Cablegate: Mexican Energy Roundtable: Declining Oil Revenue

DE RUEHME #6783/01 3402105
P 062105Z DEC 06





E.O. 12958: N/A


B. MEXICO 5148

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1. (SBU) According to studies completed by Cambridge Energy
Research Associates (CERA), President Felipe Calderon will
contend with a real drop in oil revenue from about USD 54
billion in 2006 to the USD 27 billion range in 2012 as a
result of decreasing production, a likely fall in heavy crude
prices, and declining Mexican crude quality. To address this
fall and shore up the budget, CERA believes Calderon will
likely be able to get Petroleos Mexicanos (Pemex) corporate
governance reforms passed, but that more comprehensive
changes may not be possible. PRD opposition to the Calderon
presidency, especially on the energy agenda remains deep, and
Calderon will act first on the political agenda which will
require continued substantial oil revenue. He will also have
to build a more workable coalition between the executive and
the legislative branches than was in place during the Fox
administration. More controversially, CERA discounts
Calderon's need to convince the Mexican people of the need
for energy reforms, but rather they suggest that Calderon
focus his attention on the Congress where the National Action
Party (PAN) maintains a plurality in both congressional
chambers (Chamber of Deputies 41%, Senate 39.4%). That said,
the PAN has a very weak mandate from the Mexican electorate
which remains divided. CERA also believes that post election
protest weakened Mexican institutions, threatening the
chances for energy reform. End summary.


2. (SBU) Econoff attended the semi-annual Mexican energy
roundtable presented by Cambridge Energy Research Associates
in Mexico City November 16. Participants included
representatives from the Mexican Secretariat of Energy
(SENER), Pemex, the Federal Electricity Commission (CFE), as
well as representatives of international firms active in the
Mexican energy sector. At the session, participants
discussed the outlook for the Mexican oil and gas sector over
the next five years as well as how the incoming Calderon team
would address energy policy issues.

--------------------------------------------- -----------
Declining Quality, Declining Price, and Increasing Costs
--------------------------------------------- -----------

3. (SBU) CERA produced a relatively positive forecast (i.e.
slow decline) of overall Pemex production based on Pemex's
current production outlook:

CERA Forecast
of Mexican Oil
(thousand barrels
per day)
2006 3,284
2007 3,190
2008 3,055
2009 3,051
2010 3,018
2011 2,940
2012 2,874

4. (SBU) The group agreed that as more production comes from
Pemex's most promising short term prospect, the
Ku-Maloob-Zaap (KMZ) complex, the overall quality of Mexican
oil will decrease. Tests show that oil from the Baksha,
Kayab, Zazil-Ha, and Numan oil fields which should make up 20
percent of the KMZ mix by 2012 should significantly lower the
overall quality of Mexico's dominant product, the Maya blend,
reducing the price of Mexican crude. CERA reported that even
accepting relatively optimistic Pemex production estimates,
combined quality and limited volume declines, will decrease
GOM revenue by as much as percent by 2012.

MEXICO 00006783 002 OF 004

5. (SBU) In addition to the revenue decrease due to volume
and quality declines, CERA's base case oil price forecast
shows West Texas Intermediate (WTI) crude dropping from USD
61/Bbl this year to USD 45/Bbl by 2010. CERA economists note
the drivers of the forecast include projected large new
discoveries slated to come on line in Kazakhstan and Brazil
by 2010. They also believe that the current oil price has
been buoyed by a "fear factor" sQemming from current global
instability. Without further political "shocks" to maintain
elevated prices, the "fear factor" effect on world oil prices
will reduce over time. Combining quality and price effects,
CERA forecasts the Mexican Price:

Basket Price WTI
Forecast Forecast
(Real 2005 $) (Real 2005 $)
------------ -------------
2006 55.26 61.00
2007 48.73 52.00
2008 40.61 46.00
2009 38.17 44.00
2010 36.67 45.00
2011 35.66
2012 33.57

