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Ecuador's diminishing attraction to upstream oil investors

The latest wave of resource nationalism will hit Ecuador's oil-production outlook and deter badly needed investors

UNWILLING to accept Ecuador's heavy-handed negotiating tactics over new fee-based contracts, Petrobras departed the country's upstream at the end of November. The Brazilian state-controlled company has relinquished its 30% stake in a 19,500 barrels a day (b/d) block, which holds the Palo Azul oilfield, although it retains its 11% holding in the OCP heavy-oil export pipeline.

Ecuador's state-owned PetroAmazonas, which already operates another block relinquished by Petrobras in 2008, will take over the operatorship, after Petrobras failed to sign a new contract by the government's 23 November deadline.

The new deals on offer replace profit-sharing contracts with fee-based ones, with international oil companies (IOCs) paid flat fees for their production. As a result, government oil revenues will rise from 70% to 80%. Ecuador is trying to raise funds to tackle its growing budget deficit, which is forecast to reach $3.73bn next year. But the consequences could be dire for the upstream industry, which has seen falling output and private-sector investment in recent years.

Other companies that have rejected the new deals include the US' Noble Energy, which produces 227m cubic metres a year of gas from the Amistad field, in the Gulf of Guayaquil; South Korea's Canada Grande, which relinquished Block 1; and China's state-owned CNPC, which has given up exploration Block 11.

Juliette Kerr, an analyst at IHS Global Insight, a consultancy, says investment under the new fee-based contracts will look "less attractive" to smaller producers. Operators with output of less than 7,000 b/d have until 23 January to sign the new contracts.

But not all of Ecuador's large producers are abandoning the country. The government convinced five companies to sign the new agreements, which, it claims, could boost production by up to 35%.

Repsol signed a new contract for Block 16 and its 40,000 b/d Bogui Capiron field. With 41,800 b/d of output in Ecuador, the company is the country's largest privately-owned producer. Under a new eight-year contract, the Spanish major will receive a $35.95/b fee for its production. A spokesman says that, despite the new contracts being "a long, hard negotiation, it's a question of strategic interest for us. We have a good relationship with Ecuador. We weren't willing to abandon it."

Enap was the first to accept the new terms for its MDC and PBH blocks. Chile's state-owned oil firm aims to raise output by 7,000 b/d, to 20,000 b/d within four years. It will receive $16.72/b under a 15-year deal and will invest $72m in its operations in the east of the country.

Andes Petroleum and PetroOriental – both owned by CNPC – also signed up to the new contracts. Andes produces around 39,000 b/d from its Tarapoa block and will be paid $35/b under a 15-year contract. PetroOriental will receive $41/b for its 14,900 b/d operations, across two blocks, as part of an eight-year deal. Italy's Eni accepted a 13-year contract, at $35/b, for Block 10, which produces 17,300 b/d.

Ecuador's oil output peaked in 2006, after the 2003 opening of the OCP pipeline removed bottlenecks to exports. But production has been in decline since President Rafael Correa took power in January 2007 and launched a staunchly nationalist programme to regain control of the country's energy sector. In 2009, the government seized two oil blocks operated by France's Perenco over an alleged tax dispute. Then, in January 2010, it withdrew from the World Bank's International Centre for Settlement of Investment Disputes.

Production from Opec's smallest member has dropped by more than 41,000 b/d in the past four years, leaving it averaging 477,000 b/d in the first 10 months of 2010, according to PetroEcuador – a legacy, say analysts, of Correa's strategy, which has discouraged IOC investment. Meanwhile, budget restrictions have prevented state-owned PetroEcuador from bringing enough new production on stream to replace declining private-sector output.

The oil sector accounts for 50% of Ecuador's export earnings and around a third of all tax revenues. Output from IOCs accounts for around 40% of the country's oil production, but between 2008 and 2009 this fell by 14%, to 204,511 b/d. Compounding the country's economic woes, Ecuador's refining capacity from three state-owned plants is just 175,000 b/d – leaving it unable to meet domestic needs. So while reaping the benefits of high crude-export prices for the oil it sells internationally, the bill for imported refined products is also rising.

So Ecuador can ill-afford to see big oil producers leave. Correa will at least be encouraged by the language of some of the companies, even those on their way to the exit. Speaking about Petrobras's decision to end upstream operations in Ecuador, chief executive Jose Sergio Gabrielli said this "doesn't harm any future relationship" with the country. His company, he added, "just didn't accept the conditions".

But Kerr says Petrobras' departure is symbolic of Ecuador's diminishing attraction for investors. "Petrobras has always accepted nationalisations in the region before," she says, "it shows that Ecuador's attractions no longer compare with Venezuela's."

Venezuelan President Hugo Chavez's moves to reassert state control over the oil sector saw many large oil firms – including ExxonMobil – exit the country, only to be quickly replaced. But Venezuela's 1.61m b/d of oil exports dwarf Ecuador's 329,000 b/d, as do its reserves (which Opec puts at 211bn barrels, compared with Ecuador's 6.5bn).

David Thomson, an analyst at Wood Mackenzie, says a further oil production decline is inevitable as investors leave the country. This happened in 2007, when the government introduced a hefty new windfall on production. The result was that IOCs invested "the bare minimum" in Ecuador's oil industry, triggering the output fall, says Thomson.

The IOCs remaining in Ecuador have agreed to invest around $1.2bn in the country's oil fields, but although this is "a lot of money for Ecuador", says Thomson, it's a modest amount by any global measure. Without new investment, says Thomson, production will continue to decline over the next two or three years.

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