Oil giants could get big role in Mexico for first time in decades

By BRENDAN M. CASE / The Dallas Morning News

REYNOSA, Mexico – Just across the Texas border, Mexico is sitting on a gold mine of natural gas. But instead of extracting it, the state-owned oil monopoly is
importing gas at record rates from the United States.

Petróleos Mexicanos, or Pemex, has long channeled most investment to oil, scarcely supporting natural gas. Now, however, Mexico's gas demand is booming and
pricey imports from Texas are skyrocketing, putting more pressure on high U.S. gas prices.

Soon, the burgeoning gas needs south of the border could spell opportunity of another kind for U.S. companies. Pemex aims to enlist international oil giants to
develop gas reserves in the Burgos Basin, a prime area in northern Mexico.

A handful of U.S. and Canadian roughnecks there say the area is just what the gas-starved country needs.

"I've done some drilling in my day, but nothing comes close to this," said Fred Lacey, a rig manager with PD Mexicana, a joint venture between Canada's Precision
Drilling Corp. and Houston-based BJ Services Co.

Mr. Lacy's observations presage a larger battle over Pemex's soul. While Mexico continues to set strict limits on private sector investment on hydrocarbons, rising
gas imports have undermined Pemex's claims to fuel the Mexican economy. As a result, top officials are challenging long-standing taboos.

On one side of the fight, Pemex officials aim to expand private investment in gas from a trickle to a gusher, possibly giving the oil majors a big role in Mexico for the
first time in decades.

Starting this fall, officials plan to sell up to $8 billion in newly designed contracts to extract gas from the Burgos Basin, including the area around Reynosa. In contrast,
PD Mexicana's original contract with Pemex was worth just $270 million.

"The defense of sovereignty can't mean weakening the country economically, increasing our dependence on foreign countries and losing opportunities to increase the
well-being of Mexicans," said Raúl Muñoz Leos, Pemex's director general.

On the other side are powerful politicians who say the new contracts – known as "multiple service contracts" – breach the Mexican Constitution and betray Pemex's
origins. The state-owned monopoly was born just after Mexico expropriated the holdings of foreign oil companies in 1938.

"You're violating the Constitution," Manuel Bartlett, a senator with the Institutional Revolutionary Party, or PRI, told Mr. Muñoz
Leos in public hearings last month. "We've studied the multiple service contracts, and they're illegal and fraudulent."

No relief in sight

While the political debate rages, the nation's natural gas plight is growing more severe. Gas demand is skyrocketing, due to a new generation of gas-fired power
plants, greater use in industry and the growing consumption of residential consumers.

Production isn't keeping up. Gas output this year has averaged 4.45 billion cubic feet per day, slightly more than its level last year but 1 percent less than in 2001 and
7 percent less than in 1999.

Demand has surpassed 5 billion cubic feet per day, fueling record levels of imports from the United States just as U.S. prices have reached historic highs. Gas
imports are generating a price tag that could surpass $1.5 billion this year.

There's no relief in sight. Consumption is expected to rise by nearly 10 percent annually in coming years. And desperate electricity officials are launching plans to
import liquefied natural gas, or LNG, from as far away as Africa, Asia and South America.

"There's increasing concern that you're really starting to run a risk of some major, major shortfalls in Mexico," said John Padilla, an analyst at IPD Latin America, an
energy consulting firm in New York. "The fact that Mexico is even talking about LNG is amazing. Five years ago, you would have been laughed out of the room."

Pemex officials are trying to mount a comeback in gas. They've reduced flaring, or burning off gas at oil platforms. That practice consumed fuel worth up to $2 billion
during the late 1990s, according to former officials.

Pemex is also plowing billions of dollars into gas exploration, making several promising discoveries. Officials aim to boost output to more than 7 billion cubic feet per
day by 2006, possibly making Mexico a gas exporter.

Texas geologist Eric Potter has helped Pemex interpret some of its seismic studies for such potentially rich areas as Macuspana, Laguna Madre and offshore sites
near the state of Veracruz.

"We can see a variety of opportunities in all these areas," said Mr. Potter, the associate director of the Bureau of Economic Geology, at the University of Texas at
Austin. "They're certainly in many ways underexplored."

Burgos Basin

One of Pemex's most critical tests is shaping up just south of the Texas border, in the barren, windswept fields of the Burgos Basin.

Texas' leading gas-producing counties in 2002 were Hidalgo, Zapata and Webb. Burgos lies just across the Rio Grande from all three.

PD Mexicana has drilled more than 370 wells there since 2001, finding plenty of gas.

"It's essentially an extension of what's on the South Texas side of the border," said Doug Gust, Precision Drilling's integrated services manager in Calgary. "It would
appear that Burgos has got a lot of potential that is untapped."

Pemex wants to tap more of it by changing the way it does business. Its new multiple service contracts would allow Pemex to double Burgos' production in just a
few years from the current level of 1 billion cubic feet per day, officials say. The contracts would also vastly expand the private sector's role in natural gas.

Multiple service contractors would play a far larger role in exploration and development than current service contractors like BJ Services and Precision Drilling. They
would not only bring technology and expertise. They would also raise their own financing, hiking Mexico's gas production without consuming Pemex's budget.

It remains unclear whether the effort will succeed, however.

Pemex officials are walking a narrow line between domestic political opposition and oil companies' business needs.

Politicians like Mr. Bartlett, the senator, have promised to challenge the multiple service contracts in court, saying they would violate the Mexican Constitution's strict
limits on private investment in energy.

But contractors would not receive a share of the gas they produce, nor would they get any control over Mexico's gas reserves. Oil majors typically seek deals that
allow them to boost their hydrocarbon reserves, a key component of future performance.

The contracts have attracted interest from the likes of Exxon Mobil Corp., ChevronTexaco Corp., Spain's Repsol YPF, Brazil's Petróleo Brasileiro SA and others.
But political opposition and haggling over the contracts' exact terms have led to numerous delays.

Some express doubts

A few analysts also harbor lingering doubts about Burgos' true potential. Pemex already produces about 1 billion cubic feet of natural gas in Burgos.

"There's not much evidence that Burgos has the potential they say it does," said Alejandro González, a natural gas expert with consulting firm Cambridge Energy
Research Associates. "Pemex says it could produce 2 billion cubic feet per day by 2006. We would expect a figure of about 1.3 billion cubic feet per day."

But the Burgos contracts might do more than push for more private investment. They could end up shaking the monopoly's very foundations.

State control of oil and gas has been an article of faith in Mexican politics and society since 1938. In practice, however, it's also led to falling investment in both oil
and gas over the last 20 years. That's left Mexico with falling oil reserves and rising natural gas imports.

Luis Ramírez Corzo, Pemex's director of exploration and production, has said that if the Burgos contracts prove successful, he would consider offering similar
contracts for oil projects as well.

If the Burgos contracts prove unsuccessful, greater changes could be in store. Business leaders have howled over the continuing restrictions on gas production even
as imports boom. A few leaders are even starting to muse publicly about doing the unthinkable.

One of Mr. Fox's top advisers recently said natural gas activity should be open to all comers, making it more like the gas industries in the United States and Canada.

"The real solution, for me and others," Economy Minister Fernando Canales told reporters this summer, "is a Constitutional and legal reform, so that companies
could participate in everything from exploration to retail sales."