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Ecuador’s oil industry struggling to find its way

Resource nationalism has returned to the fore in Latin America following the government takeover of YPF in Argentina

In Quito, the move recalled President Rafael Correa’s own efforts to remake Ecuador’s oil sector. A year and half after Correa forced contract renegotiations on foreign investors, though, the Opec member’s oil industry is struggling to find a clear direction.

The government’s take from the industry is up since Correa forced foreign investors sign on to new service contracts. Indeed, from the government’s point of view, the takeover was well timed, as it has coincided with a steep rise in oil prices. The government pays oil companies an average of around $35 per barrel produced under the new contract terms, meaning that the government, not companies, has been the biggest winner in the country from the rise in oil prices.

Since November 2010, when the new contracts were signed, the government’s earnings from oil exports have risen from around $735 million a month to just over $1.1 billion in March 2012, according to Central Bank data.

The improving bottom line, though, masks stagnant output and modest investment levels. Although the government’s earnings from the oil sector have jumped about 50% since the new contract regime was introduced, oil production has fallen.

In November 2010, the country’s output was around 510,000 barrels a day (b/d), but that has fallen to around 499,000 b/d, according to government data. Production was 520,000 b/d when Correa took office in 2007.

That is hardly the catastrophic fall that some of the government’s harshest critics might have predicted. But it does point to some major challenges facing Ecuador’s oil industry.

A lack of incentive

Under the new contract regime, private oil companies have little incentive to deploy expensive enhanced oil recovery techniques to boost output from Ecuador’s maturing oilfields. And the country’s state-run oil companies – PetroEcuador and Petroamazonas – lack the technical capacity to carry out the activities on their own.

Moreover, the service model contracts offer no incentive for private companies to take on the financial risk of exploring for new oil deposits. As a result, the burden for exploration has fallen on PetroEcuador and Petroamazonas. The companies have proven themselves capable of keeping oil pumping from the projects they have inherited from the nationalisations, but have not established a record of successful exploration.

In 2011, for instance, PetroEcuador drilled three explorations wells, the Cobra-1, Aguarico Oeste-1 and the Chonta Este-1 wells, but only added a modest 40.5m barrels to its probable reserves.

Petroamazonas, which will be taking over PetroEcuador’s upstream operations under a government plan to rationalise the two state-run companies’ operations, plans to increase exploration spending this year. The company has said that it will spend $38m carrying out new seismic surveys and $36m drilling exploration wells, bringing total exploration spending for 2012 up to $74m.

While the state-run companies will continue to play a very active role in the industry, the government appears to realise that the current mix of investors is not serving Ecuador’s oil sector as well as it should be.

Ecuador does not need to look far for an example of what its oil sector could look like. Next door, Colombia’s energy industry is booming. In spite of having just a third of Ecuador’s proved oil reserves – 1.9bn barrels compared to Ecuador’s 6.2bn barrels, according to the BP statistical review – Colombia’s oil production, at 1m b/d, is nearly twice Ecuadorean output.

Colombia’s success has been attributed to the combination of a strong state-run oil company and an open investment climate that has attracted a slew of new foreign investors.

President Correa is showing no signs of backtracking on recent reforms. But his government is actively seeking foreign investors. The government is hoping to attract a mix of major service companies comfortable with the country’s per-barrel fee contract regime and state-run companies from friendly governments.

In February, Ecuador signed a pair of contracts with international service companies that will see $1.7bn invested in squeezing more oil out of two of the countries mature oilfields.

The biggest of the contracts was signed with a consortium led by US services giant Schlumberger, which, along with compatriot KKR Energy and Argentina’s Tecpetrol, will work to boost output at PetroEcuador’s Shushufindi-Aguarico field.

Under the terms of the deal, the consortium will be paid a fee of US$30.62 per barrel on each new barrel it can pump on top of the field’s current production of 43,600 b/d. The companies plan to invest nearly $1.3bn drilling 72 development wells, including a horizontal well, and carrying out dozens of workovers and improvements to the field’s infrastructure. The plan is to raise output to 60,000 b/d. Work is set to get under way at the field in the middle of this year.

PetroEcuador also signed a service agreement with a Tecpetrol-led consortium for the smaller Libertafor-Atacapi oilfield in northern Ecuador. The venture, which also includes Schlumberger along with Canada’s Canacol Energy and Sertecpet, will invest nearly $400m drilling 31 new development wells at the field and reworking 28 producing wells. The consortium will be paid a per-barrel fee of $39.56 for each barrel over the current 16,000 b/d of production it can produce.

While the deals are likely to squeeze a bit more production from some of the country’s mature fields, new exploration is the country’s best hope for a major boost to production.

To this end, the country is pushing ahead with a new licensing round. The 11th licensing round will put 21 blocks in the southeast of the country up for grabs later this year, with contracts to be signed by March 2013.

The government has set aside four blocks for Ecuador’s state-run companies, seven blocks for state-run companies from what it has called “friendly” countries and the remaining 10 blocks for private companies. Although the round is open to private companies, interest is not expected to be very strong from these companies.

