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A crude awakening for the Keystone pipeline

Robert Collier,, Dec 21 2013

If U.S. President Barack Obama wants a way to appease both sides of the controversy over the Keystone XL pipeline from Canada, he might want to look in the other direction — south to Mexico.

The pipeline, furiously opposed by environmentalists yet coveted by oil companies, could simply be substituted by a new gusher of oil supply — perhaps just as controversial, but for completely separate reasons — from Mexico.

Mexico's recent decision to open its oilfields to foreign companies promises to pull the country's petroleum production out of what had been a terminal decline, thus allowing it to slake the ever-growing thirst of the petro-industrial complex along the U.S. Gulf Coast.

Last week's decision by Mexico's Congress to extend major concessions to foreign companies became unstoppable Monday, when the plan gained approval from a majority of the country's 31 state legislatures. The opening is being touted by analysts as a historic step that could stop the collapse of Mexico's oil industry and turn it into a global energy superstar. In Mexico, however, it has sparked a bitter political fight that is likely to get worse in coming months. But for U.S. environmentalists and oil companies alike, it might offer a conveniently Solomonic solution, in which Obama could forsake the highly polluting Canadian crude for a Mexican alternative.

Mexico's role in North American energy markets is contradictory. It is a circular importer and exporter of petroleum products, exporting more than one million barrels per day of crude to the Gulf region and reimporting nearly half that amount in refined products. And to an extent much greater than generally understood, Mexico's declining production has forced the American energy industry to look to the Keystone XL as an alternate supplier.

Since the decline of Mexico's oil industry began in 2004, total crude output has fallen by one-third. Formerly gargantuan oilfields have dried up, and Pemex, the state-owned oil monopoly, has proved unable to deploy advanced technologies to develop new production. As a result, the country is widely predicted to become a net oil importer by the end of the decade. This trend is of critical importance to Mexico — if not arrested, it would deprive the government of more than one-third of its revenue and deal a body blow to the economy. But it is of equal importance to the U.S. petro-industrial complex.

U.S. oil imports from Mexico, most of which are heavy crude similar to the diluted bitumen, or dilbit, produced by Canada's oilsands, have fallen from 1.7 million barrels per day in 2004 to only 900,000 today. Mexico then reimports more than half that amount in a variety of refined fuels and petrochemicals. It's just one example of the Gulf Coast's role as the world's dominant supplier of refined petroleum products and petrochemicals, with Canada and Mexico as both suppliers and customers.

But the 800,000 barrels per day by which Mexican exports have declined is conveniently roughly the same as the 830,000 barrels per day that Keystone XL would carry southward from Canada.

For the Gulf Coast refineries, most of which are configured to process heavy crude, the loss of Mexican crude cannot be easily substituted by the light, sweet crudes now pouring out of North Dakota and Texas oilfields.

This lack of supply has been compounded by a somewhat smaller decline in heavy oil shipments from Venezuela, where the leftist government has gradually shifted its export focus from the United States to China. The result is what analysts have described as a "hunger for heavy," with Gulf refineries running at less than full capacity and straining to find replacement supplies on the world spot market.

All this formed the central logic behind the Keystone XL, at least from the U.S. perspective: So, it was adiós Mexico, hello Canada. The dilbit from the Keystone XL may be "game over" for the Earth's climate, as environmentalists like to say, but it would slake the thirst of the industrial beast.

Yet lo and behold — if Mexico's oil production could be revived by foreign companies, the thirst for Canadian heavy crude could be substituted by new supplies from south of the border. Goodbye Canada, hola Mexico.

The key to this turnaround is the bugaboo of American environmentalists — fracking.

Mexico has more than 10 billion barrels of proven oil reserves, Latin America's third largest after Venezuela and Brazil. Pemex engineers believe Mexico's portion of deepwater reserves in the Gulf of Mexico contains another 29 billion barrels. To extract that oil, Mexico needs advanced technologies that Pemex has been unable to master alone. But much of Mexico's potential also lies in Northeast Mexico's shale formations, including a cross-border portion of the Eagle Ford Shale, which as a result of the successful application of fracking has become Texas's most successful single oilfield ever.

For Mexico, the world's 10th largest oil producer, the opening to foreigners is a humiliating climbdown. The government nationalized the former U.S.-owned oilfields in 1938, and the slogan "the oil is ours" has been taught and dutifully repeated by generations of schoolchildren. Until now, Mexico's opposition to the oil opening has been based mainly on this deep-seated ideology. Leftist politicians now complain loudly that the national patrimony has been given away to foreigners by "traitors" and "sellouts." But the advent of fracking could add a litany of local conflicts to fuel the opposition.

Similar to U.S. shale plays, Mexico's shale formations will require thousands of densely spaced wells. But some of the most promising formations lie underneath areas of northern Veracruz, Hidalgo and Puebla states that are environmentally sensitive and are inhabited by the indigenous Otomí people. Other shale formations are in the desert of Coahuila, where water supplies needed for fracking are already too little for fast-growing towns and farms.

Until now, there has been very little fracking in Mexico's oil industry, and the practice has received almost zero public attention. But that is likely to change fast. U.S. environmentalists are attempting to spread their concerns about the dangers of groundwater pollution and depletion from fracking, and have given assistance to a new Mexico City-based coalition, Mexican Alliance Against Fracking.

"The fine print of the energy reform is fracking," columnist Ruben Martin wrote in the Mexico City newspaper El Economista on Dec. 3, summing up a fast-growing point of view among Mexico's left.

There's little doubt that fracking and other advanced technologies are the Mexican government's desired goals. Some key details of the energy reform — such as how much favoured treatment Pemex will still receive — will only be determined by implementing legislation early next year. But the plan approved by Congress specifies that foreign companies will get largely what they want. Production-sharing contracts will provide them a share of profits and allow them to "book" reserves on their corporate balance sheet — but only for the shale formations and deep-water Gulf reserves that require fracking or other advanced extraction technologies that Pemex currently lacks. In areas where Pemex now controls production, the current system will be maintained — flat fees for contracted work and no share of production or profits.

Mexico's energy opening may face opposition sooner than expected. On Dec. 9, leftist legislators submitted 1.7 million signatures requesting a national referendum to overturn the reform. If the signatures are accepted by election authorities, a political battle royale will be set for next year. At that point, "fracking" will become a much-used word in Mexico's political lexicon, almost certainly as an insult.

But across the continent, the economic pressures for additional petroleum supplies are overwhelming. Mexico's energy reforms and the Keystone XL are interchangeable parts of a regional energy infrastructure feeding the maw of an oil-dependent society.

While Mexico's opening does not guarantee the demise of the Keystone XL, it does underline their mix-and-match nature. Develop one project, block the other, or vice versa. Or, perhaps eventually, do both. The demand is the same. More oil!

Robert Collier covered foreign affairs and energy policy for the San Francisco Chronicle for nearly 20 years. (Foreign Policy magazine)


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