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Latin American investment likely to fall 25% in 2015

Lower oil prices are putting South America's oil industry under pressure, meaning long term production will suffer

The oil boom was good to Latin America. Brazil saw billions of dollars of investment flow into its deep-water oilfields and is on the cusp of becoming a major player in international oil markets. Colombia's economy rode high for nearly a decade thanks in large part to a fast-growing oil industry. Venezuela's socialist government used an influx of petrodollars to fund a revolution at home and bolster its clout throughout the region.

But the industry will be tested by the recent oil price decline. Government budgets are under pressure and companies are slashing spending. Investment is likely to fall by at least 25% across region in 2015 putting long-term production growth at risk.

Already, Ecopetrol, Colombia's state oil company, has said it will cut spending by 26% from 2014 levels. Pacific Rubiales, Latin America's largest independent producer, says it will reduce spending by around half. Brazil's Petrobras is revisiting its spending plans and will almost certainly be forced into deep cuts as it deals with a corruption scandal on top of the falling oil price. Bolivia's YPFB says it will invest around 20% less in 2015 than it did in 2014. Other companies are following suit, and some of the region's cash-poor independents are feeling the pinch.

That spells trouble for the continent's huge untapped oilfields. Brazil's pre-salt oilfields, Venezuela's Orinoco heavy oil projects and Argentina's shale are all world-class prospects. Mexico's deep-water Gulf of Mexico will soon be added to that list with the country's oil opening. And frontier deep-water prospects also beckon off Colombia and Uruguay.

However, they are technically complex, expensive projects requiring tens of billions of dollars of investment. Venezuela, Brazil, Mexico, Colombia and Argentina alone have drawn up ambitious growth plans that would require around $1 trillion of investment over the next decade.

Before the oil price rout, the International Energy Agency (IEA) expected Latin America to see the fastest rate of oil production growth in the world over the next decade, largely on the back of strong growth from Brazil. It forecast 3 million barrels a day (b/d) of new production in Latin America by 2025.

Even in the good years, though, the continent found it difficult to turn its world-beating reserves potential into reality. The region's tricky oil politics, boom and bust economic cycles and creaky infrastructure have made it difficult to marshal the huge amounts of investment needed. The oil price rout will not help. Oil company budgets are under pressure and international majors remain wary of the region's difficult energy politics and are starting to move away from a focus on the sort of megaprojects Latin America offers.

The price fall has been as worrying for policymakers as it has been for executives. Oil and gas projects are a crucial source of foreign and domestic investment for many countries and state oil companies funnel huge amounts of money to their central governments. Venezuela's PdV in the engine of the country's economy, contributing around 50% of the government's budget and pulling in nearly all of its foreign currency. Tax receipts, royalties and other payments from Pemex make up about a third of the government's budget. Ecopetrol and Petrobras contribute around 10% of their government's budgets, according to figures from Deutsche Bank.

If history is any guide, the price decline could see yet another swing in the politics of energy in Latin America. Oil policy in the region tends to turn more statist as high prices encourage governments to seek higher rents from their highly lucrative oil industries. Over the last decade, Venezuela has led the way with Hugo Chavez's brand of resource nationalism winning followers in Ecuador, Bolivia, Argentina and elsewhere.

However, as oil prices fall, increased competition for scarce investment dollars has typically pushed Latin America's governments to pursue more open, business friendly policies. There is already some evidence of this happening. Most dramatically, it has been seen in Mexico's oil reform process, which is opening the industry to outside investors for the first time in decades. Argentina, too, has improved its investment climate as it tries to lure much needed investment into its oil patch. Others are likely to follow suit as they feel the pain of lower oil prices.

While investment and revenue are certain to fall sharply in the coming months, the affect on the region's short-term oil production will be felt unevenly across the region.

Brazil in deep

Brazil's pre-salt oil projects that are already producing or under development - where there are already significant sunk costs - will likely continue apace, leaving short-term production targets intact.

