By: Jeremy Martin and Sylvia Longmire
Journal of Energy Security
The stillness of early Sunday morning December 19, 2010 was shattered by a thunderous explosion. Residents across San Martin Texmelucan, a small town about 60 miles from Mexico City, were awakened to the latest, and one of the most deadly incidents, involving possible fuel theft at Pemex, Mexico’s national oil company. Many were more than just jolted awake: Over 100 homes were damaged or completely destroyed; 30 people perished and more than 50 were injured. It was a national calamity for a nation and state oil firm that sorely did not need it.
Explosions, shootouts, deaths and violence have been increasingly seared into the collective minds of citizens in Mexico and the United States as the drug war persists. The battles between the government and competing cartels have been well-documented and the topic has coursed through the agenda of a series of high-level bilateral meetings between the two nations, most recently during Secretary of State Hillary Clinton’s trip to Mexico.
But what has also percolated just below the surface is an alarming intersection between the drug violence and Mexico’s energy sector. For Mexico and Pemex, the increased intensity of the drug war and its damage is but the latest in a string of challenges, and a twist that has seemingly linked two previously unconnected drags on the nation.
Indeed, oil—and energy more broadly—is not a sector of the economy where Mexico needs any further impediments. Pemex’s huge hurdles, which are derived largely from its inability to replace declining oil production and navigate a burdensome nationalistic legacy, are legendary. And the commensurate fiscal implications are enough to keep policy makers on both sides of the border awake at night.
Mexico’s drug war
The drug war in Mexico is being fought on two fronts. First, roughly seven major drug trafficking organizations, or DTOs, are fighting against each other for control of lucrative drug smuggling corridors, or plazas, into the United States. Second, they are also fighting a massive military and law enforcement offensive under the direction of Mexican President Felipe Calderón, who decided upon entering office in 2006 that existing levels of drug trafficking and associated violence would not be tolerated.
The DTO’s took exception to Calderón’s new mandate, and fought back with a vengeance. Their attacks against each other and against government forces have included beheadings and dismemberments, targeted assassinations, mass murders, grenade attacks, public daylight shootings with high-powered assault rifles, and even the occasional use of car bombs. The result has been the death of more than 34,000 people, including an increasing number of innocent bystanders who have nothing to do with the drug trade. Last year, with over 15,000 deaths associated with the battle, was the deadliest yet.
Figure 1 – Map of Mexican DTO Areas of Operation
Despite the seemingly unending violence and impenetrability of DTO defenses, their drug trafficking activities—and subsequently their drug-related profits—have been taking a hit from the combination of Mexican and US law enforcement actions. The escalating violence is partly a result of increased competition for more tightly guarded plazas and an increase in drug seizures on both sides of the border.
For these reasons, DTO’s have expanded their business to include kidnap-and-ransom operations, extortion, human smuggling, and oil theft. As will be discussed below, this has brought an increasing overlap between DTO activity and Mexico’s oil industry.
From politics to finance - oil’s continued hold on Mexico’s national psyche
The interconnection of oil and nationalism in Mexico is historic and constitutional. Indeed, the Mexican Constitution sets forth the basic facts that President Lázaro Cárdenas emphasized during the nationalization period of the 1930’s: “The nation is the only owner of the all the hydrocarbons reserves and production”; that “licensing and concessions are prohibited”; and that “Pemex is the nation’s operator and controls the first-hand sales and must not share revenues, production or reserves.” This fundamental political reality continues to affect development of the nation’s huge oil resource potential by restricting private—particularly foreign—investment.
It has been said that in Mexico, oil is not merely a chemical compound but rather a fundamental element of sovereignty—a part of the national DNA. The story is well known but worth repeating: Oil is an essential part of the national treasury. Though diminished in relative terms for Mexico’s economy, oil still generates over 15 percent of current export earnings. Moreover, Pemex, due to its onerous fiscal and tax regime, accounts for about 40 percent of the government’s budget.
Oil long ago emerged as a significant form of hard currency and provided what amounted to an economic lifeline for a series of Institutional Revolutionary Party, or PRI, governments. In some cases, oil earnings provided a last gasp to stave off financial crisis in the country, such as the 1994 peso crisis.
In late 1994, as Mexico neared default, the United States orchestrated an international bailout of roughly $50 billion. Mexican oil sales were used—quite successfully—as collateral for the roughly $20 billion in US loans to Mexico.
