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Mexican Oil, Mature Wells, and the Future of Gazprom

by | published February 28th, 2011

Last week’s installments of Oil & Energy Investor, prompted by the events in the Middle East, have certainly increased the flow to my inbox lately. Readers have had some truly excellent comments and questions.

As we await further developments from the region and the impacts they will have on the price of crude oil, now seems a good time to answer some of them.

Q: Kent, I believe Mexico is the eight-largest producer of oil, and its output equals Libya’s and Iraq’s combined. What is the quality of Mexico’s oil, and who does it supply? Thanks. ~ Kirk

A: Kirk, the Mexican national oil monopoly, Petroleos Mexicanos (Pemex), is currently producing about 2.6 million barrels a day (mbd), while Libya (before its slide into civil war) and Iraq combined come in at around 4.3 mbd. So not quite equal.

That’s because Mexican production has experienced more than a 25% decline since reaching its peak in 2004. And there remain serious questions about the ability of Pemex to increase volume due to the lack of finding new fields of any size and a heavy debt load.

Mexico has been a major supplier to the U.S. market. However, given the problems south of the border, there are widespread opinions that Mexico will become a net importer of oil by 2020, with any guarantee of export flows to the U.S. fading by as early as 2017.

While production levels have appeared to stabilize over the last several months, prospects for any additional volume are not good.

Most of Pemex’s production comes from the huge offshore Cantarell field in the Gulf of Mexico. When discovered in 1976, it was the third-largest field in the world. Today, it is in rapid decline. From 1.2 mbd in January 2008, the field is now producing barely 480,000 barrels per day. And Pemex has nothing new coming in to replace any of this loss.

And then there is the oil quality

Libya provides light, sweet crude (with low sulfur content). Over half of the export flow from Mexico – including virtually all that comes into to the U.S. – is heavier, sourer oil (with higher sulfur content). Called Maya benchmark crude, this is roughly equivalent to Saudi exports, but more expensive to refine.

Bottom line here: no increase in U.S. imports from Mexico; rather, a virtual certainty that imports will decline appreciably. Even if that situation were to reverse, Maya crude remains more expensive to process than the Libyan crude it would replace.

Q: If the Middle East does blow, will the $100 to $150 barrel per day producers get back in the picture? What is the upside for investors (if there is one) from this play? ~ Joe

A: Actually Joe, they have never been out of the picture.

In the U.S., “stripper wells” – those producing 10 barrels or less a day – provide more than 60% of total daily production.

The problem here has always been how much it costs to lift those barrels.

For one thing, these are very mature wells, having low pressure and requiring considerable artificial assistance to bring the crude to surface.

In addition, there is the problem of the water cut. It is not unusual for stripper wells to be producing between 12 and 20 barrels of water for each barrel of oil. That considerably increases the processing costs at the wellhead, resulting in lowered profitability and an increasing rate of well shut-ins.

Of course, this remains largely a matter of price. The higher the price of oil, the higher the expected barrel production from stripper wells. But this needs to be put in perspective.

In July of 2008, when crude prices hit $147.27 a barrel, there were still over 360,000 orphan wells in west Texas housing million of barrels of known reserves. Even at this historic high price, it was still too expensive to open the wells.At the time, I calculated that a price of $183 a barrel would have made all of them profitable.

But if we do reach such nosebleed altitudes, economic contraction will certainly have already kicked in.

Most of the very small producers are private companies, providing no genuine access for the investor. They remain either heavily leveraged or unable to increase production much from current levels.

The way to play what is happening is to emphasize the North American medium- and smaller-sized producers. Now, we are still talking about production well above 150 barrels a day (several thousand barrels is the target). However, these are not the Big Boys.

Look for three attributes:

  1. a track record of successful production in the U.S. or Canada with no exposure to the Middle East;
  2. well-positioned fields with upside reserve access; and
  3. sufficient trading liquidity (adequate market cap and daily trading volume) to allow you to get in and out when you choose to do so (rather than when the market requires that you move).

