Can Oil Economies like Mexico Survive?

At the beginning of the 20th century, Mexico was one of the worlds leading producers of oil with private institutions owning the majority of the mineral rights. In 1917, a new Mexican Constitution was written that gave all of the subsurface rights to the government and the national oil company, Pemex, was formed. Since that time, Pemex and their reserves have served as a virtual ATM for the Mexican government and have provided major funding for infrastructure initiatives. This policy works reasonably well as long as oil production in Mexico and worldwide oil demand both remain strong. Currently, both of these key pieces to a successful Mexican economy are being put to the test with the long term effects being potentially devastating for Mexico.

The role of Pemex as a source of funds for the federal government has had a detrimental effect on the operational efficiency of Pemex. The exploration and production of oil and gas is only partially privatized through the implementation of Multiple Service Contracts (MSC’s) that were first implemented in 2003. These contracts do not allow for exploration of oil and gas which limits there ability to add to Mexico’s reserve base. Mexico’s largest field, Cantarell, reached peak production in 2004 and is rapidly declining. Advanced recovery techniques such as water injection and separation as well as horizontal drilling have only recently been successfully implemented in Mexico (companies have been successfully using these techniques for decades in the US and North Sea). Discoveries in Chicontepec have the potential to add significant reserves but it this field is going to take significant technological resources to exploit. It is unclear that Pemex will have the necessary resources to exploit this potential “elephant” without significant private investment. This would require a Mexican policy change that would significantly alter the constitution of 1917 to allow private ownership of some of these reserves. The current MSC structure just doesn’t promote enough private investment.

In addition to Mexico’s problems with reserve replenishment, there is the additional concern of softening demand for oil and the resulting declining prices. We saw oil go from $147/barell to $40/barell in a matter of months. This does not bode well for a country like Mexico that is heavily dependant on oil revenues to fund the majority of the government’s activities. While most analysts think that the price of oil will rise again in the coming years there are questions about oil’s validity as a global energy source for the next 50 years. Environmental and geopolitical concerns are driving a race to find reliable and clean sources of energy to replace oil. These concerns are legitimate and the problems of climate change and geopolitics must be addressed. However, if the developed world is successful in curbing its appetite for oil, countries like Mexico must find a way to replace the oil revenue that is lost. If they are not able to ween themselves from being an oil economy, they will likely face hardships that will cause social unrest and pose a serious risk to the governmental institutions in place. While this may be a good thing for countries like Nigeria that has suffered from the “Oil Curse,” it is likely that some countries (and states like Texas) that have successfully embraced an oil economy will suffer.

Sources Used for this Blog:

1) Rosellon, Juan and Halpern, Jonathan; World Bank; “Regulatory Reform in Mexico’s Natural Gas Industry: Liberalization in the Context of a Dominant Upstream Incumbent,” January 2001

2) Library of Congress; Sourced at http://www.county-studies.com/mexico/oil.html

3) Lunhow, David; “Mexico Tries to Save Big, Fading Oil Field”; April 5, 2007; sourced from http://www.rigzone.com/news/article.asp?a_id=43560

4) Energy Information Administration; Sourced at http://www.eia.doe.gov/emeu/cabs/Mexico/NaturalGas.html

5) Salazar, Francisco; Chairmen of the Energy Committee, Chamber of Deputies of the Mexican Congress; Presentation at the James A Baker III Institute for Public Policy, Rice University; “Natural Gas in Mexico; Current Trends and Alternate Scenarios”; May 27, 2004

6) BP Statistical Review of World Energy; 2008