6. (SBU) CERA and the industry representatives present
agreed that Pemex's financing, operating, and capital costs
would rise. Worldwide, oilfield services and supplies have
increased 15 to 25 percent in the last 12 months. In the
Mexico specific case, 74 percent of Mexican production today
has an extraction cost below USD 4/BBL. While extraction
costs for new develoments should be equivalent, beginning in
2010-2012, a significant portion of the Mexican production
mix (11%) should begin to come from Chicontepec, a much more
difficult to produce onshore field with production costs near
USD 14/Bbl. Total production costs will more than double
during this period. At the same time, capital costs (reserve
development and infrastructure construction) will rise
dramatically as Mexican oil becomes much harder to find and
develop. CERA predicts that exploration and development
spending will increase 3.5 times between 2005 and 2012.

7. (SBU) Combining the effects of volume price, and quantity
declines, and taking into account operating cost hikes and
then applying the current formula for Pemex extraction duties
and other taxes, CERA estimates the GOM's real income from
hydrocarbons will decline from about USD 54 billion in 2006
to approximately USD 27 billion in 2012, even taking into
account relatively rosy Pemex production forecasts.

Legislative Reform Strategy

8. (SBU) To offset this difficult scenario, the Calderon
administration will have to develop a strategy to reform the
sector. The crux of that strategy will depend on how
Calderon and his administration manage the Congress. To
describe the political process, CERA analysts divided
necessary decisions into three areas

(1) Ideology versus Pragmatism -- the Calderon team must
decide how deep and market based reforms must be, taking into
account they must win the at least tacit support of the Party
of the Democratic Revolution (PRD) to avoid derailing reforms

(2) Institutionalization versus Politicization -- The
Calderon team must decide whether to trust in formal
legislative mechanisms or informal political relationships,

(3) Status Quo versus Liberalization -- Calderon must also
decide how quickly reforms are to be introduced. His team
must move slowly enough to build support, all the while
keeping in mind the growing GOM oil revenue decline.

Ideology versus Pragmatism

9. (SBU) Street protests since the July election have

MEXICO 00006783 003 OF 004

dwindled, but as evidenced by their behavior in the lead-up
to his inauguration, PRD opposition to the Calderon
presidency remains deep. The incoming administration's first
instinct has been to be pragmatic as evidenced by the
President elect and his advisors' statements during the
transition (reftels). CERA believes Calderon's first moves
will be to protect national security, promote state's
interests, and help to ensure the rule of law. At the same
time, they see a real need for Calderon to develop a more
workable coalition between the executive and the legislative
branches than were in place during the Fox administration.

10. (SBU) Somewhat more controversially, CERA believes that
there is a "dichotomy between public opinion and real
support," thus they discount Calderon's need to convince the
Mexican people that energy reforms would be worthwhile,
instead, they believe that the new President will focus
attention on the Congress. On the positive side, Calderon's
National Action Party (PAN) maintains a plurality in both
congressional chambers (Chamber of Deputies 41%, Senate
39.4%) and will benefit from institutional support offered by
the executive. Especially after the abortive protests by the
PRD, the PAN's support is growing. The country's economy
remains stable, and politically there is significant
continuity with the outgoing Fox team. Still though, the PAN
has a very weak mandate from the Mexican electorate which
remains divided. Calderon opponents are mobilized with the
fate of the energy sector one of the principal points of
division. CERA believes that post election protest weakened
Mexican institutions, a view not shared by all participants.
Congress itself remains fragmented, and energy reform must
share the stage with an extensive political agenda.

11. (SBU) Looking to the past performance of the Energy
Committee, CERA analysts searched for indications of how the
upcoming 60th legislature would behave based on the
performance of previous Mexican congresses. CERA analysts
argued that Mexican politicians have recently become more
focused on hydrocarbons. In the 58th Legislature (2000-2003)
50% of proposals dealt with electricity and 24% dealt with
hydrocarbons. The situation reversed under the 59th
Legislature (2003-2006) 54% of proposals dealt with
hydrocarbons and 26% dealt with electricity. CERA suggested
that the switch resulted from the belief that CFE and the
electricity monopoly had been "taken care of" while the real
focus should be oil and gas. In both the 58th and 59th
legislature, the PRI proposed more amendments than the PRD,
the PAN or the Executive neither of which was active
introducing energy legislation. The 58th legislature's
Energy Committee within the Chamber of Deputies introduced 63
proposals while the 59th legislature introduced 97.
Nevertheless, only 10 proposals passed (including fiscal
reform for Pemex and a cogeneration package) The Chamber of
Deputies, the analysts suggested, was a legislation filter,
bringing only those bills forward that would justify passage.
Despite the PRI's majority almost of the successful
proposals came from the PAN.