[Editor’s Note: Kent’s Energy Advantage has already factored moving on such companies into its recommended Portfolio. And subscribers are already profiting. Just click here to learn more.]

Q: I’m invested since 2009 with “GAZPROM CAPITAL” corporate bond-maturity 2016, coupon 6.5%. It’s been a good play until now (a big increase in nominal value). What do you think about Gazprom’s future, taking into account the new market view of natural gas from conventional and unconventional sources? ~ Mario

A: Mario, Gazprom bonds will continue to pay a decent dividend, but they may not be the better play here.

The company’s stock itself has been performing much better – up 9% for the month, 14% thus far this year, and 42% over the past six months. It is traded as an American Depositary Receipt (ADR) from the London Stock Exchange and is also available over-the-counter in New York at OTC:OGZPY.

Gazprom is the largest natural gas company on the face of the Earth and Russia’s dominant company. It also sits on the biggest conventional gas reserves in the world. It has the advantage of significant government support, since it is often used to advance Russian policy abroad.

However, there are some significant questions moving forward.

To begin with, since it is a vehicle for government policy abroad, the decisions are not always ones that advance bottom-line considerations. Case in point: the ongoing negotiations with China on exports (in which Gazprom may have to accept a lower price for geopolitical rather than profit reasons).

And then there is the fact that the company has a management reacting to the Kremlin’s view rather than the market’s, has an irritating habit of absorbing assets that are not core, and is facing huge capital expenditures in harsh climates to offset an accelerating decline of volume at maturing major fields.

It has little medium-term exposure to unconventional production competition in either Europe or Asia. Shale and coal bed methane production will be increasing in both regions, but the overall demand for gas will be increasing faster. By 2015, that may change, as more of the energy balance comes from unconventional sources.

Gazprom does not regard shale gas as a significant concern moving forward and continues to downplay its importance. However, it is moving quickly into its own coal bed methane production.

The more pronounced alternative source in the European market now is liquefied natural gas (LNG) coming from Qatar, from northern Africa (Algeria, Egypt, and Tunisia, where the current instability has not to this point had an ongoing impact on exports, but may in the future), and, to a lesser extent, from the Caribbean (Trinidad & Tobago).

These new sources are obliging Gazprom to revise long-term pipeline contracts with western Europe. That, combined with continued instability in demand projections, will result in ongoing pressure on the traditional pipeline contracts upon which Gazprom continues to rely.

Gazprom performance is not largely based upon the market. It is based upon a combination of political and social objectives. The company’s overall profitability depends upon its ability to raise prices domestically. That is a very contentious issue.

While the government has said it will liberalize Russian consumer prices over the next several years, the jury is still out on how committed the officials are to raising prices. Wide areas of Russia cannot afford the increase, and the country is shortly moving into another election cycle.

Strange as this may sound to those of us who grew up during the Cold War, Russia is a democracy. And opposition to gas price increases may well prove to be the primary factor restraining Gazprom’s profitability.

Sincerely,
Kent

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

  1. alan tatom
    February 28th, 2011 at 12:47 | #1

    i would like your opinion on gasfrac (gsfvf)

  2. Don Mowers
    February 28th, 2011 at 12:58 | #2

    If we were to be able to get past the environmental issues and tap the large and various sources of oil we have in this country, what would stop the companies from exporting it for higher prices? It seems that profit comes before the stability and security of our own oil reserves, for our own use.

  3. mort stenz
    February 28th, 2011 at 13:18 | #3

    Is there any downside to the petrofracking process Gasfrac uses? Do you think the oil companies using the older water type will switch and become gasfrac customers?

  4. Mario
    February 28th, 2011 at 13:39 | #4

    I understand there is a trend in the U.S. of using natural gas as a fuel for truckers hauling cargo . I read that at least one third of
    trucking companies are now relying on this type of fuel and many plan to shift to natural gas. Price of gas is significantly lower than diesel . What is your opinion of this trend and what impact may it
    have on oil demand in the near future .

