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Ecuador clashes with foreign oil, again

Ecuador's uneasy relationship with foreign oil firms has again slipped towards threats and recriminations, complicating the smallest Opec nation's production outlook

INTERNATIONAL oil companies (IOCs) are once again in the crosshairs of the Ecuadorian government, which is stepping up state control over the oil sector. Firms that held fast through the last round of brinkmanship, which culminated in a new 99% windfall-profits tax being imposed in 2007, are now being ordered to renegotiate their existing deals to turn them into fee-based services contracts.

The country's oil output, which spiked after the 2003 opening of the OCP pipeline removed bottlenecks to exports, has been drifting lower since President Rafael Correa, a close ally of Venezuelan leader Hugo Chavez, assumed the presidency in January 2007. Production slipped to 495,000 barrels a day (b/d) in 2009, down by nearly 50,000 b/d from its 2006 peak, as the aggressive approach to relations with the foreign companies that produce more than 40% of the country's oil has discouraged investment. Budget restrictions have complicated national oil company PetroEcuador's efforts to replace the declining output from the private sector with new production of its own.

The latest confrontation comes even as the government is once again struggling to finance PetroEcuador's activities and despite warnings from officials that oil production, which funds about a quarter of state spending, is likely to fall in the coming years because of underinvestment. The government hopes the new contracts will encourage fresh IOC spending and reactivate exploration. Capital spending by foreign firms is expected to tumble to $490m this year from $0.772bn in 2006 and commitments for future expenditures remain low. Only $80m is expected to be spent in 2013, according to the government.

Not surprisingly, the decline in investment has led to a slump in output at fields operated by the 34 foreign firms active in Ecuador. Production has declined from 287,000 b/d in 2006 to less than 200,000 b/d this year. Fiscal troubles are already appearing. The energy ministry projects output from foreign-operated projects will fall to 162,000 b/d by 2013, a decline that will cost the government $3.3bn in revenue over the four-year period.

Nevertheless, the government aims to boost output from state-controlled projects to 384,000 b/d by 2013, up from 264,000 b/d today, although spending plans are unclear and PetroEcuador has struggled to meet lofty investment expectations in the past. Its budget has been cut by $140m this year, equivalent to more than 10% of planned upstream investment, because of fiscal constraints. And faced with a hostile reception in foreign bond markets the government has turned to China for another $1bn loan that will be backed by oil shipments that could further reduce the government's financial wiggle room in the medium term.

The hard-line approach of the government to recent talks with foreign firms will have done little to encourage new investment, however. Ecuador cancelled the contracts of Perenco in July after the French independent and the government failed to resolve a $327m dispute over the windfall tax. The two sides were already headed for arbitration after the Correa government, in 2009, seized 70% of Perenco's fields – blocks 7 and 21 in the Oriente basin and the Coco-Payamino field – to pay arrears the state said were owed under the windfall tax. The move echoes the government's seizure of Occidental Petroleum's assets in 2006, underlining its willingness to take severe measures against companies it deems to be breaking the law.

The new operating contracts remain the topic of negotiation between the private sector and the government. The law itself specifies that the contractors will receive a fee that covers the amortisation of investments, operating costs and an additional sum as a rate of return for the contractor. The law also stipulates that a minimum 20% of the revenues from oil sales will accrue to the state. Talks on the new pacts, which for large firms must be finalised before the end of November, were set to begin late last month and although the law itself leaves plenty of room for bargaining over fees, Ecuadorian officials have made it clear they are aiming to increase the state's take from 65% now to at least 80% or more of revenues.

Operators are largely resigned to the revision of their contract terms and expect to reach a deal, if only to salvage what they can from existing contracts. Both Petrobras and Repsol, the two largest foreign operators in Ecuador, have shown flexibility in the past and a willingness to concede on revenue terms. But the hard-line approach is likely to deter large companies from playing any part in future exploration contracts.

And operators say privately that the new scheme will almost certainly speed up the decline of fields they operate, as investors will be reluctant to invest in anything but projects that offer fast payback times. Even Chinese firms, which have shown themselves to be more accommodating than western companies over rates of return have grown less enthusiastic for investments in Ecuador, despite the government's hope that they would step up spending.

Ecuador's oil output could be further pressured by the mounting need for investments in its ageing refineries. Although some of the country's fuel needs are covered by a swap deal with Venezuela's PdV, the increasing proportion of heavy crude in the Ecuadorian slate is adding to difficulties at local refineries. The government says it will invest $0.7bn to overhaul the 110,000 b/d Esmeraldas refinery on the Pacific coast, but previous modernisation programmes have been held up by shortages of funds.

As if expecting trouble securing new investment, Ecuador is already pushing a scheme to put some of its oil prospects in the Amazon into a special trust that would ensure they were not developed in return for an upfront cash contribution from wealthy nations. The $3.6bn plan would see the Ishpingo Tambococha Tiputini (ITT) extra-heavy oilfields in the Yasuni nature reserve withdrawn from future investment plans in return for annual payments.

The scheme has been proposed in the past following lukewarm interest from foreign investors over developing the project – which would require the construction of an upgrader to improve the quality of the extra-heavy crude before it could be processed in conventional refineries – but the previous attempt to convince rich nations to pay $350m a year to keep the ITT project out of development did not fly. But this time, officials say several European nations have expressed interest in funding the project as part of climate-change mitigation measures.

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