Foreign Relations of the United States, 1969–1976, Volume XXXVII, Energy Crisis, 1974–1980

170. Paper Prepared by the National Security Council Staff¹

Washington, November 22, 1978.

PRM 41—Energy

U.S. Interests and Key Issues

The discovery of sizeable oil and gas deposits in Mexico is a major development which can make a significant contribution to world oil supply and exert a restraining force on oil prices. Within a decade, Mexico will be at the forefront of the world’s oil nations, producing at a level double the projected production of Nigeria, Kuwait and Libya and probably on a par with Iran. Mexico’s announced “potential reserves”—160 billion barrels of oil plus gas equivalent to an additional 60 billion barrels—far exceed those of other nations except Saudi Arabia.

These new discoveries substantially alter opportunities for Mexican development and offer the United States an important new source of oil with reduced vulnerability to political and military developments beyond the hemisphere.

Mexican oil will impact significantly on the United States. Our major interest is to see Mexican oil production increase rapidly—at a rate consistent with Mexico’s own hydrocarbon development program, its economic and social objectives, and world oil market requirements. In view of the Mexican policy to promote rapid oil development and production, some question whether U.S. actions to accelerate Mexican production prior to 1982 (the end of Lopez Portillo’s term) will be needed. Others believe we can and should move vigorously to stimulate Mexican output.

Our interests in Mexican gas raise complex issues. The potential availability of 2 billion cu. feet per day of Mexican gas (rising to a level of 5 bcf by 1985 or just under 4 percent of total U.S. gas consumption) would be highly attractive under certain conditions. Whether such imports would exert a positive economic impact on the U.S. would depend largely on price and displacement factors.

From a strict supply standpoint, because National Energy Act incentives have spurred new domestic production, we do not now “need” Mexican gas, and are unlikely to need it until the mid 1980’s—assuming (a) we continue to pursue a strategy of stimulating increased domestic gas production by allowing higher prices and (b) we do not wish to import Mexican gas as an alternative to imported oil.

In negotiations last year the Mexicans held tenaciously to a price of $2.60 per thousand cu. feet, with an OPEC-tied escalator, or 20% above the comparable price for imported Canadian gas. President Lopez Portillo is strongly and publicly committed to that price and PEMEX Director Diaz Serrano has reiterated recently that Mexico now does not want to talk gas for two years. Nevertheless, whether the Mexicans will be prepared to adjust downward in view of the larger domestic U.S. availabilities has not been tested.

If Mexican gas were available below U.S. domestic gas prices, that could exert a positive impact on the cost of living in those areas serviced, although it would run counter to the production incentive provisions of the National Energy Act and might jeopardize the Alaskan gas pipeline deal. If Mexican gas were available at prices above those prevailing domestically, there would be no domestic displacement but it could spur increased Canadian prices on the 3 bcf exported to us, at a cost of $900 million.

While it might have some impact on domestic and Canadian production and prices, Mexican gas could represent a net addition to U.S. gas consumption, possibly replacing imported oil from the Middle East. One impact would be that $5–6 billion per year in U.S. payments for energy imports would go to Mexico’s economy rather than Middle Eastern oil countries. With 62 percent of Mexico’s imports coming traditionally to the U.S., a significant part of U.S. gas payments are likely to return in the form of Mexican payments for imports from the U.S.

The key issues in energy therefore are both long term and immediate, e.g., (1) what policies, if any, the U.S. can or should pursue to encourage the development of Mexico’s petroleum resources and increase U.S. and world access to Mexican production; (2) what our position should be on the proposed Mexican-U.S. gas deal.²

U.S. Demand for Oil and Gas

Petroleum: Between 1978 and 1990, U.S. consumption is projected to increase from 21.8 to 24.2 million barrels per day. During this period U.S. domestic production probably will decline slightly, from 10.2 to 9.8 million b/d and imports rise from 11 to 13.8 million b/d.³

Gas: Current U.S. consumption of natural gas is approximately 20 trillion cubic feet (tcf) annually. Domestic production accounts for about 19 tcf, or 95% of this amount. Imports of natural gas from Canada and high cost LNG from Algeria make up the balance. DOE anticipates 1985 domestic production still will be approximately 19 tcf feet and consumption 21 tcf.