  5. Kitridge Buritsch
    February 28th, 2011 at 14:04 | #5

    Kent,

    Back in January 2010, I saw an interview with you and and a fellow
    named McDonald. At the time you mentioned a company by the name of
    Escophere . I purchase some shares and wondered what
    your opinion is at this time.

    Kit

  6. C. J. CORNELIUS M.D.
    February 28th, 2011 at 14:08 | #6

    WHAT IS THE STATUS OF THE DRILLING AND PRODUCTION OF PETROLEUM IN POLAND?
    CJC

  7. Dave
    February 28th, 2011 at 15:28 | #7

    Q: I recently read that the regulatory climate in Penn. was becoming less favorable for the use of hydraulic fracturing. Is this true? If so, how does this affect development of the Marcellus Shale? Dave

  8. debby
    February 28th, 2011 at 18:50 | #8

    Dr. Moors,

    There is a new oil well producing 800 barrels a day near the Terra Haute airport in Indiana. What shale formation is that? In an article in the Indianapolis Star, they mentioned drilling a couple of other wells and getting seawater? Why would they be getting seawater? If they contined drilling down and possibly through a salt layer,is it possible they would find oil?

  9. debby
    February 28th, 2011 at 18:55 | #9

    Dr. Moors,

    With shale formations has anyone tried using sound waves to “frac” the rock? I know little about the geology of shale except that is is not particulary hard. Walking around in various state parks I see shale and can crush it with my hand. Sound waves should able to fracture that shale.

  10. Roger Nelson
    February 28th, 2011 at 18:55 | #10

    @Mario
    I am surprised that truckers haven’t converted way before this. I drove cars on Propane for a number of years but had to stop when I moved to big city and could not find suppliers. In addition to lower cost (and somewhat lower energy) Propane burns clean, meaning you rarely change oil and the engine is carbon free, lasting many miles.

  11. Gord Smith
    March 1st, 2011 at 08:41 | #11

    How do I go about finding and investing in OTC or ADR that are recommended, I am in Canada and cannot seem to be able to find these through my on-line broker.

  12. clair orvin
    March 1st, 2011 at 09:52 | #12

    Dr. Moors, before I joined you, you talked a good bit about the super shifts.Because of the latest uncertainties in the mid east, are you holding back on them? If not, and you think they are still good investments, why haven’t you promoted them?

  13. tom hague
    March 1st, 2011 at 10:03 | #13

    how will it benefit me as i am uk based, i really need to buy stock here on the uk market

  14. tom hague
    March 1st, 2011 at 10:05 | #14

    happt to subscribe but as uk based find it difficult to buy in usa

  15. Chris
    March 1st, 2011 at 12:00 | #15

    KENT,
    You may have heard that BP is selling their Texas City refinery a
    475,000 bpd which is located on the Gulf of Mexico. Valero, PBF
    energy and PETROPLUS are the known companies interested.
    Which company would benefit the most from this site because
    they sell mostly to the Brazilians.
    Thanks,
    Chris

  16. Bill Gasperso
    March 1st, 2011 at 12:04 | #16

    Dr Moors, thanks for the good information on our energy sources. I look forward to being very profitable with your recommendations. Can you tell me the best was to invest in Lithium? All the best and I look forward to your answer
    Bill Gasperson

  17. Herminio Gamponia
    March 1st, 2011 at 19:41 | #17

    I am still a member of the 50 Oil Inergy Circle.

  18. Williambaxter
    May 2nd, 2011 at 18:58 | #18

    Dr. Moors. Question? What’s Hugo Chavez doing with Venezuela’s oil? Is he producing enough to market abroad?Is it High Sulpher like Mexico? We haven’t heard much from Hugo lately….? Que pasa en Venezuela?

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