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Age of the independents for Latin America's energy sector

Brazilian firm OGX's collapse into bankruptcy highlights the risks smaller companies face in Latin America's energy sector. But, as Justin Jacobs finds out, independent players can thrive in the region

Latin America's oil business revolves around the region's huge state-owned companies - Petrobras in Brazil, PdV in Venezuela, Pemex in Mexico, YPF in Argentina and Ecopetrol in Colombia. They are the unquestionable rulers of their fiefdoms, a reflection of the statist energy policies that have reigned across much of the region for decades.

While those companies' domination largely persists, smaller domestic and international independents, such as Pacific Rubiales in Colombia, are playing an increasingly important role in driving growth at a time in which state-run companies have struggled to deliver on the region's huge resource potential.

Independents, most of which are valued in the hundreds of millions of dollars rather than billions, are finding their niche by going where their larger state-run and international oil company competitors are not. The region's largest resource plays, such as Venezuela's heavy-oil Orinoco belt and Brazil's deep-water pre-salt province, are the preserve of state-run players and, to a lesser extent, major international companies. These plays are hugely expensive to develop and involve politically important projects that suck up the lion's share of government and industry attention, cash and manpower.

Instead, smaller independents are focusing on mature and smaller basins throughout the region. They may not have the explosive growth potential sought by larger companies, but can be transformational for a small company and can cumulatively contribute significantly to national output.

On the face of it, the rise of these smaller companies could be seen as a threat - unwelcomed by many in governments and state-run companies across the region - to the state's domination of oil resources. But this is not necessarily the case, argued analysts at Edison, an investment research company, in a recent report Fallen Angel, Rising Stars. "This new trend involves smaller independent exploration and production companies, which have brought capital and global experience to Latin America's oil and gas basins resulting in what we expect will be mutual and sustainable advantages to all parties," the report says.

For independent explorers, Latin America offers huge untapped reserves, if they can gain access to them. And for the countries that welcome smaller players, those companies can reshape the dynamics of an industry for the better.

Smaller companies, the report notes, are often willing to invest in and develop smaller fields overlooked by, and often uneconomic, for larger national oil companies (NOCs) or international oil companies (IOCs). And developing those fields can free up NOC resources to focus on larger projects. Independents are also more willing to invest in frontier exploration areas - fairways where NOCs may be too timid to tread. Moreover, the more entrepreneurial independents are willing and capable of developing new technologies in the field than NOCs, which, as seen in the US shale sector, can open up  significant new resource plays.

Colombia is the poster child for the model. State-run Ecopetrol, with a market value of around $90 billion, is by far the largest operator in the country and accounts for around 60% of total national production. But since the government introduced more attractive fiscal terms in the mid-2000s, a slew of international independents have entered the country.

The result has seen Colombia's energy sector develop into Latin America's most diverse and best performing oil industry. Colombia doesn't have the huge oil deposits of others in the region, but output has nearly doubled over the last five years from 531,000 barrels a day (b/d) in 2007 to an average of slightly more than 1 million b/d through the first eight months of this year.

The smaller companies have been instrumental in developing new technologies needed to increase output from Colombia's heavy oilfields. By contrast, Venezuela has the largest proved oil reserves in the world but has seen stagnant production as state-run PdV has been overwhelmed by its operational and social commitments.

Ecopetrol has played its part in the revival of Colombia's oil industry. But companies such as Pacific Rubiales, the country's largest independent explorer, as well as Petrominerales (recently acquired by Pacific Rubiales), Gran Tierra Energy, Parex Resources and others - all minnows in comparison to Ecopetrol - have been the key players in this revival. Pacific Rubiales, in particular, has seen huge growth after developing and operating the Rubiales oilfield, Colombia's largest.

Many of those companies are now looking elsewhere in the region as they sets their sights on further expansion. And countries that had previously been wary of opening up their oil sector could be more welcoming as they look to replicate the successes elsewhere.

That could see a dynamic similar to that in Colombia take hold in other countries in the region, the Edison analysts said. "We expect production from smaller independent oil companies to realise similar results in Argentina, Peru, Trinidad and onshore Brazil over the next five years, creating a host of advantages to Latin America's NOCs, and a sustainable working model for smaller independent oil companies," the report says.

