Fracking "unconventionals" has rapidly accelerated US oil production, boosting output by more than 60 percent since 2010, but Mexico hasn’t "even scratched the surface on the unconventional side,” according to Craig Steinke, CEO of Renaissance Oil, who just won the rights to develop three onshore fields in northern Mexico during December’s auction.
That precedent-setting auction took place because Mexico is trying to save Pemex, its sprawling, state-owned energy behemoth, which is vying with Venezuela's dysfunctional PDVDSA for monopoly underachiever of the new century, after it hit a financial brick wall.
By the end of the year, output at the stumbling oil giant dropped almost 7 percent from 2014, falling for an eleventh straight year after a series of accidents and budget cuts stunted output. Weighed down by $100 billion in debt and posting a record loss of $10.2 billion in the third quarter, the bloated company plans to cut jobs this year.
Shale bonanza
Meanwhile, across the border, Texas has opened up over 14,000 on-shore lateral wells, overshadowing Mexico, where Pemex has only managed to drill a few test wells. Since the Eagle Ford Shale straddles both countries, that disparity marks the difference between an entrepreneurial culture that developed today's new drilling technologies and a risk-averse monopoly.
But the recent auction promises to unleash the market forces that will help Mexico emulate the US fracking miracle, now that the country amended its constitution in 2013 to allow private companies to compete after a 75-year forced hiatus.
Decades of easy oil
Many of Mexico's current energy problems can be traced back to the creation of Pemex and its incestuous relationship with a succession of governments.
Even though early oil production by Shell, Jersey Standard, and Standard Oil of California (now Chevron) made Mexico the world’s second largest oil producer in the 1920s, it provoked bitter labor strife and popular resentment, leading President Lázaro Cárdenas to nationalize the whole industry in 1938.
Since then the oil and gas reserves have been off-limits to outsiders and the exclusive domain of Pemex, which got lazy getting most of its oil from two huge, easy-to-tap offshore formations.
During decades of easy oil, Pemex became notoriously inefficient: stuffed with a cautious bureaucracy, teeming with too many workers, and stunted by corruption. So it's not surprising that in a country that some geologists say contains the largest unexplored petroleum area beyond the Arctic Circle, Pemex engineered a steep decline in Mexico’s oil output.
During the decline, Pemex has failed to keep up with the technological revolution the US industry has undergone over the past decade. While new deepwater drilling and hydraulic fracturing technologies have opened up vast new deposits in the United States, Mexico’s oil production has fallen by more than 20 percent since 2004, to 2.6 million barrels a day. That has put increasing pressure on the government, which relies on Pemex for a third of its tax income.
Instead of using Pemex's revenues to invest in new exploration, technology, or even maintenance, they're diverted to government programs, leaving Pemex with only 15 percent to reinvest in exploration activities, far less than Brazil’s Petrobras and other competitors.
While the country took some tentative steps at energy reform in 2008, it only allowed private companies to work as Pemex subcontractors. It wasn’t until 2013, when President Enrique Peña Nieto overhauled several sectors of the economy that change began. The greatest breakthrough was allowing private companies to bid on blocks of mineral rights that had been hoarded by Pemex, whether the company explored them or not.
Frackpolooza
The importance of Mexico's energy reform is huge. Despite dumping more and more money into exploration by Pemex, oil production in the country peaked back in 2004. Without reform, Mexico would have most likely transformed from a net exporter of crude to a net importer within a few years.
Pemex officials believe shale has the potential to provide Mexico with more oil and gas than the country has produced since it first struck oil in the early 20th century. “Mexico has the sixth largest gas shale fields in the world. And you’re all welcome to come join the exploration opportunities,” Emilio Lozoya, Pemex chief executive officer, told an energy conference in Houston in March.
Estimates for recoverable unconventional oil in Mexico pencil in at 13 billion barrels, according to a US EIA study in 2013. But developing those resources would require up to $1.2 trillion, according to Goldman Sachs. That's a huge investment the debt-ridden monopoly can't afford.
