Latin America politics: Resource nationalism revived

Apr 06, 2007 02:00 AM

Latin America has seen a resurgence of resource nationalism in the past two years as wide income inequalities -- amid soaring world commodity prices -- have prompted demands from disenchanted citizens in some countries for a larger share of the windfall from energy resources.
In Bolivia and Ecuador populist leaders responded to these demands and succeeded in winning their respective presidential elections in 2005-06. The Venezuelan president, Hugo Chavez, started his third term in January 2007 announcing a further expansion of state control over strategic economic sectors, including oil and gas. But the extent to which the three governments can raise rents on private-sector investments varies based on the size of their hydrocarbon reserves.

Supported by the popular mandates that brought them to power and the positive outlook for crude prices, these presidents are tightening investment conditions to raise the state's share of oil-and-gas revenue. However, while Mr Chavez’s government is deepening that process, helped by the attractiveness to investors of Venezuela's vast reserves, the governments in Bolivia and Ecuador have been forced to take a more pragmatic approach towards private companies.
Venezuela, with Latin America's largest proven hydrocarbon reserves, can be more demanding because it has more to offer -- 80.5 bn barrels in proven conventional oil and 149 tcf of natural gas. Of particular interest to investors are the non-conventional oil reserves around the Orinoco River Belt, which are estimated at 235 bn-270 bn barrels.

The attractiveness of these heavy crude reserves has increased owing to a lack of available conventional reserves around the world and high oil prices that make these ventures financially more attractive, despite their steeper extraction costs and lower sale prices (heavy crudes sell at a higher discount to lighter blends).
Bolivia and Ecuador, on the other hand, have less to offer. This has forced Bolivia’s government to be more accommodating to the demands of private companies when renegotiating contracts terms, and the same could happen in Ecuador if the new government there aims to retain the interest of some private investors.

Extreme approach in Venezuela
Government intervention in Venezuela is the most radical in Latin America. In spite of falling output -- by February 2007 it had fallen to 2.46 mm bpd from 2.7 mm bpd at the start of 2006, according to the International Energy Agency (IEA) -- the government tighten the screws on private investors. In 2001 Mr Chavez used special decree powers to pass a new Hydrocarbons Law that reversed the privatisations in the oil industry of the previous decade and started a gradual transfer of control of all oil ventures to the state-owned oil company, Petroleos de Venezuela (PdVSA).
He has also invited the state-owned companies of several politically friendly countries around the world to participate with PdVSA in the certification and quantification of the Orinoco reserves. Once that exerciseends, probably in 2008, Mr Chavez is set to offer these companies the option of signing joint ventures with PdVSA to further develop the Orinoco River Belt.

Most of these state-owned companies arguably lack the expertise and the funds for the development of heavy and extra heavy crude oil, which needs expensive technology adapted to the specific soil and depths where the unconventional reserves are located. Since the 1990s, six international private oil companies have invested more than $ 14 bn to design specific technologies to run the four projects that currently pump out 630,000 bpd of heavy Orinoco crude. Once extracted, the oil is upgraded into lighter synthetic crude for export.
The profits of these upgrading projects normally derive from the export of the synthetic crude. So far the Venezuelan government appears to have disregarded private-sector proposals to develop new projects in the Orinoco. Instead the government is trying to increase its control over the four existing ventures, which are Venezuela's most profitable oil-producing projects.

Mr Chavez used his current decree powers to set a June deadline to finalise negotiations with the six operators of the four Orinoco projects, aimed at increasing PdVSA's stake in the ventures to at least 60 % (up from the current average of 40 %). The final rules that will apply to these projects are considered an indication of the extent to which Mr Chavez will impose increased state control on the oil industry in coming years.
Furthermore, operating conditions for these companies have been tough as they have also been forced to shoulder the heaviest burden of Venezuela's 195,000 bpd cut in output, agreed under its OPEC commitments in December 2006. The OPEC quota cutbacks severely impaired the profitability of the Orinoco projects, and prompted downgrades by international credit-rating agencies, which question the capacity of the four ventures to meet their financial commitments on $ 4 bn in outstanding debt.