U.S. Sources of Supply

Most oil imports come from the Middle East, which has grown rapidly as the prime source of supply for the U.S., from 21 percent in 1975 to 40 percent today. Future production by other established suppliers like Indonesia and Nigeria is expected to stagnate or decline during the 1980’s. Absent Mexico or other major new sources, U.S. dependence on Middle East suppliers will continue to grow. Exports of Mexican oil could modify this trend somewhat and provide the U.S. and its allies with a more diversified and balanced oil import pattern. The Middle East will continue to play the dominant role in the supply of oil to the U.S. and world markets. But Mexican production will help and could have a positive impact on world oil prices as well.

U.S. Security Interests

The strategic, political and security ramifications of even further dependence on the Middle East in the mid-80’s are obvious. Recent events in Iran underline U.S. vulnerability. The summary judgement of the Department of Defense on the national security implications of Mexican petroleum is:

“Mexico provides a relatively close source of supply to meet present and future U.S. energy needs during periods of war or international crisis. We believe that much of the oil produced in Mexico will naturally flow to the U.S. because of the U.S.’ geographic proximity to Mexico and its large market. However, the U.S. should offer positive encouragement to Mexico to develop its energy sources and to build infrastructure projects such as pipelines which will connect Mexico with the U.S. petroleum (liquids and gas) distribution system. Such cooperative arrangements enhance U.S. security by providing overland routes not subject to ocean interdiction.”

Mexico’s Oil and Gas Reserves

The full scope of Mexico’s petroleum reserves is not yet determined. On the basis of exploration to date, they would seem clearly to exceed those of any country outside the Middle East. Official estimates are:

—“Proved reserves” of 20 billion barrels (both oil and gas in oil equivalents);

—“Proved and probable reserves” of 57 billion barrels (40 oil and 17 gas in oil equivalents);

—“Potential reserves” of 220 billion barrels (160 oil and 60 gas in oil equivalents).

By comparison, using the conservative 40 billion barrels “proved and probable” oil reserves, Mexico has more oil than almost all major producers, including: the U.S. (39 billion), Iraq (36), Libya (25), Nigeria (19), Venezuela (14) and Canada (8) and is exceeded only by the USSR (41), Iran (60) and Saudi Arabia (150). If its “potential reserves” prove out, Mexico (160) will exceed Iran and could move into a class with Saudi Arabia (150).

These are staggering estimates. The finds are so recent, however, (most of Mexico’s resources are located in fields discovered since 1972 in the Reforma area of southern Mexico), experts still disagree strongly on their full extent. Because of this, some experts recommend using 100 billion barrels (more than Iran, less than Saudi Arabia) as the best rule of thumb for now. Whatever its ultimate reserves, Mexico is clearly destined to move into the front rank of major world producers within the next 5 to 10 years—a factor which will greatly benefit the U.S. and other consuming nations.

Mexican Oil Production

Mexico’s total crude oil production is slated to reach 1.6 million b/d by year’s end, with nearly 600,000 b/d exports, a tripling of its output since the initial Reforma discoveries in 1972. Reforma output, from 17 fields, will account for over half the total this year, or about 950,000 b/d.

Until Lopez Portillo came into power, PEMEX had a very conservative approach to oil matters and developed resources slowly. After the 1976 elections, Lopez Portillo opted for a strategy of massive and rapid development to provide funds for Mexico’s pressing social problems. He reorganized PEMEX, and appointed Jorge Diaz Serrano as Director General.

With the new orientation production and export guidelines have been revised steadily upward. PEMEX had previously indicated that it would produce 2.2 million b/d in 1982 and export roughly 1.1 million b/d. Plans now call for reaching these targets in 1980. PEMEX now expects to produce 2.7 to 3.0 million b/d by 1982, and exports of about 1.5 million b/d.

Rapid increases in output have been accomplished in the face of severe problems. Although fields are productive, initial development has been slow because the Reforma reservoirs are extremely deep, geologic conditions and terrain are difficult and infrastructure has been lacking. PEMEX now has about 150 producing wells in the area, up from about 100 a year ago.

There seem few technical constraints to higher output. PEMEX, established with the nationalization of foreign oil companies in Mexico in 1938, is an experienced oil company with impressive expertise in all aspects of the petroleum industry. It is credited with the huge Chiapas-Tabasco discoveries and development. Financially sound, PEMEX enjoys an excellent credit rating and there are no company financial obstacles to constrain rapid oil development.