After all, just to keep ahead of declining oil production, Mexico will need more than 40,000 new wells. With each well costing $10 million to $20 million, Pemex can't afford to drill these horizontal wells, so private investors finally have an opportunity to play on the former monopolist's turf.
“The drilling density in Mexico is vastly, vastly underdeveloped," according to Steinke.
Slow change
After a disappointing start during the country’s offshore oil auctions last year, which were largely snubbed, particularly by US oil majors, Mexico just awarded 22 oil production and service companies rights to extract crude from onshore fields.
The most successful bidder was a consortium led by Geo Estratos, which won four contracts. Next came Renaissance Oil Corp. of Vancouver, Canada, and Strata Campos Maduros, a Mexican startup, each of which won three contracts. Diavaz Offshore, which for years has been a domestic service provider to Pemex, won two. One other Mexican bidder was Compania Petrolera Perseus. Three other Mexican companies each claimed two areas.
“The primary objective of this round was to plant the seed to grow the Mexican oil industry,” said Lourdes Melgar, Mexico’s deputy energy minister, Bloomberg reported. “That goal was achieved.”
The bulk of Mexico’s shale prospects appear to lie in the northeastern sections of the country, where infrastructure is often largely undeveloped. This means that in order to tap the country’s bounty of shale oil and gas, roads, housing, rail, pipelines and many others will have to be built out first. Security issues must also be addressed.
Turf wars
OK, your company just won a chance to finally drill in Mexico, now there's a major obstacle in the way: Mexico's reigning entrepreneurs: drug gangs.
While there are anticipated difficulties in Mexico, most are typical like water scarcity, but the country's Breaking Bad factor is daunting. The best shale, found in the Burgos Basin, sits in the playground of Mexico's vicious drug gangs. In Tamaulipas, just below Texas, gun battles, kidnapping, and carjacking are now taken for granted. But now the gangs have morphed into shadow oil companies, illegally tapping pipelines and hijacking tanker trucks with such brazen impunity that Pemex looses about $1 billion a year.
Pemex documented 3,600 illegal taps on pipelines in 2014, a 40 percent increase from the 2,627 a year earlier. They more than quadrupled from 2009 to 2013, according to Pemex, which attributes part of its 11-year production slide to the illegal taps, and are on pace to exceed a record 4,000 incidents of pipeline theft this year, up from 710 in 2010.
The big jump in illegal siphons came after powerful drug cartels like the Zetas realized the profitability of the oil flowing through their territory. Fleets of tankers are now being stolen, and the Mexican press reports the Zetas and the Gulf Cartel have distribution operations that rival Pemex.
When designing the auction, the government said that it wanted to avoid confrontations between the oil and the narcotics businesses.
"We can't deny there are high risk areas," said Edgar Rangel, a commissioner at Mexico's National Hydrocarbon Commission, which is managing the new oil and gas provinces.
Even though Rangel went on to say that the agency had deliberately excluded blocks in the bidding where drug violence is rampant, nevertheless, 1,168 pipeline taps occurred where the 25 onshore fields were auctioned. Two of the fields are located in Tamaulipas state, which reported 561 pipeline thefts in 2015 through August, the most of any state, according to Bloomberg
Gunfire
Contrary to the government's public assurances, on the ground the oil business gets very complicated. Last April, according to The Dallas Morning News, 30 workers for Weatherford International, a Swiss oil field services company, were escorted out of a town in Tamaulipas by police after gunmen riddled their hotel with bullets.
Although Rod Lewis, CEO of Lewis Energy in San Antonio, who won a contract to drill test wells for Pemex in the middle of gang country, declined to be interviewed, employees at one of his drilling sites near Nuevo Laredo said they are forbidden from leaving the facility after dark. According to workers, the gated site is like a military compound, with strictly controlled access.
Will drug gangs derail Mexico's oil comeback?