?Petróleos Mexicanos is in trouble. In a time of extraordinarily high oil prices, its net profit fell 56% in the second quarter of 2008 from a year earlier. Total oil output fell 11% to average about 2.8 million barrels per day. The company’s medium-term target of 3 million a day has not been met this year and is the lowest in six years.


Exports declined 18.3% to average 1.4 million barrels per day in the second quarter.


At its aging Cantarell oil field, the largest producing offshore field in the world, output is now only 1 million barrels per day—half what the field was producing at its peak in 2004. Production in the field swooned 25% in the first quarter and more than 30% in the second quarter, from like periods a year earlier. (This is in addition to the fact that Mexico became a net natural gas importer from the U.S. several years ago.)


Despite this dire situation that threatens Mexico’s economy, politicians and voters cannot agree on what steps to take. President Felipe Calderón is trying to restructure Pemex as well as amend its charter to allow for increased participation by private and foreign oil companies. The PRI (opposition party) and unions are fighting for the status quo. A non-binding public referendum held in late July suffered from disappointingly low voter turnout, but the vote was overwhelmingly against Calderón’s reform proposals.


No consensus has emerged, though not for lack of trying. On July 22, the final session of more than 70 days of Senate testimony took place in Mexico City. More than 160 witnesses and more than 133 hours of debate were shown live on the Congress’ Internet channel.


Throughout, the moderator of the sessions was Sen. Francisco Labastida, president of the Senate Energy Committee, a public figure with strong credentials: He was the PRI presidential candidate in 2000, a governor of Sinaloa state, and secretary of energy in the early 1980s.


At the session were rhetorical giants at the head table. First, Manuel Bartlett—the PRI’s “Mr. Everything:” former interior minister, education minister, and senator from and governor of Puebla state. A handsome and elegant speaker, Bartlett, whose university studies were in France and England as well as Mexico, argued with his customary white-heat passion that the legislative bills that had been submitted to Congress by President Calderón in April amount to nothing more than a shameless surrender to foreign interests.


On the other side of the Great Oil Divide was Juan José Rodríguez Prats, an erudite federal congressman from Tabasco state, whose rapid, almost-shouting style of delivery, were it that of a preacher, would make the most vile sinner repent. Rodríguez ridiculed the idea that the intent of the government’s proposals was to privatize Pemex. “It is acceptable to have personal opinions,” he said, “but it is unacceptable to have personal facts.” He insisted that the opening of Mexico’s economy began with the entry of the nation into GATT in 1986, “not in 1994 under the pressure of NAFTA (the North American Free Trade Agreement), as some speakers have insinuated.”


Also on the administration’s side that day was the young Nestor García Reza, the general counsel of Pemex whose credentials include studying at Harvard. He argued that the basic purpose of the president’s proposals was “to strengthen Pemex.” He insisted that there was no privatizing agenda and that the petroleum rent of Mexico would not be shared nor compromised.


A third speaker was Humberto Lira Mora, a former general counsel of Pemex who denounced the Calderón proposals as “nothing new” and “unconstitutional.”


This snapshot of just four speakers gives a glimpse of the range of testimony of the previous two and a half months.

Out of control
So what is all this fuss about? Ponder the comments of Labastida, when he addressed the “Colima Forum on Oil Reform” on July 12, on the last day of a three-day event.


As keynote speaker, Labastida began with two observations. The first was that, in contrast to the initial public reaction to the government’s report, “Diagnostic of the Situation of Pemex,” which was issued March 30 and dismissed as “alarmist,” his personal view now was that “the government’s diagnosis falls short of describing both the seriousness and complexity of Pemex’s situation.”


His second observation was that Calderón had been completely right to put this topic on the table for public discussion, as the situation was urgent and further delay was unacceptable.


As in all things, the devil is in the details. Labastida observed that “none of the president’s bills would pass as proposed,” and, in his remarks, he explained some of the reasons.


Before going further, step back and look at the big picture, which is complicated enough. Mexico, in 1917, changed its oil-friendly rules. Article 27 of the new constitution declared that, in effect—and in contradiction of previous legislation that dated back to 1884—the owner of the surface property was not thereby the owner of the mineral rights.