Leaders for years have depended upon and pointed to the windfall of the nation’s oil patch for its economic well-being and, during the good times, growth. Without broad tax and fiscal reform in the nation, Pemex will remain a financial linchpin, albeit an increasingly tenuous one.
From Cardenas to Cantarell’s golden age
The Cardenas legacy is celebrated in textbooks and with a national holiday on March 18 to celebrate the expropriation, but it was a fisherman’s discovery that really gave it legs. Aided by a prolific field in the shallow waters of the Bay of Campeche, Mexico entered what might be termed a Golden Age of Oil in the 1970s with the discovery of the supergiant Cantarell field.
Cantarell catapulted Mexico and Pemex into position as one of the world’s most important oil exporting nations, particularly in the Western Hemisphere. Nowhere was this more evident than in the oil commerce between Mexico and its northern neighbor, the United States. Thanks to Cantarell, Mexico became, after Canada, the United States’ most trusted supplier of foreign oil. The timing of the relationship’s maturation was perfect as our increasing dependency on oil took inescapable hold in the 1970s.
In hindsight, what seemed like a golden age for oil production and government coffers in Mexico instead foisted upon the nation a more ominous trend toward the first effects of Cantarell disease and easy oil affliction. The myopic policies of the time, coupled with the seemingly infinite spoils of Cantarell, placed Pemex and the nation on a bumpy path toward the unkind decade of 2000-2010 that saw Cantarell’s production crash.
True, Cantarell is not the only significant field in Mexico. But the steady production increase of Ku Maloob Zaap (KMZ) has barely offset Pemex’s overall plummeting production. Worse, in 2010 Pemex indicated that KMZ production reached its peak and has about a three year horizon for the current optimum production of roughly 850,000 barrels per day (bpd). And then there’s the Chicontopec field. A geologically challenging play, it has proved a major disappointment for Pemex, which long offered it as the key to offsetting both Cantarell and KMZ decline. Chicontopec has only recently hit 40,000 bpd, far below earlier estimates of hundreds of thousands of barrels per day of production.
The facts are unfortunate but fairly plain to see: Mexico’s oil production is in serious decline. In 2004, Pemex oil production peaked just below 3.5 million barrels per day (mbd); in 2009, it dipped to roughly 2.7 mbd. And though some success at stabilization has been made, production in 2010 still ended at just under 2.6 mbd. Figure 2 offers a stark picture of the issue at hand for Mexico, Pemex and the regional energy matrix. Simply put, the recent decade was not kind to Pemex.
Figure 2 – Mexican Crude Oil Supply 2001 - 2009
To further answer the question of what happens in Mexico beyond Cantarell, the current predicament and context must be acknowledged. Indeed, estimates have pointed to oil production average decline rates of about 5 percent per year, beginning in 2010. In the last few years, talk has emerged that Mexico will likely cease to be an oil exporter by the end of the current decade. The Energy Information Administration, however, indicates that may be an optimistic premise: In its International Energy Outlook 2010, it estimated that Mexico could become a net importer by 2015, with imports surpassing 1 mbd by 2035.
It is also worth noting that Mexico’s stated plan to deal with the foregoing scenarios and its hope to reverse these ominous trends lie in the deep waters on Mexico’s side of the Gulf. The touted “treasure at the bottom of the sea” bandied about during the 2008 energy reform debate remains the true “X factor” for any legitimate answers to what happens beyond Cantarell, and whether or not the EIA forecast for imports in 25 years holds true.
Pemex exposed and impacted
As discussed previously, oil theft from Pemex pipelines, money laundering by way of service stations, and, worst of all, provocative kidnappings of the company’s executives and those of service companies working with the state firm, are all on the rise.
Unofficial figures place thefts from the Pemex network at roughly $2 billion annually. And security experts point to this as an important source of revenue for drug cartels—especially as the Mexican government continues to crack down on them. Thefts from the Pemex network are not new, but the increase and the strain it is placing on the already-taxed company is important. And the illegal tapping has grown significantly in the areas where the drug war is the most pervasive.
The spike in fuel thefts and illegal trading, as well as kidnappings, has led some to question whether Pemex is fully in charge of all its facilities across the nation.
