Mexico: Running Out of Oil and Options

by: Sean Maher September 07, 2008 | about stocks: EWW / FXM    

Sean Maher

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As equities commence the dramatic autumn slump I've been anticipating in recent weeks, it is uninspiring to witness the standard of political debate in the US Presidential election. It seems that neither candidate is aware of, or at least willing to articulate, the tectonic shifts taking place in global financial power which threaten to severely limit the room for maneuver of the incoming administration. Roosevelt said America should talk quietly to the world but carry a big stick; now a big begging bowl is more appropriate. We hear references to Iran and Russia as geopolitical challenges, but nobody is talking yet about a bigger threat right on America's doorstep: the potential implosion of the Mexican state.

There are two pressing issues that are putting intolerable stresses on the Mexican economy and society; the first is the huge escalation in drug related violence and corruption, as US support for the Colombian war on drugs has displaced Cartel activity into Mexico, now the primary base for cocaine shipments in the region. The revenues involved are estimated by the DEA to have reached over $40bn a year (or about 25% of all official exports), financing very effective private armies, and rampant high level corruption.

In recent months, ever more daring assassinations have included high ranking policemen and District Attorneys, including the head of the Federal police in May (equivalent to killing the head of the FBI). Criminal kidnappings have reached epidemic proportions and now threaten much of the urban middle class, and law enforcement bodies are so thoroughly corrupted that they are often complicit in these crimes.

The second crisis relates to collapsing oil production and hence state revenue; the biggest Mexican oil field, Canterell, has seen production tumble 37% in a year and down 50% from its 2004 peak, equivalent to 1.2m barrels a day. For US energy security this is a full blown emergency; this field was a 'Supergiant', as big as the four largest discovered in US Gulf waters combined and Mexico is currently the third largest oil exporter to the US, after Saudi and Canada.

Amazingly, Mexican production fell 10% and oil exports dropped over 16% in the first 7 months of 2008. The faster decline in exports reflects soaring domestic demand. Canterell may be down to just 600k b/d with a couple of years, with devastating implications for Mexican tax revenues; 40% of all revenues are generated by oil, and Pemex, the state oil monopoly, pays an effective 61% tax rate. The company has been plundered by politicians for decades, and the resulting underinvestment is now proving disastrous, exacerbated by the fact that foreign companies with superior technology and experience have been barred by statute from involvement.

Some economists estimate that Mexico will run out of oil within just 7 years, implying a near halving of the tax base just as hugely wealthy criminal warlords step up their challenge to Federal authority.

Oil exports will certainly have dried up on that timeframe. The balance of resources between the government and criminal groups will deteriorate rapidly in coming years, and the US may face a de facto criminalized narco-state as a neighbor with violence spilling across its Southern borders. Other implications would include a massive surge in illegal immigration from the current estimated 450,000 a year as impoverished Mexicans flee both declining living standards and rampant lawlessness, and the US losing energy security by becoming even more dependent on oil shipped huge distances from the Persian Gulf and West Africa.

Ironically, the success of US policies to support the Colombian government now threaten to undermine the strategically far more important Mexican one, a classic case of the law of unintended consequences in action. It will take more than that fancy new border fence or oil drilling in Alaska to address the looming crisis that will almost inevitably explode by the end of the new President's first term.

I have been bearish of emerging markets in general in recent months, and Mexico is one of the most vulnerable to capital flight as the combination of falling oil prices and production creates a fiscal crisis in 2009.

Disclosure: None

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This article has 14 comments:

  •  
    Sep 07 06:56 AM
    100% correct.
    Reply | Link to Comment
  •  
    Sep 07 07:30 AM
    Poor Mexicans are better off to stay where they are,the US is going to hell in a handbasket
    Reply | Link to Comment
  •  
    Sep 07 09:06 AM
    Interesting article. Do you live in Mexico or visit a great deal? What is the future on the political horizon?
    Reply | Link to Comment
  •  
    Sep 07 09:53 AM
    It looks more like Mexico will reach a point to where the crime will flow over our southern border like a tsunami. At that point, we might have to take over Mexico and destroy the drug cartels, because the damned Spaniards running the country won't loosen up and let people have more freedom and economic opportunities. Or we could simply legalize drugs and yank the black rug out from under the cartels.
    Reply | Link to Comment
  •  
    Sep 07 12:22 PM
    We could try either or both, but we won't. The question is when Mexico will wake up and allow more foreign investment, and who will be willing invest there in their present circumstances. Our energy industry is the most likely possibility, since they are used to working in foreign lands under less than ideal circumstances.
    Reply | Link to Comment
  •  
    Sep 07 02:03 PM
    The Mexican government has to quickly endorse allowing Pemex to partner up with the big multi-nationals. Otherwise, not only will they suffer the financial issues as spelled out above, but the US will also suffer consequences. We will have a greater influx of illegals migrating to the US and we will lose a valuable source of oil. California's refiners garner 1/3 of their supply from Mexico presently. If Mexico doesn't get off the stick, I expect that there will be a greater backlash on the issue of immigration, no matter which party makes it into office here. As the underground economy is Mexico's second largest source of income, that would be strike two!