Despite the very real Mexican sensitivity to foreign interference in oil matters, PEMEX uses U.S. contractors and consultants, asking only that PEMEX be clearly in control and the foreign presence be relatively unobtrusive.

Few political obstacles exist to rapid expansion of Mexican petroleum production through 1982 and Mexico is expected to continue its rapid development efforts. The President of Mexico remains the key to major petroleum decisions but the environment in which he operates is also important. Outside of PEMEX, some of the government and business elite question the wisdom of a rapid pace of oil production and believe the substantial new oil earnings will disrupt the economy, as happened in Venezuela, Nigeria and Iran. Some fear the oil bonanza, combined with other dynamics such as the rapid demographic changes and continued high levels of unemployment could disrupt the balance in Mexican politics and society. In the years ahead, Mexican policy makers must weigh these factors carefully as they set oil policy.

By 1985, production is likely to reach from 3.5 to 5 million b/d. The more conservative estimate assumes that Mexico tries to increase production at the same rate as in 1978–82 but faces increasingly real absorption problems. The higher estimate assumes the new Administration that takes office in 1982 at least continues, and perhaps steps up, the current fast pace development effort, that there are few serious technical constraints and that Mexico is able to absorb the revenues generated.

Gas Production

This year, Mexican production of natural gas will be 2.1 billion cfd, 1.1 billion cfd of Reforma gas (associated with oil) and 1.0 billion cfd of non-associated gas.

Mexico’s domestic demand for gas amounts to 1.6 billion cfd with another 0.5 billion cfd flared. Consumption has been stagnant for the past few years because of supply and distribution problems, but expansion of domestic pipeline capacity now underway will enable Mexico to increase future usage. Mexican gas production could grow to 8.3 bcf by 1985. With strong Mexican Government stimulation, domestic demand could grow to 2.5–3.0 billion cubic feet by 1985.

Status of Natural Gas Import Proposal

PEMEX signed a Memorandum of Intention in August 1977 with a consortium of six U.S. pipeline companies to sell 2 bcf daily of natural gas. The proposal called for a 6-year renewable contract with a border price equivalent to the price of #2 fuel oil in New York Harbor (then $2.60 per thousand cu. feet, now $2.87) and an escalator clause also tied to the price of #2 fuel oil. U.S. officials were concerned by its impact on energy legislation and the price of the larger quantities of natural gas imports from Canada, priced at $2.16 per mcf at the border and had strong reservations concerning the proposed price escalator because of its tight link to OPEC-determined oil prices. The U.S. and Mexico could not reach agreement and the Memorandum expired. Lopez Portillo, who had staked personal prestige on the gas deal as a sign of the advantages of close cooperation with the U.S., was bitterly disappointed at our failure to reach agreement. We had indicated, however, willingness to resume negotiations whenever Mexico requested after passage of U.S. energy legislation.

Without exports to the U.S. Mexico will be forced to adopt several measures to maximize domestic use and avoid flaring and could conceivably attempt to look elsewhere for exports. With the gas deal still in suspense, Lopez Portillo committed Mexico to expanded domestic usage. Construction of the gas pipeline from the Reforma area to Monterrey has begun and should be completed by the end of 1979. A possible second pipeline would increase through-put to over 4 billion cfd.

The building of the pipeline to high energy consumption areas gives Mexico two options: to use the gas domestically (including the shutting in of non-associated gas), or to add a spur to the U.S. border should an export agreement be reached. Increased domestic use would involve substantial conversion costs, however, and force Mexico to use such energy for lower priority requirements. The use of cheap gas to subsidize the power costs of domestic industry—and make exports more competitive—provides an attractive option for Mexican planners.

Privately, Mexican officials have made clear that at some point they expect substantial quantities of gas surplus to Mexico’s needs to be available for export. It is difficult to tell whether Mexico would agree at present to the 2 billion cfd gas deal on terms acceptable to us. Given Lopez Portillo’s desire for foreign exchange to finance Mexico’s development before 1982, such a gas agreement still may be negotiable, if we judge it to be in our interests. But we have seen strong evidence that we may be too late—that Mexico may have decided to go ahead on its own without a U.S. linkage on gas.

Importance of Oil and Gas to Mexican Development

Mexico’s new oil and gas discoveries represent a dramatic opportunity to deal with the problems of underdevelopment. The government now seeks to develop its large-scale reserves as rapidly as possible consistent with sound oil management. Although well aware of the problems that rapid oil development could entail, the Lopez Portillo Administration is determined to achieve full benefit of its new petroleum resources to attack serious socio-economic problems.