For some experts following the situation, the answer is a resounding no. Indeed, many analysts indicate that the physical security and monitoring of pipelines belonging to Pemex are severely lacking. According to Mexican daily El Universal, oil looting has occurred in almost every state in Mexico, while the Wall Street Journal, citing Pemex statistics, indicated that between January and November 2010, Pemex discovered 614 illegal siphons—368 in liquid fuels pipelines, 196 in oil pipelines, and 50 in liquefied petroleum gas ducts. Pemex has begun installing systems to detect declines in pressure in some oil product pipelines but the project is expected to take years to complete.
Kidnappings send shudders
Kidnappings of Pemex executives and subcontractors, including workers from international firms, have taken place across the country but most notably in Tabasco, Tamaulipas and Nuevo Leon, sending shudders throughout the company and Mexico.
The kidnappings have terrorized a community where, according to a Los Angeles Times story, jobs on the oil rigs and at the gas wells are handed down, father to son, for generations. “How is it,” asked a relative of a kidnapped worker, “that Pemex, supposedly the backbone of the nation, can be made to bow down like this?”
One analysis, published by Grupo Reforma highlighted the oil town of Reforma, Chiapas, where at least 30 Pemex employees—ranging from executives to laborers—have been kidnapped over the past year.
Mexico Weekly has also reported on other forms of violence that have flared in prime Pemex production zones, such as the Burgos Basin, site of Mexico's biggest natural gas field in Tamaulipas. Last spring, gunmen seized the Gigante Uno gas plant and kidnapped five Pemex workers. Increasingly unsafe conditions are severely hindering Pemex’s ability to produce natural gas in the Burgos Basin.
The Burgos Basin stretches across the northern border state of Tamaulipas, where the Gigante Uno plant is located, and spills into the states of Nuevo León and Coahuila. All three states are experiencing extremely high levels of drug-related violence, especially along these states’ border with Texas. The stretch from Nuevo Laredo to Matamoros is in the midst of a bloody conflict between the Gulf cartel and Los Zetas, former paramilitaries and enforcers for the Gulf cartel who are now one of the more vicious DTOs in their own right. Los Zetas are viewed as largely responsible for the kidnapping of Pemex employees in that region.
“Once Pemex … comes under regular attack from the cartels, rather than just random, disorganized thugs, then you have far more serious national security problems – much worse in the government's eyes than a bunch of homicides in the slums of Ciudad Juárez," said Malcolm Beith, author of The Last Narco, a book about the hunt for Joaquin “El Chapo” Guzmán Loera.
Regrettably, Burgos is becoming synonymous with the perilous intersection of Mexico’s raging drug war with Pemex’s efforts to produce the critical energy supplies the nation and region demand.
The Murphy Energy case
One case of fuel theft from Pemex that’s winding its way through the justice system provides a unique insight into that part of the problem the company is confronting.
According to MarketWatch, federal documents released in August 2010 revealed a Texas chemical plant, owned by German chemical company BASF Corp., bought $2 million worth of petroleum products that had been stolen from Pemex and smuggled across the US border. The documents also showed the stolen condensate passed through several companies' hands before arriving on a barge at the BASF facility in Port Arthur, Texas.
The actual transport of stolen oil from Mexican pipelines into US corporate hands is complicated at best. Donald Schroeder, former president of Trammo Corp., testified that in January 2009, two companies, Murphy Energy Corp. and Continental Fuels, contacted him. Both wanted to sell him stolen condensate. Apparently he agreed to buy it, and the transfers began. “Unnamed import companies” would sell the condensate to intermediary companies like Continental (which has since shuttered its headquarters in Houston). Those import companies would smuggle the condensate across the border and store it in Continental facilities. No details were available on how those trucks managed to successfully cross the US Mexico border. These piecemeal transfers would continue until there was enough oil in the storage facility to fill a barge and ship to BASF.
Jim McAlister, an Assistant US Attorney, said he has no reason to believe that BASF has any involvement in the alleged wrongdoing. The President and founder of Murphy Energy Corp., Matt Murphy, said the company did not know that the condensate was stolen. Josh Crescenzi, the vice president of Continental Fuels, has not been indicted in the case, nor has anyone else from Continental.
This particular case has been a success, resulting in the handover of $2.4 million by US customs authorities to the Mexican government. But the extent of corruption in Mexico—within Pemex, in particular—and the ease with which oil can be stolen from pipelines makes the mitigation of oil looting an almost insurmountable challenge. Adding to the problem is the fact that Mexican cartels are involved. According to Reuters, the Mexican government believes the cartels use stolen jet fuel in their aircraft to cover up any evidence of illicit flights. In August 2009, Mexico’s federal police commissioner Rodrigo Esparza said Los Zetas used false import documents to smuggle at least $46 million worth of oil in tankers to unnamed US refineries. President Felipe Calderón has said that DTOs in northern Mexico are responsible for most oil theft.