12. (SBU) Earlier activity in the Congress also indicates
that despite their function as a legislative filter,
liberalization was unpopular. Only 5% of proposals dealt
with the issue. Furthermore, in the 58th and 59th
legislature, 33 percent and 47 percent of proposals were
meant to strengthen institutions (CRE, SENER, Pemex, etc.).
From this, CERA analysts that the PAN sought to strengthen
the institutional basis for reform (Pemex fiscal reform).
Nevertheless, they avoided direct political confrontations
with the opposition and radical factions (PRD) by avoiding
the liberalization issue. Questions remain as to how willing
the PAN will be to approach the reform issue in the 60th

Institutionalization versus Politicization

13. (SBU) The group also discussed whether Calderon would
depend more on informal channels of communication between
parties to achieve portions of his agenda, a strategy used by
former President Carlos Salinas, or would he depend more on
formal lines of communication between the legislative and
executive that President Fox tried to use. While Fox
depended on his cabinet secretaries to manage the Congress,
CERA analysts noted that on energy, the administration failed

MEXICO 00006783 004 OF 004

to provide the political support to the energy secretariat to
complete meaningful legislation -- electing to focus on
maintaining short term Pemex revenues high to boost
government income. Even the most recent legislative
proposal to reform Pemex corporate governance, with
relatively broad acceptance across the political spectrum,
failed to receive real support in congress from the Fox
administration. The Secretariat of Energy (SENER) is
traditionally weak; hence Fox's dependence on formal
mechanisms combined with SENER's weakness in formal
networking made it much more likely that reform legislation
would fail in the previous congress.

Status Quo vs. Liberalization

14. (SBU) CERA believes that in the relative short term (3
months) Calderon will be able to "Address the main political
obstacles to energy sector restructuring" and "confront
urgent needs." On the energy side, CERA believes that most
legislative action would be geared to changing energy subsidy
rules to better favor the poor. In the medium term (1 year)
CERA suggested that Calderon will "Create an appropriate
political environment for stimulating stable, legislative
policy change in the sector." Internal lobbying for reform
would be possible but would largely depend on how reform
responsibilities would be distributed in the new cabinet. In
the long term (3 years) CERA suggested that Calderon will
"consolidate a coherent integrated energy reform." They
believed that partial reforms such as diluting the
representation of unions on the Pemex board would be
possible, but a comprehensive reform was less likely. Going
forward, the observers felt the PAN would seek to take
advantage of the "new players" (i.e. the departure of 'old
guard' such as the obstructionist PRI Senator Bartlett).
CERA believed that the PRI role would be the most important
for the PAN strategic interests.


15. (SBU) Of all Mexican energy prognosticators, CERA's
current production forecast for Mexico is the most rosy,
nonetheless, their price forecast suggests an almost 50% drop
in Mexican government oil revenues over the next six years.
CERA and most other participants in the session agreed that
if any energy reforms that do pass, they would be slow in
coming and would likely not be sufficient to stem Mexico's
revenue slide. The balance between managing the energy
sector to maximize current GOM revenues and ensuring future
energy security through increased investment and
liberalization will remain a difficult challenge.

16. (SBU) Some analysts believe that the Calderon team has
already signaled it will behave as previous administrations
and "take the money now." At the same time, new Finance
Secretary Carstens said publicly on December 5 that Mexico

should expect a fiscal reform proposal in 2007 given the
GOM's need to increase revenues and allow Pemex to make
significant investments over the next few years to maintain
its export platform. This approach signals that the new GOM
is aware that unless remedied, the costs of declining revenue
and production will come due for Calderon by the middle of
his term.

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