Mexico is the third-largest supplier of oil to the U.S. after Canada and Saudi Arabia. But its largest field, Cantarell, offshore Mexico, shows signs of aging. Its eventual fate may be tied to the fact that this year, Mexicans will elect a new president. These factors could portend changes to the country's oil future. As Cantarell declines, will state company Pemex be able to add production elsewhere, especially in the deepwater Gulf? Will its budget be increased? Will it allow foreign participation after all? Where do the three leading presidential candidates stand on these issues? There is a major issue regarding access to reserves based on the long-standing ban on foreign ownership of Mexican oil and gas. "Elections are due this year, and oil and gas investment and development will be the single biggest specific policy issue. Given Mexico is a huge player in non-OPEC, and a Top 3 U.S. oil supplier, there are obvious implications for the global oil balance," say Paul Sankey and Mike Urban. The Deutsche Bank analysts recently reported on their tour of Cantarell, which is named after the Mexican fisherman who found oil-soaked nets and reported it to the government. The field began producing in 1979. "Mexico is a microcosm of the world's oil problems," the analysts say. "Its super-giant field, Cantarell, which produces 60% of its oil, is moving into decline, literally this year." Currently the field produces about 2 million barrels per day, but it is being injected with nitrogen at the rate of 1.2 billion cubic feet per day to sustain output. This super-giant field is one of only four globally that produce more than 1 million barrels a day of oil. (The others are Ghawar in Saudi Arabia, Burgan in Kuwait, and Da Qing onshore China.) Making matters worse as production starts to fall at Cantarell, internal Mexican oil demand is growing. With a larger middle class and more autos on the road, it is seeing 5% growth this year in gasoline and distillate demand, which pressures net oil exports, the analysts say. Pemex is increasing its debt; its ability to finance its activity is limited by Congress continuing to suck cash from the company, which provides around 10% of Mexican GDP but 30% of Mexican tax receipts. Problems ahead? Ultimately, Cantarell is expected to recover around 6 billion barrels of heavy Maya-grade oil. The field generates $70 million per day of free cash flow. "The gas cap is now around 25% of the reservoir in Akal (the main Cantarell structure, which we visited). As the gas-oil contact increases, more wells are being shut in, requiring more workovers as well as increased infill drilling," the Deutsche Bank report says. A press report said Cantarell was set to decline at 36% per year annualized from 2005-2009. A firm rebuttal from Pemex stated that the "freefall" decline scenario was expected only in the case of limited further investment in the field. "Pemex has published a new production outlook, which we subscribe to, showing a 6.3% decline in 2006 (to 1.9 million barrels a day), followed by a 12% annual decline to 1.4 million in 2008," the analysts report. Sankey warns of two potential downsides: First, water encroachment is forcing wells to be shut in, at an estimated cost of around 50,000 barrels a day in 2005. There are no water-handling facilities onsite, but they are being installed for start-up in 2006 to handle 60,000 barrels a day. Second, Pemex's current budget assumes $10.4 billion in upstream spending in 2006, down from $11.7 billion spent in 2005 (the company uses a roughly $48 WTI equivalent in planning). In the recent past, Pemex has been able to get additional funding when commodity prices were strong and demonstrable production enhancement opportunities came into focus. But as in the U.S., higher drilling costs may eat into any budget increase. This is especially pressing for Pemex as long-term, low-dayrate contracts signed during the last down cycle are rolling off on a large scale, the analysts say. "We expect increased activity in some areas. For example, even based on the current published budget, exploration spending is set to jump 75% in 2006 (albeit after a sharp 2005 decline) and continue growing for the next several years." Faced with the reality of decline at Cantarell, Pemex's efforts appear to be more technology- or service-intensive than previous programs, it notes. Potential increases Deutsche Bank says Mexican production should actually go up in 2006, driven by Ku-Maloob-Zaap, a vast development that should increase from 360,000 barrels a day in 2005 to 430,000 in 2006, and 750,000 in 2010. Second, Litoral de Tabasco should double to 240,000 a day by 2009. A major uncertainty is Chincotepec. This onshore field found in 1926 has massive potential-up to 140 billion barrels in place-but suffers from tight reservoirs. Increased use of secondary recovery techniques and new directional or horizontal wells and multilateral completions should help boost production, possibly up to as much as 300,000 barrels a day by 2010 from current levels of 30,000. Mexico's deep water has huge potential and will be the focus of most exploration. The Perdido Foldbelt, an area of major discoveries such as Shell's Great White and Unocal's Trident, runs across the border into Mexican waters. "We estimate around 50 billion barrels of oil equivalent of deepwater reserves are yet to be found, and capex in exploration is being ramped up aggressively." Exploration has so far yielded one well for one discovery, the Nab-1, drilled north of Cantarell in 681 meters of water for heavy oil (estimated at 200 million barrels). "...the Mexican deepwater is one of the great potential underexplored plays in global oil. Pemex stresses that it needs foreign expertise and technology to develop the deepwater." The analysts see the election this year as likely to clarify the potential for super-major Western oils to enter Mexico, possibly with better master service contract (MSC) terms forthcoming. "There is consensus from CFOs to taxi drivers that Pemex needs more independence and better corporate governance with less direct political interference, for example an independent board."