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Ecuador has the potential to double production, but neither the market nor Ecuador’s political establishment support that outcome in the near term, experts say. (Photo: Petroamazonas)
Wednesday, January 27, 2016

Ecuador Energy: Wrong Track

Ecuador’s energy policy is on the wrong track, experts warn.

Inter-American Dialogue

Analysts have said Ecuador could be producing twice as much oil as the roughly 550,000 barrels per day it currently produces, but add that it will be difficult to find investors needed to drive increased output, given the global drop in oil prices. Does Ecuador have the right strategies and policies in place to successfully develop its hydrocarbon resources in the current global context? Should the government focus on boosting other areas of the economy instead, as the price slump continues, or will growing oil output take on more priority as fiscal demands increase? How will OPEC’s decision on Dec. 4 to maintain current production levels affect Latin American oil producers?

Abelardo Pachano, president of Finanview in Ecuador, former CEO of Produbanco and former Ecuadorean central bank president: Under the current conditions, it is quite difficult to find a way to increase Ecuadorean oil production. Since 2006, there haven’t been any new developments in this area. In addition, if there are no changes in the energy production market, the government will not have the resources to accomplish the goal of increasing oil production. As of now, there are no clear economic policies for pursuing new private investments in this field. Hopefully, Ecuador is able to maintain the current level of production if the ITT oil field activates its production in early 2017. However, because of the natural decline of oil fields, especially those under private production, net results will offer no more than 470,000 barrels per day by 2020. Exploiting the mineral sector (gold and copper) in the Amazon forest area could be the only solution, with the potential of replacing current oil resources lost by price reduction. However, this option would take no less than four to five years. In order to re-establish economic equilibrium, the only option is to reduce fiscal expenditure. The government is too large for the Ecuadorean economy to maintain. Finally, the Dec. 4 OPEC decision confirms the group’s strategy to defend market shares no matter what happens with the price. In that sense, petroleum-producing countries in Latin America will continue to face great losses in their economies. For Ecuador, this means no less than 7 percent of GDP.

Jose L. Valera, partner at Mayer Brown LLP: OPEC’s decision on Dec. 4 to maintain current production levels is a hard blow to Ecuador as lower export revenues directly affect government budget revenues. Crude oil and related products account for over 50 percent of Ecuador’s exports and one-third of government revenues. Remaining exports are mainly bananas, shrimp, gold and other primarily agricultural products. Given its excessive dependence on the export of commodities and the current down-cycle, Ecuador should both change its present policies for the development of its hydrocarbon resources and boost other areas of the economy away from commodities and toward services and value-added products. Ecuador’s current policy to develop its hydrocarbon resources is to use state-owned companies and, to a lesser extent, private sector companies. The latter are currently allowed to operate through service contracts only, pursuant to which the contractor bears all exploration and production risks and costs and is remunerated with a fixed fee on the basis of units of production delivered to the state. Costs are reimbursed out of production. The contractor pays income taxes on its fee income. These arrangements do not offer upsides for the companies. Because the fee is fixed, in the good times they do not benefit from increases in the value of production. Naturally, these arrangements only attract true service companies and not the companies that have the incentive to risk capital in exploration. Exploration, therefore, falls on the state-owned companies, and therein lies the problem: Because of the government’s voracious appetite for the money that these companies generate from production and exports, they are not left with sufficient capital and means to acquire operating capacity and technology to properly develop the country’s resources and replenish reserves through exploration programs. The law allows for greater incentives to the private sector, but the government’s policy remains unchanged.

Mario Alejandro Flor, partner at Bustamante & Bustamante: Although the state-owned petroleum enterprise’s installed capacity is good for processing at least 450,000 barrels a day, plummeting oil prices have made it necessary to make decisions this year. The Ecuadorean government has responded by reducing production by 2.6 percent, which is equal to almost 10,000 barrels a day; and by cutting the public petroleum budget by 24.3 percent, equal to a $1.137 billion adjustment, the biggest cut being in investment. The drop in the price per barrel could also mean that the state would seek a renegotiation of the service contracts in effect with private companies. In most cases, the sale price of crude oil is below the agreed tariff. The decision that OPEC made on Dec. 4 merely confirms the prediction that international oil production will not decline until the big players (the United States, OPEC and Europe) reach a common agreement. The Ecuadorean government is currently undergoing a financial restructuring for managing the resources obtained because of low oil prices. The idea is to also optimize the technology employed in the production of hydrocarbons. This is the case of the retrofitting of the Esmeraldas Refinery for it to be able to refine up to 110,000 barrels a day, as well as optimizing the generation of the electricity required by oil fields so operations can be sustainable. This will not be enough, though. Ecuador’s huge dependence on oil has once again taken its toll.

Francisco X. Swett, chairman of Pallas Management Corp. and former Ecuadorean minister of finance, member of Congress and central bank president: Ecuador’s oil prospects are about as dark as the color of crude. These days, prices are below the referential $35 per barrel minimum used to construct a budget. Although basing the budget on a low oil price signals a downward trend in fiscal expansion, the budget is still full of assumptions and gimmicks, including using bank and social security reserves to purchase government bonds. Tax receipts have followed the way of the economy and started to fall, adding to pressures. Production has fallen by 17,000 barrels due to lower investment outlays. Yasuní exploration is not feasible. The oil services contracts which replaced the old concession agreements have to be renegotiated to avoid additional negative cash flow. The arbitration award in favor of Oxy will add another $1.6 billion in obligations and has essentially settled the case in favor of Andes Petroleum, the Chinese concern that bought 40 percent of Oxy’s interest and unleashed the spat between the government and the company. Lower prices require delivery of more barrels of oil to cover oil-advances made to Petroecuador, and the central government budget has no oil income to support ongoing fiscal programs, adding to Correa’s current political woes. Ecuador has received in excess of $120 billion in oil income since 1974, but it does not have a lot to show for it. Except for few manifestations of friendly policies, the period has been marked by hostilities and legal insecurity for investors. The country indeed has the potential to double production, but neither the market nor Ecuador’s political establishment support that outcome in the near term.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

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