Much of Brazil's 2015 production growth will come from projects brought online in 2014 ramping up output throughout the year, a relatively low cots process. Petrobras plans to bring just one new production system - Iracema Norte - into production in 2015.  Pre-salt operators need just $23 a barrel (/b) to cover the cost of keeping their existing oilfields running, according to analysts at Bank of America Merrill Lynch, so there is little threat to these projects.

Analysts at Raymond James, an investment bank, expect Brazil's oil production to grow by around 80,000 b/d in 2015, behind only the US and Canada. "Essentially all of Brazil's incremental production is coming from textbook long-lead-time projects: pre-salt developments in the deep-water Santos basin," Raymond James says. "Thus, any supply response is unlikely to emerge in 2015 or even 2016. We certainly think that Petrobras will have to curtail spending in view of the current oil prices, along with its over-levered balance sheet, but the effect on production wouldn't be felt for several years."

Beyond 2016 the situation starts to look far more troubling for Petrobras and Brazil's oil sector. If oil prices remain depressed through 2015 it could force Brazil to scale back its deep-water production ambitions, especially as a huge corruption scandal at Petrobras compounds the difficulties brought on by the oil price rout.

Petrobras plans an unprecedented wave of deep-water development from 2016. The company plans to spend around $35bn a year on its upstream business to bring around 28 new production systems online from 2016 to 2020 and add around 2m b/d of new production. The plan, though, assumed an oil price of around $100/b. And it's not clear it can hold up with a significantly lower oil price.

The company has laid out its argument for the pre-salt's future in a lower oil environment. It says the pre-salt projects work at just $45/b, and that could fall even further as the company continues to reduce drilling and well completion costs and service companies cut their prices on reduced demand from the industry.

For instance, Petrobras says it has cut the amount of time it takes to drill a pre-salt well in half since 2010 and made huge improvements to its well designs. Moreover, offshore rig rates are likely to fall dramatically as the industry cuts back on expensive deep-water projects around the world.

Even with high oil prices, though, Petrobras has seen significant delays and struggled to hit its production targets. Many new projects are still in the tendering phase and could be delayed if oil prices remain low.

Moreover, contracting for new projects will be very difficult as long as the corruption investigation into Petrobras and its suppliers continues. The alleged kickback scheme, which reportedly could involve more than $30bn in rigged contracts and money laundering, has pulled in nearly every one of Petrobras' major domestic suppliers and could result in Petrobras being forced to look to new contractors.

Venezuela's scary maths

The falling oil price has hit Venezuela the hardest. The price the country gets for its oil fell below $40/b in mid January - setting off alarm bells in Caracas as the country sinks deeper into an economic crisis.

President Nicolas Maduro went on an emergency world tour in January to allies China, Iran, Qatar, Saudi Arabia and Russia seeking help to shore up the government's finances and to build a coalition of Opec and non-Opec countries to cooperate to lift oil prices.

However, it's not clear how successful the trip was on either front.

Maduro told audiences at home that he had secured $20bn in investment for energy and infrastructure projects from Beijing, but few details of the agreements were released. Crucially, it does not appear Venezuela secured any new loans from Beijing that could be used to deal with the country's immediate financial difficulties, though China has eased the terms on some of the countries' earlier oil-for-loan deals. In Qatar, Maduro claimed progress on deals for billions of dollars of financing for energy projects, but it does not appear any of the agreements have been finalised.

Venezuela's diplomatic push to forge a coalition of like-minded producers to help buoy the oil price has also not been successful. Venezuela is in no position itself to reduce production, which has undermined its attempts to get others to do so.

The plunging oil price will put additional pressure on cash-strapped PdV. As the country's economic woes worsen, the government will lean even more on PdV to keep the everyday business of the government running, especially as Venezuela enters another election year, when PdV's spending on social programmes typically rise sharply.

That will leave very little cash available for the company to invest in its huge Orinoco heavy oil projects, the country's best hope for turning around its declining production trend. Moreover, as PdV's international partners evaluate their businesses in the new low-price environment, the troubled Orinoco projects, which have seen little apparent progress in recent years, will likely be near the top of the list for spending cuts.

