment in the energy sector is complicated. In 2018, the total direct investment in the country was US$34.1 billion, of which US$7.9 billion corresponded to investment in the energy sector, which is 23%. Historically, this percentage corresponded to an average of 7% before the implementation of the 2013 Energy Reform; however, the energy autonomy objectives implemented from 2019 reduced this proportion back down to 7% in 2022 and the forecast for 2023 is for 4-5%.
In order to substantially increase investment in energy, we must talk about adapting the energy policy and most likely a complementary energy reform to the one carried out in 2013. The necessary condition is that the next administration adjusts its vision to a reality that goes beyond ideological positions and responds to other factors. Is it possible?
PEMEX's bet has been focused on maximizing the production of mature fields, on the one hand, and on the other hand, betting on onshore fields and shallow water projects that have a contribution to production in the shortest possible term. Although it has been successful in a certain sense in halting the fall in production, it has also resulted in a constant financial deterioration and higher direct costs.
This constant financial deterioration has resulted in PEMEX today losing its investment grade rating from the rating agencies and having the largest debt of any oil company in the world (+/- US$107 billion), despite the fact that during the current administration, the government has contributed a total of approximately US $69 billion between capitalizations and fiscal subsidies , and today there are serious doubts about the government's capacity to maintain contributions in a sustained manner after 2025 without falling into a deterioration of the country's sovereign debt rating.
Clearly, what happens in PEMEX determines the direction of the oil sector in Mexico, since it produces 95% of the country's total, although the production of the private sector will continue to increase gradually as they develop their assigned fields, this proportion will continue to be mostly from PEMEX.
As we know, in 2024, we will have presidential elections and as of 2025 the new administration will need to make substantial decisions on PEMEX in order to solve or at least try to avoid a financial disaster.
There are many opinions about what should be done at PEMEX to improve its financial situation. Talking to some experts and reading others, I believe that some measures on which many of us agree are:
Unsuccessful business model: The various lines of business should be restructured, prioritizing profitable processes and divesting those that report losses, as is the case of industrial transformation (mainly refining).
Restructuring of labor liabilities: We must think of different ways to manage them and to contain their growth, this within the possible legal margins and avoiding conflicts with workers.
Review and adjustment of internal processes: This to add operational efficiency and flexibility for decision-making. As a result, this should adjust its organizational structure and adjust the number of workers per barrel produced to standards closer to the global industry.
Establish a new tax regime: A new tax regime would allow it to free up cash flow and redirect it to investment and operating activities.
Exploit the potential of unconventional fields, leave behind the political discussions regarding fracking and implement more pragmatic solutions to boost production, such as partnerships, allocations and new rounds.
Make quick decisions regarding the establishment of farm-outs to increase reserves and future production in deepwater;, here, time is a factor against.
Prioritize longer term and riskier projects in order to improve the outlook for future reserves, gradually moving from the current short-term approach to a portfolio of longer term and riskier projects, but with a better return on investment.
The above items are somehow where I think most of us agree, this without including ESG issues, investment in a mix that contemplates the incursion into renewables, carbon capture initiatives, green hydrogen and others that are possibly the subject of a separate article on how to turn PEMEX into an energy company.
The interesting part will be to ascertain which of the required changes have real possibilities of being implemented, this in a political environment with a certain level of uncertainty and in an environment of global energy transition, where Mexico is clearly lagging, and time is advancing rapidly .
Gas and Its Infrastructure
Mexico currently produces +/- 5,000MMcfpd. Production has been increasing thanks to developments mainly on land while projects such as the Lakach field will contribute up to 1,800MMcfpd; however, today we continue to have a high level of dependence on imports from the US.
The pipeline infrastructure for its transportation and distribution still has a lot of potential to be developed. Projects such as Southeast Gateway are of great importance as they will allow us to connect with the Sur de Texas pipeline (from Texas to Tuxpan, Veracruz) and thus bring natural gas to the southeast of Mexico, benefiting the Yucatan peninsula where CFE is already building two combined-cycle power plants and expects to cover the supply/demand gap that currently exists. However, demand will continue to grow at a higher rate than the rest of the country thanks to Yucatan's success in attracting more industrial investments, such as the most recent investment announced by Heineken, which joins others already in the state, such as Amazon, Walmart, and Modelo.
Likewise, the transportation and distribution capacity from east to west in several regions can generate more development poles than those usually located in the north of the country. There is a lot of investment to be made and for that there is also a paradigm that must be left behind: the supposed "prohibition" on fracking.
There is no limitation whatsoever on fracking in the current regulation; in fact, CNH has authorized several developments that use this technique. The potential of unconventional reservoirs is very relevant and can generate a substantive change in the mix of domestic production versus imports to improve energy security. It must be considered that the US gas export platform could change in the next five to seven years, when the automotive electrification process could influence domestic demand, causing the US to reduce its exports to satisfy its domestic demand, having a direct impact on Mexico if we do not have an adequate mix.
Recently there was an announcement of an investment of US$10 billion to develop the Trion field in the farm-out modality, expecting to produce in 2028 and thereafter about 100,000Boed for at least 10 years. Also, developments such as Lakach and especially Zama are being carried out at deeper depths than PEMEX operates. Time is a factor here for other deepwater developments, as the technological challenges, investment amounts and availability of key assets make it difficult to make investment decisions in light of the progress of the energy transition. It is not that oil will cease to be used (that is a long time away), it is that the time and resources compared to the trend in future demand make a very real case that the risk that the prospective resources in deepwater may remain buried there, never to be used. Let us not forget that several private oil companies have returned their deepwater blocks in the last two years.
From the point of view of prospective resources, Mexico still has enough potential to be able to develop future production and cover its demand with a sufficient level of energy security; however, the energy sector and in particular the oil and gas sector must rethink priorities and act rapidly in order to take advantage of these resources, taking into account that 63% of prospective gas resources are concentrated in unconventional fields and 53% in the case of oil.
In addition to the above, today, in terms of O&G investment, oil companies and investors linked to the sector are concentrating their interest in opportunities in Brazil, Trinidad and East Africa. Competing for this investment for Mexico is more complicated in the current circumstances and requires the next government to make quick decisions and rethink its position with respect to energy policy, as well as to establish a new complementary reform that generates the conditions to attract direct investment in the sector once again.
A great deal of attention must be paid to gas and its potential as a transition fuel, its availability in unconventional fields and above all the infrastructure for its transportation and distribution, which can generate relevant changes not only in the southeast of the country but also in other regions in a transversal manner.
In the case of PEMEX, well, what happens to PEMEX, as already mentioned, determines the direction of the oil sector in Mexico, so its restructuring is a necessary condition to improve the sector and reduce the risk against the country's sovereign debt and the government's financial capacity to continue supporting it.