    However, it may already be too late. Large multi-nationals are already scaling back their drilling and exploring in favor of buying back their stock, and those that might have been inclined are busy with Brazil, or as recently noted, diagonally tapping in to Mexico's supply in the Gulf with one of the world's largest rigs.... "He who snoozes, loses!" ..

    jegan ;-)
    Reply | Link to Comment
  •  
    Sep 07 02:35 PM
    I live and farming in Mexico and taught Mexican politics at the University of New Hampshire. Mexican Oil exports are forecasted to end by late 2010. 40 % of federal revenues come from oil export sales. Mexico will experience inflation, unemployment, and greater social problems. I moved here knowing all of this. Where I am living is very sustainable and of the crime problems exist here so far. Not far in the future, the U.S. will experience the same problems. I used to live in NH-USA, but moved to a sustainable place. Anyone interested in relocating to a nice, pretty, sustainable area with a good climate and good soil? Email: clifford dot wirth at yahoo dot com or give me a phone call which operates here as my old USA-NH number 603-668-4207. survivingpeakoil.blogs.../
    Reply | Link to Comment
  •  
    Sep 07 02:49 PM
    Interesting perspective from an outsider. Although the general terms might be correct, it's by far not the whole.
    Oil production has been steadily declining, due to antiquate equipment, which is a result of a) nearly 90% of profits have to be payed in taxes to the federal government and b) corrupt government officials. This is now being adress by the current Calderon Administration, however since Mexico is a democartic country, it had to battle fierce discusions and proposal to the reviteliasation and restructuring of the OIL industry. A consensus has been found and detailes are being worked out, which will take a few more months till the process starts. Having said that, spanish Repsol Oil conglomarate is already deeply involved and you might be surprised to know that China is already on the ground and many PRC nationals are working in some sectors of the industry (as outsourced manpower resources).

    And don't forget gasoline is heavy subsidiesed considering that the mayority of gas is refined and processed in the US and India.

    As for the drug war, 40bn USD is about the right figure. The 40bn USD are generate from sales in the US. This is a huge industry and can only work with corrupted US politicans from congress to municiplities, not to mention police and certainly the US banking systems.
    So do not worry anymore...it has spread over the boarder along time ago. Where do you think the sofisticated drug armies get their hard and software from? Only the US sometimes with a detour via Iraq. weapons are purchased in US and shipped to Mexico.

    as it looks like the root cause of the drug violence is not Mexico, but the United States of America.

    Mexico's biggest vunerability is it's heavy dependency on the US. 75% of all it's exports go to USA. This is about to change Asia was neglected by mexcian industries and government. I have seen first hand agri product exporters, which only supplied US clients, which again re-exported the Mexican product for a multiple to Asia clients, cut the intermediatery and go straight to China, South East Asia and middel east.

    Kidnapping is a serious problem and so is corruption and poverty. Sean Maher is partially right. Columbians drug criminals have relocated to Northern Mexico and caused territorial disputs with mexican cartels.

    The main crime activity zone is 150 miles from the north and south the boarder. The terrible killing on the south side is a result of the current Calderon government to effort to stop the violence. It will take time and lot's of blood. It needs guts and determination to change. Something that is absolutly wanting in the US.
    Reply | Link to Comment
  •  
    Sep 07 05:21 PM
    I wonder how much declining oil production is because of lack of maintenance, vs. real depletion. Not much good can come declining oil revenues, especially considering that the population is much much larger than before the oil boom, and probably growing even larger. Illegal immigration appears to be their pressure relief value.

    On the other hand, I am not sure how the average Mexican citizen benefits from oil revenues. It could be that 95% of revenues are hoarded by the oligarchs, and they occasionally build a road and a soccer stadium to pacify the masses.
    Reply | Link to Comment
  •  
    Sep 07 05:23 PM
    I wonder how much declining oil production is because of lack of maintenance, vs. real depletion. Not much good can come declining oil revenues, especially considering that the population is much much larger than before the oil boom, and probably growing even larger. Illegal immigration appears to be their pressure relief value.

    On the other hand, I am not sure how the average Mexican citizen benefits from oil revenues. It could be that 95% of revenues are hoarded by the oligarchs, and they occasionally build a road and a soccer stadium to pacify the masses.
    Reply | Link to Comment
  •  
    Sep 10 05:43 AM
    Unfortunately there is little that "foreign companies with superior technology and experience" can do; an oil field that is declining rapidly cannot be made to do more than increase production in a small way by using different methods of extraction, and this merely ensures that the field will decline more quickly anyway.

    World Peak-Oil production is here and there's nothing that can be done to stop the decline; the best that could be done is to reduce demand, but only at the expense of world industrial expansion. A new way of looking at economics will have to be embraced, it will be called The Economics of Permanent Decline in the Age Of The Scavenger.
    Reply | Link to Comment
  •  
    Sep 10 10:02 AM

    I'm sure TB Pickens would be ecstatic to put nat gas on the market at a break even of $2.50/gal equivalent. I'm amazed that the market thinks oil is a bargain at $100. Very short memories, I suppose.
    Reply | Link to Comment
  •  
    Sep 12 04:35 PM
    The best strategy for US interests is to increase real investment in Mexico. Most Mexicans would rather stay home if the jobs were available. Mexico is seriously underemployed so they will go where the jobs are, that's the way markets work. I recently vacationed in Mexico and encountered a growing number of Mexicans who spoke English and learned it in the United States. They returned home and brought skills learned here with them. I also met many US citizens who are retiring in Mexico for obvious reasons. This cross cultural movement is good for both countries.

    Some of that $40B in drug money is spent here in the US on guns which are used against the Mexican police. We could help the situation by following the money to the gun dealers. I'm with Stephanie and think that decriminalization of drug use will deprive the bad guys of funding. But not in this administration even though legalization is pure Reaganomics.

    Reply | Link to Comment
  •  
    Dec 06 03:41 PM
    Lets just run all the Mexicans out of the USA, then seal off the borders so we dont have to deal with their problems. My taxes pay for these legal and Illegals here. I DONT like that at all!!
    They need to go. Already in WA, many jobs require bi-Lingual (spanish) to get hired and the spanish here do not like whites at all and think its THEIR country.
    Enough is enough. Kick the bastards out!
    Reply | Link to Comment
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