Can Ecuador Save Its Ailing Oil Sector?

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By Matthew Smith

The tiny impoverished Latin American country of Ecuador continues to struggle with its legacy of resource nationalism. Even a push by the current administration of President Lenin Moreno to implement business and investor friendly policies to attract offshore investment is failing to gain the desired traction. While Ecuador’s mining industry is bounding ahead, because of Moreno’s policies aimed at boosting international investment in the country’s vast resources, the same cannot be said of the petroleum industry. The previous administration of Rafael Correa gained a reputation for heavy handed regulation and resource nationalism. A combination of strict state controls on the allocation of lease and production contracts, investment, taxation and local content rules were a significant deterrent to investment. This negative perception was further magnified by the $18 billion 2012 judgement issued by an Ecuadorean court against global energy major Chevron. This was later reduced to $9.5 billion and found to be fraudulent by several courts in different jurisdictions. Those events indicate that there is a considerable degree of negative perception for Quito to overcome to attract investment to Ecuador’s ailing oil industry. While there is a long journey ahead for Moreno’s regime the outlook is not as negative as some analysts have portrayed. Ecuador, despite a rough start to the COVID-19 pandemic has become one of the best performers in Latin America for managing the virus. Quito has not allowed the pandemic to derail its plans to become a more business friendly jurisdiction and bolster foreign investment in the domestic oil industry. The sharp impact of the pandemic on Ecuador’s already fragile economy, with the IMF predicting it will shrink by a worrying 11% during 2020, makes it more important than ever for Quito to unlock the country’s petroleum wealth. Unlike nearby Colombia, which produces more oil, Ecuador possesses considerable proven oil reserves, totaling 8.3 billion barrels at the end of 2019. Despite those significant proven reserves, Ecuador is struggling to attract the capital, technology and skilled labor required to boost oil production and unlock the considerable wealth they contain.
For September 2020 Ecuador only produced an average of 511,585 barrels of crude oil daily. While that is more than double the 208,062 barrels pumped daily during April 2020, when pipeline spills and outages sharply impacted operations, it is still well below the 600,000 barrels daily Quito aspires to. A key reason for this is the lack of international investment. Foreign direct investment in Ecuador has declined for three out of the last four years, falling 38% during 2019 to just under $1 billion. It is expected to decrease significantly during 2020 because of sharply weaker oil prices and the fallout from the pandemic. Softer prices, elevated levels of geopolitical risk and high breakeven costs are all acting as a disincentive for investment from foreign energy companies. Breakeven costs have been estimated to be around $39 per barrel which, while lower than Argentina and Colombia are higher than Brazil and Guyana. Sale prices for oil produced in Ecuador are benchmarked to West Texas Intermediate, rather than the international Brent price as in neighboring Colombia, Brazil and Guyana. That means oil producers operating in Ecuador do not benefit from premium Brent pricing, with the international benchmark trading at almost $2 per barrel higher than WTI.

Another deterrent for investment from foreign energy majors is that Ecuador’s oil is primarily composed of heavier sour crude, which is becoming less popular with refiners because of higher processing costs and the global push to significantly reduce the sulfur content of fuels. Ecuador’s key crude oil benchmarks Oriente and Napo have API gravities of 23.6 and 16.8 degrees respectively with 1.61% and 2.33% sulfur content. This indicates they are heavy sour crudes which are waning in popularity among Asian refiners because they are more expensive and difficult to refine into high quality low sulfur content fuels than lighter sweeter crude oil. That, along with claims that peak oil demand will occur by 2030, suggests there is a limited window for Ecuador to attract the required capital and technology to unlock the considerable wealth held by its petroleum reserves.

The dire state of Quito’s finances is highlighted by Moreno’s administration applying for and receiving a $6.5 billion IMF loan. The government also recently signed an oil backed $1.4 billion loan with Beijing earlier this month to further bolster finances. These developments come on the back of the country’s economy shrinking by just over 12% during the second quarter 2020, its worst performance in roughly two decades. For the economy to benefit from Ecuador’s vast oil wealth, Moreno’s administration has made some important changes to attract foreign energy investment. An important step was the Andean country leaving OPEC at the start of 2020. This freed Quito from having to comply with mandatory cartel production cuts, giving the central government more freedom and allowing it to freely boost oil production and hence oil revenues. A crucial change was the reintroduction of participation contracts in place of service contracts. That essentially gives oil companies ownership of the oil reserves and production, allowing them to treat their oil reserves as an asset that can be used for collateral. This major change from the previous service contracts, which existed under the Correa administration, is a particularly important development and act as an incentive to attract offshore investment.

The free market austerity focused reforms are continuing with Moreno’s administration push to find a private operator of the 110,000 barrels per day Esmeraldas refinery. The plant which is owned and operated by national oil company PetroEcuador has been operating sporadically for years because of poor maintenance and a lack of capital. Quito hopes this will see the refinery receive the investment required to secure operations and allow the plant to consistently operate at full capacity. That development signifies an important change in direction for Ecuador’s petroleum industry, a move to allowing private operators to become partners in key assets so that they not only receive appropriate maintenance but can be developed to maximize production. The parlous state of Ecuador’s oil infrastructure and need for the investment in crucial maintenance as well as development activities, was underscored by mudslides taking out two crucial oil pipelines in April 2020. That caused average monthly petroleum production to plunge to a mere 208,000 barrels daily for that month. The need for investment and the transfer of technology and industry knowledge could not come at a more crucial time for a fiscally challenged and impoverished country experiencing considerable fallout from the COVID-19 pandemic. The clock, nonetheless, is ticking because of the growing popularity of light sweet crude in preference to heavier sour crudes which are more costly to refine. The complexities surrounding Ecuador’s oil industry are magnified by environmental concerns, with the most productive fields located within the Amazon and traditional indigenous lands.

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