The Orinoco Belt's eight leading projects need a total of around $20bn of investment every year to come into production by the end of the decade, of which PdV would have to cover around 60% of that cost to cover its ownership stake, according to the state company.

With oil prices at $100/b, this plan looked tenuous. But with oil prices now at less than half that, the company's situation looks increasingly dire.

PdV only receives market prices for about 1.2m b/d of its oil production after selling at a heavily discounted price into the domestic market, sending around 500,000 b/d of crude to China to repay its oil-for-loans deals and exporting heavily subsidised oil around the region under the PetroCaribe programme.

At $45/b, PdV's 1.2m b/d of exports will bring in just $19.7bn, only a small portion of which will be left over to invest in its operations after its contributions to the government and debt payments. 

The price decline will also force Venezuela to consider whether or not it can still afford its generous petro-diplomacy strategy. Venezuela sends around 100,000 b/d of oil to Cuba and around 100,000 b/d to other countries around the Caribbean on very favourable terms under its PetroCaribe programme. PaetroCaribe has won Venezuela friends and influence throughout the region, but it is becoming difficult to sustain as oil prices plunge, the country's foreign reserves dwindle and the country's lenders are openly fretting about a possible bond default.

Colombia takes a hit

The oil price decline comes at a difficult time for Colombia's oil business. After a decade-long production boom, 2014 was the most difficult year for the industry in a long time as pipeline attacks, community blockades, regulatory gridlock and new competition for investment dollars from Mexico took their toll. The 2014 licensing round was a disappointment for the government and production for the year was flat at around 1m b/d.

It will be difficult for the industry to turn things around amid falling oil prices. State-run Ecopetrol and Pacific Rubiales have announced deep spending cuts, and Colombia's independent producers have seen their share prices plunge on worries over their growth prospects.

Falling investment will make it difficult for Colombia to sustain production growth, and could see output fall. Unlike Brazil, where production comes from long lead time projects that already have significant amounts of sunk costs, Colombia's production comes from short-cycle onshore mature heavy oilfields that require significant ongoing investment and intense drilling activity to keep production rising.

The IEA cut its 2015 production forecast for Colombia to 930,000 b/d in January, down by 170,000 b/d from the previous forecast, making it one of the hardest hit country's in the world.

Mexico's reforms on the rocks

For Mexico, falling oil prices have complicated its reform process. The country has won praise for enacting deep reforms to its oil industry, seen as necessary to reverse falling production and draw the foreign investment and expertise to open new deep water and unconventional frontiers.

The government launched the first bid round for a batch of relatively small, shallow-water Gulf of Mexico projects late last year. These projects are unlikely to be affected by the oil price declines because of they are relatively low cost, says Deutsche Bank, which estimates the break-even for these fields to be around $23/b. However, these projects will not bring in significant amounts of new investment or add significant amounts of new production.

The real threat to the reform process is if international oil companies balk at Mexico's deep-water fields because of low oil prices. Deutsche Bank estimates the break-even for Mexico's deep-water projects to be around $50/b, which makes them uneconomic at today's prices, but potentially attractive to companies that think the oil price is set to bounce back in the next few years, when production would begin on any possible discoveries.

However, even international majors have switched from growth mode to conservation mode. So even those confident in long-term higher prices might find it difficult to justify big new frontier exploration projects in Mexico, even if there is a relatively high chance of success.

"We would expect companies to be extremely selective in terms of the projects they undertake," Deutsche Bank analysts said in a recent report. "We estimate that at current prices additional reform-related [foreign direct investment] would be cut by approximately 50% from our previous scenario to $10bn per year. This reduction is consistent with the recent announcements made by major oil companies about cancelling a proportion of their global investment projects."

If there are signs of waning interest from international companies, Mexico could be forced to delay bid rounds expected for later this year and early next year.

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