Ecuador using OPEC cuts to take over the energy sector

Ecuador has announced that it will seek to terminate the contracts of two oil production companies, France's Perenco and Italy's Agip.
This will increase Quito's hold over the energy industry and will further isolate Ecuador from international investment.

Analysis
The Ecuadorian government hopes to terminate oil production contracts with two European energy companies -- France's Perenco and Italy's Agip -- by mutual agreement, Ecuadorian Oil and Mining Minister Derlis Palacios announced Jan. 8. The move is another step toward Quito's gradual consolidation of control over the energy sector.
Under cuts mandated by the Organization of Petroleum Exporting Countries (OPEC), of which Ecuador is the smallest member, the government has already imposed severe production restrictions on these two companies. The goal for Ecuador is to bring production down by 40,000 bpd from its previous quota of 500,000 bpd.

Between the two of them, Agip and Perenco produce about 9.6 % of Ecuador's total output -- just about the exact amount that OPEC has ordered Ecuador to cut. Forcing foreign companies to bear the brunt of the OPEC reductions, and then cutting the contracts completely, not only brings Ecuador in line with production quotas without hurting the state-owned company, but also gives the country an opportunity to add to its production portfolio.
The exit of these two companies would give another chunk of the country's production capacity to Ecuadorian state-owned oil company Empresa Estatal Petroleos del Ecuador (PetroEcuador).

PetroEcuador has had a good year. Despite initial projections that the company would have to revise production estimates down to 172,000 bpd (down from a goal of 180,000 bpd) during 2008, PetroEcuador actually hit record production levels in December 2008. As of August 2008, PetroEcuador was producing about 53 % of the country's oil output.
The percentage is as high as it is partially as a result of the 2006 nationalization of the production facilities of Occidental Petroleum, which brought PetroEcuador's contribution from 37 to 46 % of total production in one fell swoop. (The remaining 47 % is produced by a number of foreign energy companies, including Spanish-owned Repsol-YPF and Chinese National Petroleum Corp.)

Despite the good news, however, as a state-run company, PetroEcuador has an interdependent relationship with the Ecuadorian government. Quito relies on PetroEcuador for income but is also experiencing a fiscal crisis, which has required Ecuador to default on its debt. The company is thus hampered in its ability to make the major investments necessary to run an entire industry.
Yet for Ecuadorian President Rafael Correa, consolidation of control over the country's resources is very much in line with his own populist policies, and follows in the footsteps of regional ally, Venezuela.

Within the past year, Correa has forced the renegotiation of the contracts held by all foreign energy companies in the country, barring them from participating in production-sharing agreements. The negotiations forced at least one company -- US-owned City Orient -- to opt out of investing in Ecuador, and the state bought out the company's facilities.
It appears that with their production shut down completely, Agip and Perenco could follow suit and concentrate their efforts elsewhere in less hostile investment environments.

With an eye toward terminating the involvement of both Agip and Perenco, the government has made a move that will almost surely alienate major potential investors.
Having already defaulted on its international debts, Quito appears to be on a path toward ever-increasing isolation from the international economy. With little investment flowing into Ecuador, the country is at risk of a severe economic downturn, which, coupled with the financial squeeze caused by the default, could quickly devolve into an economic crisis.