We judge that Mexico could produce enough crude, 5 million b/d, to support oil exports of about 3.4 million b/d in 1985 and gas exports of nearly 5 billion cfd. Earnings from oil would approach $30 billion by 1985 (assuming oil prices increase 3 percent annually in real terms) and gas sales another $7 billion (assuming sales priced at $2.60 per thousand cubic feet plus an escalator tied to the U.S. rate of inflation) bringing total oil and gas revenues to $37 billion annually by 1985 (or about $20 billion in constant 1978 dollars). Taking a more conservative projection (oil exports limited to 2.5 million b/d, and gas to 3 bcf) oil and gas revenues in 1985 will be $25 billion. This compares with export earnings from all sources of $5 billion in 1978.

OPEC Membership

Mexico determines its own pricing and production policies. Like all exporters, Mexico follows OPEC price leadership on oil. It is unlikely that Mexico would join OPEC, however, because of its stubborn resistance to any outside influence on its oil policies. It already gets the benefits of high OPEC prices on oil, without paying the dues of membership, much as it benefits from GATT tariff reductions without joining GATT and gets GSP which OPEC members do not. Mexico is determined to maintain the independence of its petroleum industry and resists adamantly any outside influence, or the appearance of yielding to foreign pressure, on its oil and gas policy.

U.S. Influence on Mexican Energy Policies

The PRM–41 review has revealed disagreement among the agencies on whether the U.S. will be able to influence the pace of Mexico’s petroleum development. Deep-seated political sensitivities in Mexico seriously constrain our ability to influence the evolution of Mexican energy policies. These sensitivities are based on the long-standing fear of domination by the United States. Thus, the level of Mexican production will be determined basically by Mexico’s perception of its national interests. Mexican internal political factors, especially the need for revenue to finance labor-intensive development and other programs, could push the Mexicans to expand production. Nevertheless, prospects for direct U.S. influence do not appear to be great, unless we are prepared to play some heavy chips.

Although Diaz Serrano has stated categorically that Mexico does not wish to discuss the export of gas for two years, Mexico will have more gas than it can consume domestically at some point. Essentially, time is on our side since the price which Mexico seeks for its gas will converge with the U.S. market price after deregulation in 1985, and the current surplus of gas will come to an end.

We are, however, the only feasible external market for Mexican gas (unless the Japanese are prepared to invest heavily in liquification facilities) and the natural market for Mexican oil and this close symbiosis plus the need for upfront gas and oil revenues to finance Mexico’s development in the 1980–82 period suggest a degree of common interest.⁴

1. Source: Carter Library, National Security Affairs, Staff Material, North/South File, Box 32, Pastor Country Files, Mexico: PRM 41 (Policy), 10/77–11/78. Secret. This paper is part of a larger study on the central issues affecting U.S.-Mexican relations, produced in response to PRM 41 (see footnote 3, Document 167).
2. The PRC discussed this paper on December 6. At the meeting, Schlesinger recommended that the United States try to reach a natural gas agreement with Mexico and that an approach on the issue be proposed for the President to discuss with Mexican President José López Portillo. Everyone “recognized the importance of resolving this issue to secure energy and ensure good relations with Mexico.” (Carter Library, National Security Affairs, Staff Material, North/South File, Box 32, Pastor Country Files, Mexico: PRM 41 (Policy), 10/77–11/78)
3. Source: Energy Information Administration, “Annual Report to the Congress,” 1977. The data comes from the “Base Case,” (or Case C). [Footnote in the original.]
4. On December 12, Brzezinski sent a memorandum to members of the Cabinet informing them that the President approved the conclusions of the December 6 PRC meeting, including reaching an agreement on natural gas with Mexico. Brzezinski asked, among other things, that the Departments of State and Energy coordinate with each other to “prepare a short paper which suggests a strategy for concluding an agreement with Mexico on the importation of natural gas.” He added: “This should also include talking points which the President could use with President Lopez Portillo and recommendations for how to relate the President’s trip to the conclusion of such an agreement.” (Carter Library, National Security Affairs, Staff Material, North/South File, Box 32, Pastor Country Files, Mexico: PRM 41 (Policy), 10/77–11/78) The President made a State visit to Mexico February 14–16, 1979. See Document 190.