Peru’s state-run oil company PeruPetro is one of the friendly foreign state-owned company’s interested, Ecuador’s Minister of Non-Renewable Natural Resources Wilson Pastor has said. Other companies that are expected to show an interest include Venezuela’s PdV, Colombia’s Ecopetrol and China National Petroleum Corporation (CNPC).

Given the countries’ close political ties, PdV would seem to be a logical partner for PetroEcuador for future projects. But the countries’ Rio Napo joint venture at the Sacha field has been beset by challenges. At one point Pastor threatened to find another partner for the project after he accused PdV of not providing the rigs it said it would and saying the company did not have a plan to enhance recovery from the field.

Healing old wounds

The rift between the partners, though, appears to have healed. Late last year, the pair said they would invest $1.27bn at the field over the next 15 years to increase production from 50,000 b/d to a peak of 64,000 b/d in 2013.

Most of all, though, Correa appears keen to keep Chinese dollars flowing into Ecuador’s economy. China has provided a crucial financial lifeline to the country since it defaulted on $3.2bn of government bonds in 2008.

Most recently, Correa has turned to the Chinese to finance construction of the proposed 300,000 b/d Refineria del Pacifico refining and petrochemical project. The plant is a joint venture between PetroEcuador and PdV and is expected to cost $13bn to construct.

It is central to government plans to cut costly refined product imports. Although Ecuador is a significant oil exporter, a dearth of refining capacity and ongoing problems at the country's main Esmerelda refinery means that the country is reliant on products imports.

In March, the Industrial & Commercial Bank of China signed a letter of intent expressing its interest in the project. CNPC and Sinopec are also interested in joining the project, Jorge Glas, the minister coordinator of strategic sectors has said. Ecuador hopes to have the plant up and running by 2016.

A deal to finance the Refineria del Pacifico would likely see Ecuador commit additional future oil exports to China. Since 2008, Ecuador has signed a series of oil-for-loans deals with China totalling around $7.3bn, accounting for nearly all of the country’s foreign borrowing in recent years.

In spite of the deepening economic ties, China’s role in the oil sector has been relatively minimal. Andes Petroleum – a joint venture between Sinopec and CNPC – produces less than 40,000 b/d of oil, or well under 10% of the country’s overall output. That compares to the country’s biggest foreign producer, Spain’s Repsol-YPF, which is producing around 44,000 b/d.

China’s role in the sector though seems almost certain to grow as Correa becomes increasingly reliant on the country to fund his government.

Yasuní-ITT initiative get tentative backing

Figure 1: Ecuador
Figure 1: Ecuador's oil infrastructure

The Yasuní-ITT initiative, a novel plan aimed at keeping a major oilfield in Ecuador’s Yasuní National Park from being developed, is set to continue through at least 2013.

But concerns are mounting among the initiative’s backers that funding for the programme could fall short as European and North American economies continue to struggle and budgets in those countries continue to be strained.

In December last year, Ivonne Baki, the head of the Yasuní-ITT initiative, announced that it had raised nearly $117m in 2011. In response, Ecuadorian president Rafael Correa said that he would continue to support the programme. The initiative aims to raise $291m annually in 2012 and 2013.

Although the fundraising has been enough to keep the project going, it can hardly be said to represent a ringing international endorsement for the programme. Correa donated $40m himself from libel damages he collected in a controversial suit against opposition newspaper El Universo.

By far the largest contribution came from Italy. But its $51m dollar “donation” came in the form of debt forgiveness from former Italian prime minister Silvio Berlusconi.

The programme was first proposed by Correa at the United Nations in 2007, but took three years of difficult negotiations to start-up. Under the initiative, Correa has said that his government will refrain from developing the Ishpingo-Tambococha-Tiputini (ITT) oil field, which lies in an area of the Yasuní National Park that has been renowned for its bio-diversity.

In exchange, Correa has asked the international community to contribute half the value of the fields estimated 800m barrels of oil, or $3.6bn over a 13-year period. The funds from the agreement are to go towards preserving the Yasuní National Park, protecting indigenous people’s rights and developing renewable energy resources in Ecuador as part of a broader plan to ease the country’s oil reliance. Oil exports fund about half of Ecuador’s national budget.

There is currently one project producing oil in the Yasuní National Park. Repsol-YPF operates a producing project in Block 16 in the national park.

While Correa has been broadly supportive of the initiative and instrumental in its implementation, some continue to question his motivations. Correa has repeatedly said that his government will pull out of the project if funding does not materialise, calling into doubt his green credentials.

Ecuador would likely struggle to attract the foreign investment needed to develop the ITT field’s extra-heavy oil reserves considering the lack of interest in the country from foreign investors. So taking a steady revenue stream from the international community would seem a safer bet.

Moreover, the programme has proved very popular in Ecuador. Polls show that nearly 90% of the public supports the project. Baki has said that the initiatives next step will be to launch an aggressive marketing and promotional campaign across Europe, North America and Australasia.

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