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Downturn hits Latin America’s upstream hard

Worsening economic conditions set to slash oil production growth in the region

The Opec+ collapse is leading to an unprecedented wave of crude hitting the market just as demand plunges due to the Covid-19 pandemic. Latin American government revenues will take a big hit because of the outsized role that oil and gas plays in regional economies.

As elsewhere, companies active in the region have reacted quickly, making deep cuts to their capital spend plans for this year, with discretionary spend being pulled back wherever possible.

Current oil prices may not be sustainable beyond the short-term, but the focus for companies is to minimise cash burn and protect their balance sheets. Production will be hit, and short-term shut-ins have already begun. Longer-term growth will be pushed out as activity is deferred and project sanctions delayed. Deal making will grind to a halt and exploration licensing put on hold. And the services sector, having barely recovered from the last downturn, will experience significant pain.

Short-term production risk

Lowering running costs is the priority for all E&Ps. Latin America produces more than 7mn bl/d of crude, half of which is uneconomic at current prices. This does not mean all of these wells will be immediately shut in. There are good commercial and reservoir/asset management reasons to keep them running, especially offshore assets where the shutdown and start-up of facilities is a complex process. But output inevitably becomes increasingly at risk as long as low prices continue and company losses grow.

7mn bl/d – Latin American production

Operating costs depend on many factors, including crude properties, logistics and operator efficiency. Fiscal terms also play a part as royalties cannot be avoided, even on loss-making projects. That said, the depreciation of regional currencies against the US dollar (down by over 20pc in most key producers since the start of 2020) does provide some relief, given up to 80pc of operating costs can be denominated in local currencies.

Brazil is best placed to weather the immediate storm. Its deepwater projects might be expensive to develop, but its world-class reservoirs are cash-generating machines once onstream, resulting in highly competitive operating costs—the pre-salt average is around $20/bl.

At first glance, Mexico’s asset base looks to be struggling. However, state-owned Pemex owns nearly all output, and operating costs becomes much more competitive after backing out any revenue-related taxes. Elsewhere, some higher-cost production is at risk in Argentina and Colombia, particularly at projects operated by companies with stretched balance sheets.

Budget cuts and longer-term impact

Investment in oil and gas projects has been slashed. Over $40bn of planned spend has been cut globally, a figure that will increase as more companies disclose changes to their plans for 2020. The average cut in capex in Latin America is 41pc, with key players such as Colombia’s Ecopetrol, Canada-based Gran Tierra Energy and Brazilian firm PetroRio announcing big reductions. Others, such as Brazilian national oil company Petrobras, continue to review their spending plans. There is a wide variation within the group, largely related to financial strength—those companies with stretched balance sheets have no choice but to cut deep.

Brazil is best placed to weather the immediate storm

The impact will be felt immediately. Short-cycle investments will be hit hardest given their exposure to near-term prices. Drilling programmes and incremental development work will be curtailed. This will start to affect onshore production, particularly in countries such as Argentina, which require continuous drilling to offset declines from conventional and unconventional legacy projects.

Top-ranking projects, such as ExxonMobil’s Liza development offshore Guyana, will continue to move forward. But new project sanctions will be delayed and there will be cuts to exploration programmes as companies take the opportunity to defer activity to 2021 wherever possible. The result will inevitably be a slower production growth trajectory in the longer term.

Ruaraidh Montgomery is director of research at Latin American upstream consultancy Welligence Analytics

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