Through the years, the government tried, unsuccessfully, to convince oil companies to convert their titles into 50-year leases or concessions. (Today, they would accept such an offer at once,) But the situation by 1937 had gotten out of control and, on March 18 of the following year, the oil industry was nationalized.


The government created Petróleos Mexicanos (Pemex), and in the next 70 years came to see how things could really get out of control in the oil sector.

Lame ducks
For Calderón, the phrase “strengthen Pemex” is a short-hand way of saying “f­­ix the entire oil sector, not just Pemex.” He has an understandable urgency to start moving, as he is in his second year of a single six-year term. The Mexican political system bars reelection of officials, hence, he—along with all other elected officials in the legislature—is counting the remaining days in office. A peculiarity of the nation’s congress is that, while the 108 senators are elected for a six-year period, the members of the lower house are elected for only three years. As there is no system of staggered terms, every three years the entire body of 500 legislators is not up for re-election—it is replaced.


The next election is in July 2009. Most observers say Calderón needs to get something approved before December 2008—before the midterm election cycle begins in earnest. If Calderón cannot achieve approval of his oil-reform bills in their original or modified forms, the likelihood that he will be able to accomplish anything further in his term of office is diminished sharply.


The situation that needs fixing is this: At present, Pemex has a monopoly not only over oil, but—in fact, not in theory—also over oil policy. And this monopoly is not only over oil policy, but also over the technical information and human resources (petroleum engineers and earth scientists) who can evaluate the merits of Pemex’s programs and proposals. Thus, at present, the government is a mere bystander of petroleum policy as conceived and executed by Pemex.


But even this description falls short. Once inside Pemex, the situation is worse: The director general is largely a figurehead and the board of directors is used exclusively for ceremonial purposes. The real levers of power are found in the four independent business units of Pemex: E&P, refining, chemicals and natural gas (which each have status as legal entities with a board, and which are far too independent, many believe), the oil union and the finance ministry.


These dark facts are not in the public view, however, as there is a culture of occultation in Mexico that puts a smiling face on anything Pemex does or proposes to do.


Further, oil production is falling. Cantarell, the world’s third-largest oil field, was producing 2.3 million barrels daily in 2004. This has fallen to 1.4 million. National production has fallen below 3 million a day for the first time in six years. Labastida sees with alarm the prospect that production could fall to 2 million a day.


“At $100 a barrel, such a fall in production would be the equivalent of 5% or 6% of GDP,” he warned.


So, what should the president, facing these challenges, do? With the question put in this form, the Calderón proposals start to make sense: Give Mexico’s energy ministry more responsibility, and teeth; give the same to the Pemex director general, expand the Pemex board and give it more teeth, increase transparency by creating new oversight committees and officials, and allow Pemex flexibility in organization, procurement and financial management.


Calderón proposes a new class of contracts called “incentive contracts” under which the contractor may be paid additional amounts that reflect the quality, technology and service-ability of the work. Under present rules, a contractor may be paid only an agreed-upon price or an agreed-upon schedule of prices, regardless of outcome.


Critics say, for diverse reasons, that such a contractual model would violate the constitution. The government’s reply is, in effect, “Hey, get real. Pemex needs technological parity with other oil companies.”


Suppose Pemex today has a two-year contract for oilfield services that cost $100,000 a day. Suppose at the end of the first year there is a new technology that costs twice that, but with three times the benefit. Today, Pemex cannot pay more for the new technology under the existing contract, a defect in the law that has a terrible and unacceptable opportunity cost for Pemex and the nation.


Calderón’s proposal fixes this problem and gives Pemex the flexibility it needs to obtain the best technology in a timely manner—as it becomes available.


In Mexico, there is an intellectual gridlock that is observed in the U.S. in relation to oil policy: Neither Pemex nor the government is able to explain to the congress—or to the critics on the street and in the media—why it is that the rules of procurement and management for the oil industry should be any different from those of any other industry. Thus, the solid arguments that the government present are treated as mere dissimulations by opponents.


To conclude, the direction of the Calderón proposal is correct, the details debatable and the political science brutal.

George Baker is research director with Energia.com, a Houston-based consulting firm that specializes in Mexico’s oil and gas industry. He may be reached at 713-255-0000.