On some levels Pemex is not just a victim of oil-thieving DTOs; sometimes, it’s directly involved. In February 2010, Mexican military units seized more than four tons of marijuana at Pemex installations in Reynosa, Tamaulipas. The discovery was made after Pemex security alerted officials that armed men were removing Pemex employees from a fuel supply station. In response, a Mexican Naval helicopter was dispatched to the scene but retreated after receiving heavy weapons fire from the ground. When military units arrived on the ground, they found the marijuana loaded on trucks abandoned at the site.
These alarming facts have led to perhaps the most ominous question of all: Is the company being infiltrated by the perpetrators of the nation’s drug business? In light of the increasing number of incidents President Calderón has acknowledged, there may well be internal operatives at Pemex aiding and abetting the DTOs.
For its part, Pemex is soliciting the help of the Mexican people to try to put a stop to oil looting. Last August, the Mexican government posted a Pemex press release, in which exhorts that oil looting is not just an unpatriotic crime against the company and the government, but against the Mexican people. It also offers the number of a hotline where individuals can anonymously report pipeline breaches.
Why the perilous intersection matters
The relevance of what is happening in Mexico matters on a variety of levels, but in particular, there are three broad reasons that bear discussion.
First, and as best portrayed in Figure 2, Pemex has seen its oil production drop precipitously since 2004. The firm has been struggling for the better part of the last decade to deal with a burdensome tax straitjacket, poor planning at its largest field, a lack of new discoveries of oil and production, and an inability to implement serious reform. Moreover, by the nature of being dragged into—and becoming part of—Mexico’s massive drug war, Pemex is clearly suffering from the additional strain and havoc wrought by the myriad elements of the conflict on its business. From huge financial losses to the increasing inability to control its network and prevent theft to the more serious kidnapping threats, the evidence is only becoming clearer.
The second reason concerns Mexico’s fiscal dependency on oil and Pemex. As assorted struggles impact the company's and the nation’s fiscal well-being, broader and longer term economic growth and employment discussions become ever more complicated for policy makers. These issues are particularly critical as the nation appears far from passage of the necessary and far-reaching national tax and fiscal reforms that could ameliorate some of the burden on Pemex and the nation’s oil dependency.
Third, all of the above leads to the real potential for further erosion of Mexico’s critical role as a secure and constant energy supplier for the United States and the Western Hemisphere. As oil prices steadily rise in early 2011, it is quite rational to revisit the significant energy security aspects of Mexico’s persistent energy woes, which are now clearly exacerbated by the overflow of drug war violence and corruption.
On the heels of yet another State of the Union address in the United States that included elegant rhetoric about the country’s energy imbalance and energy security risks, a comprehensive, all of the above approach and solution remains far from reach.
Clearly oil, and energy more broadly, is not a sector of the economy where Mexico needs any further impediments. Pemex’s huge hurdles derive largely from its inability to replace declining oil production and navigate a burdensome nationalistic legacy. What is now added to the combustible mix is an increasing drain on the company’s finances and, worse, a sense of trepidation among executives in the field. Threats against its executives and loss of its resources are surely not a useful element as the company makes efforts to reform itself.
All of the above analysis is of extreme relevance to Mexico for its financial and overall well-being—and especially for Pemex. It is also critical for North American energy security as the United States, in the wake of the Deepwater Horizon incident, deals with offshore drilling restrictions and slow downs in the formerly prolific Gulf of Mexico. Moreover, there are thorny issues surrounding increased production from Canada’s oil sands for the US market. This was made abundantly clear during an early February visit by Canadian Prime Minister Stephen Harper to the White House. More than 80 environmental groups used the occasion to send a letter of protest to President Obama. These concerns do not appear to have any immediate or simple resolutions and make the United States' need to count on Mexico greater than ever before.
That Mexico’s drug war has now directly intersected with the perilous energy situation that Pemex—and the nation—is facing makes the fight that much more important.
And that was before the uprisings in North Africa and the Middle East sent oil analysts, government officials and company executives scrambling to revise their 2011 outlooks and analyses.
Contributor Jeremy Martin is Director of the Energy Program at the Institute of the Americas & Sylvia Longmire is a Mexico Security Expert & President, Longmire Consulting.