Venezuela's natural-gas industry, which is under private development (but at a very early stage), is also likely to be nationalised at some point. Earlier this year, Mr Chavez said he would seek to change the constitution to increase state control over this industry. However, his statements were later qualified by other government officials.
Venezuela's gas production deficit is such that it will need to start importing from neighbouring Colombia once the construction of a new Caribbean pipeline (with a capacity of 150 mm cfpd) is finished, probably later this year. The government hopes to address the problem of a domestic gas shortage by boosting its own output through a combination of PdVSA and private-sector investments.

As the rules stand currently, the possibility of 100 % private ownership, plus relatively low royalties of 20 % and tax rates of 34 %, have attracted private companies in the past six years to develop the largely untapped gas reserves.
Venezuela's reserve potential (149 tcf) and its proximity to the growing US market could act as a magnet for private investment, but investors are likely to be deterred both by worries that the government might tighten the legal framework and the slow pace of talks currently taking place between the operators and the government over the development of a potentially more lucrative liquefied natural-gas (LNG) industry.

Ecuador's policy remains undefined
The operating environment in Latin America's fifth-largest oil producer, Ecuador, has more limited appeal for oil companies searching for new investment opportunities at a time of high oil prices. The president, Rafael Correa, an ally of Mr Chavez, took office for a four-year term in January 2007. During his campaign he pledged to renegotiate contracts with private oil companies to raise the state's share of the crude extracted to 85 %.
The previous government had already begun raising the state's share. Under the hydrocarbons reform that was started before Mr Correa came to power 50 % of gross revenue generated by private oil companies is paid to the state when oil prices exceed $ 15 per barrel. Private operators were also told by the previous government to pay more than $ 1 bn in retroactive taxes dating back to 2001; Mr Correa has not lifted this demand.

Tougher investment terms will not be conducive to increasing Ecuador's total oil output, which has not seen a boost since 2003, when companies invested to fill up the capacity of a new, privately owned pipeline. Nor will Mr Correa's decision to exclude private operators from plans to expand the country's inadequate refining capacity enhance the investment climate.
Instead, and in much the same vein as Venezuela, Mr Correa has invited state companies from South American countries to form joint ventures with the Ecuador’s state oil company, PetroEcuador, to build a new refinery. It is envisaged that it will have refining capacity of 320,000 bpd and will be located in Manabi province. The project would require at least a $ 4 bn investment, and PetroEcuador would own up to 60 % of it.

The project is important for Ecuador, which has to import expensive crude derivatives to meet its domestic needs. The country's largest refinery, Esmeraldas, has the capacity to refine up to 110,000 bpd of oil, but poor maintenance and investment in recent years has reduced its capacity by nearly half to 50,000 bpd, forcing the country to import. A bidding round planned by PetroEcuador in September 2006 for a $ 130 mm expansion of Esmeraldas appears to have been abandoned for lack of interest.
The new refinery would process heavy crudes from the Ishpingo-Tambococha-Tiputini (ITT) oil project, Ecuador's most promising oil fields in the Amazon near the Peruvian border. The area holds estimated reserves of 950 mm barrels of heavy crude and would cost about $ 13 bn to develop. Oil companies have in the past expressed an interest in ITT, which could boost the country's output to 700,000 bpd from 540,000 bpd.

But Ecuador's chronic political instability and more stringent investment rules in recent years have cooled private sector interest. Several state-owned companies, including PdVSA, have expressed an interest in forming a consortium of government-owned companies to jointly develop ITT.
Even if Mr Correa suddenly adopted a policy of welcoming private oil investments, companies would be wary of his plans for Ecuador to rejoin OPEC. The country quit the oil cartel in 1992, arguing that the quota system was hurting its economy. Reintroducing a policy of production cuts will not materially reduce Ecuador's need to stop its falling output levels. It would also be detrimental to attracting badly needed private investment to revive the country's oil industry.