In Argentina, for instance, the main attraction is the country's emerging shale oil and gas plays, thought to be potentially the largest outside North America. But its mature fields also offer opportunities for companies that specialise in enhanced oil recovery.

Companies have shied away from Argentina because of the difficult operating environment and poor fiscal terms. The government, though, has shown a willingness to offer producers a better deal of late as it faces declining output and a mounting fuel import bill that is draining the treasury's limited dollar reserves. The moves have seen some new investment flow into the sector, but most companies say the government still hasn't yet gone far enough.

The Colombian example shows how quickly a turnaround can take place if the resources are there - as they almost certainly are in Argentina - and the right operating environment is in place. A number of smaller players, including Petrogas, Crown Point and Madalena, have conventional and unconventional projects in Argentina are betting on such a turnaround.

Colombia-focused independents have been the darlings of the investor community in recent years, but those investors could increasingly look to those companies working in Argentina if policy improves, argue analysts at Edison.

Brazil is another potentially lucrative province for Latin American-focused independents, particularly in onshore plays where state-run Petrobras is less active and the government is looking to pull in new investment.

"While strategically less important than its massive pre-salt basin reserves, Brazil's onshore blocks could be more rewarding financially for international independents, with conventional and unconventional oil and gas opportunities potentially attracting more independent oil and gas companies with access to capital and technology," Edison said.

IOCs and Petrobras snapped up Brazil's under-explored deep-water Equatorial Margin blocks in the 11th bid round earlier this year, while independents such as Petra Energia, Gran Tierra, Chile's Geopark and others focused on the shallow-water and onshore blocks offered in the round. Brazil will put a further 240 onshore blocks comprising conventional, unconventional and frontier acreage up for bidding in late November.

Trinidad and Tobago and Peru are two other countries that have increasingly opened up their oil and gas sectors in recent years and improved investment terms in a bid to lure new exploration. Both countries are holding licensing rounds this year that will be attractive to independent explorers.

Some are looking farther afield as well. At present, land-locked Paraguay has neither booked reserves nor production, but is getting the attention of some of the region's more intrepid explorers. "Currently lacking booked oil and gas reserves and with few wells drilled over the past 25 years, President Energy, Amerisur Resources and Sintana Energy are among a handful of independent oil companies taking a fresh look at the potential of Paraguay's basins," the Edison report noted.

Mexico's oil industry remains the sole preserve of Pemex. But that could change, if the country passes proposed energy reforms that would break Pemex's monopoly over the country's upstream. One of the prime aims of those reforms is to lure international majors into Mexico's deep waters in the Gulf of Mexico.

The reforms, however, could also open the doors to international independents, particularly to explore and potentially develop Mexico's substantial unconventional resources. Mexico also has mature and heavy oilfields that may suit companies with experience and technology developed in Colombia. Pacific Rubiales, for instance, has expressed an interest in working in the country.

The trend is not uniform across the region. Major reserves holders Venezuela, Bolivia and Ecuador are unlikely to roll back their statist energy policies, making those countries either off limits or unattractive for many international companies. That brand of resource nationalism runs deep in Latin American politics and could re-emerge in countries that have, so far, allowed a greater degree of foreign participation in their energy sectors.

Other challenges have emerged as well. In Colombia and Peru, oil exploration pushing into new areas has sparked conflicts between the industry and local communities, particularly indigenous communities that often do not share equally in the new-found oil wealth. Protests have repeatedly shut down operations and delayed projects in both countries.

The troubles faced by Brazilian independents OGX and HRT have also served as reminders of what a high-risk enterprise oil exploration remains, especially for smaller companies with their fortunes pinned to the results of one or two projects. The companies went public in recent years hoping to ride Brazil's oil boom, but both have fizzled. OGX filed for bankruptcy in late October after conceding that its flagship offshore field, Tubarao Azul, was a bust. HRT has lost nearly 90% of its market value over the last 12 months after disappointing results from its exploration campaign in the Amazonian Solimoes basin.

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