Bolivia backtracks
Bolivia is a case where radical resource nationalism has had to be tempered by pragmatism. In May 2006 President Evo Morales sent the army in to seize control of the oil-and-gas operations in the hands of private investors. Soon after, he started negotiations with Brazil over the low price it paid for the 920 mm cfpd of gas it buys from Bolivia -- around $ 4.3/mm Btu. Mr Morales demanded that Brazil raise the price to $ 7/mm Btu, but Brazil insisted on sticking to the quarterly price adjustments as laid out in its take-or-pay contract. The contract to import up to 1.06 bn cfpd of Bolivian gas through the Gasbol pipeline runs until 2019.
In less than a year, realising that both Brazilian and other foreign companies were serious about curtailing their investment in Bolivia, Mr Morales changed tack. The initial aggressive stance was set aside and, in its place, the government rapidly signed new joint ventures with operators and made a new deal with Brazil.

In both cases Mr Morales took a carrot-and-stick approach. The new contracts established a commercialisation straightjacket for producers, which will no longer be able to sell their output freely. Instead, they are required to hand it over to the state oil company, Yacimientos Petroliferos Fiscales Bolivianos (YPFB), which is accorded a monopoly for marketing the country's hydrocarbons. The government will keep 50 % of the revenue from gas sales. From the remaining 50 %, the producers' investment and operational costs will be reimbursed, and what is left will be evenly divided up between the state and companies as profit.
Although the new joint ventures lowered the returns and freedom of producers, the agreements are a far cry from the government's initial threats, which included the confiscation of their fields.

More interesting for producers, the government offered them an expanded export market to sell their product after it signed a deal with Argentina to raise current gas exports of 270 mm cfpd to 978 mm cfpd by 2010. Bolivia will not be able to reach this target without private investment. Its current output of 1.4 bn cfpd is totally taken up by the domestic market and exports to Brazil, its main market.
Price negotiations with Brazil followed a similar pattern with an initial intransigent stance by the government giving way to a negotiated solution. After gruelling talks Mr Morales convinced Brazil to pay international prices for the liquid portion of the gas imports it receives through the Gasbol flows -- ethane, butane, propane, natural gas liquids and natural gasoline. Bolivia does not have a separation plant, so it sells both methane and the more lucrative liquid components of the gas together instead of profiting from their individual commercialisation. Brazil also agreed to pay more, $ 4.20/mm Btu (up from $ 1.09/mm Btu) for a small gas import contract – 43 mm cfpd -- to feed a thermal plant in the state of Mato Grosso.

Though Mr Morales failed in his original attempt to raise the price on all of Bolivia's gas exported to its main customer, he managed to keep his constituency happy by securing a greater share of the proceeds of the country's natural resources. Moreover, oil operators showed their general willingness to negotiate a more equitable distribution of their windfall profits rather than give up their investments altogether, especially at a time of high international prices.
With negotiations with the oil operators and Brazil concluded, and with the certainty of Argentina's increased gas demands, some investment is projected to resume. Hydrocarbon investments for the next five years are estimated at around $ 3.5 bn, mainly in exploration and transport infrastructure to meet Argentina's increasing demand. Other investment projects include the construction of two gas liquid separation plants and a petrochemical complex.

Nevertheless, it will take some time to bring back the kind of large investments that entered Bolivia in the 1990s during the opening up of its hydrocarbons industry. Although Mr Morales has moderated his stance, it may be too late to revive previous investment plans, particularly an earlier plan to expand Gasbol's capacity to export 1.2 bn cfpd to Brazil, up from 1.06 bn cfpd.
The experience with Bolivia's resource nationalism appears to be encouraging Brazil to look for alternative gas suppliers in order to reduce its dependence on a single country.

Corporate responses
Meanwhile, energy companies have been responding in several ways to the rise of resource nationalism in the region. In the cases where hydrocarbon fields have been nationalised, many companies with operations in the region have been forced to cut the amount of reserves they account for in their books. This has had little effect on large oil corporations whose assets are well-diversified geographically and whose exposure to Latin America is only 3-4 % of total assets in most cases.
Nevertheless, rising nationalism will result in investment cutbacks by large oil corporations in the coming years. Many are likely to reorganise their regional assets and refrain from making new investments in Latin America.

Smaller players, in contrast, will risk more in order to take advantage of high oil prices, not least with a view to turning themselves into attractive buy-out opportunities down the line.
Smaller operators will continue to target specific investment opportunities, particularly in the more business-friendly environments of Colombia, Peru and Argentina.

Source: The Economist Intelligence Unit
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