Ecuador’s Shock Presidential Election Result May Save Its Oil Industry

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By Matthew Smith

Ecuador’s beaten-down petroleum industry has been struggling to recover from a savage 2020 where pipeline failures, the COVID-19 pandemic, corruption scandals, and heightened political uncertainty sharply impacted operations. There were fears that the presidential elections would see poll favorite socialist economist Andres Arauz, the protégé of former President Rafael Correa, emerge victorious from the runoff held on Sunday. Polls, only last week, indicated that Arauz was the leading candidate going into the presidential runoff against conservative candidate Guillermo Lasso. Correa’s protégé made it clear he was opposed to outgoing President Lenin Moreno’s oil industry reforms and would block the privatization of the Esmeraldas refinery, Ecuador’s largest.  Before the presidential runoff, Arauz had even filed a lawsuit claiming that the privatization of operations at the facility was unconstitutional. During his campaign, Arauz stated that if he emerged victorious, he would revoke the contract putting private operators in place at the Esmeraldas refinery if that was completed before he assumed office. Those events triggered substantial concern that Arauz would roll back Moreno’s reforms and saddle Ecuador’s oil industry with further policies centered around oil nationalism and heavy-handed state regulation. In a surprise outcome, Lasso won Sunday’s presidential runoff, garnering over 52.5% of the vote and declaring victory with around 93% of the total vote counted. His opponent gracefully admitted defeat. This is a positive development for Ecuador’s energy sector, boding well for further reforms and dialing down much of the political uncertainty which has surrounded the petroleum industry since Arauz topped polls and won the first round in February 2021.

A key plank in Moreno’s energy sector reforms was privatizing the operation of the 110,000 barrel per day Esmeraldas refinery, which is Ecuador’s largest and has been afflicted by operational failings for over a decade. The situation is so precarious that the facility cannot produce IMO 2020 compliant low sulfur content maritime fuel nor refine sufficient oil to meet domestic fuel demand. Despite Ecuador having over eight billion barrels of proved crude oil reserves, being Latin America’s fifth-largest petroleum producer and a population of under 18 million, domestic refineries are incapable of producing sufficient gasoline and diesel to meet local consumption. This has forced a fiscally challenged national government in Quito to rely on fuel imports, which are then sold at a heavily subsidized price placing greater pressure on its strained fiscal position.

Even a $2.3 billion 2015 refit of the Esmeraldas refinery, which was dogged by significant corruption, did little to alleviate the myriad problems impacting its operations. In February 2021, Petroecuador, the state-controlled operator, was forced to conduct maintenance of the refining train which saw the refinery operation at 50% capacity, or 55,000 barrels per day, between 13 February and 2 April 2021. Those incidents indicate that significant work needs to be carried out on the Esmeraldas refinery if it is to be fully functional, consistently operate at full capacity, and produce high-quality compliant fuels. Outages at the refinery have a marked impact on Ecuador’s balance of trade, government finances, and gross domestic product, because of a dependence on the export of crude oil and derivative products to drive the economy.

Lasso’s victory is a positive portent for the privatization of the Esmeraldas refinery continuing and for Ecuador’s poorly performing petroleum industry, which is in urgent need of further reforms if it is to realize its true potential. The millionaire former banker, who takes office on 24 May 2021, will adopt an orthodox business-friendly free-market economic approach and keep working with the IMF on rebuilding Ecuador’s nearly broken economy. In a move that was reassuring for financial markets and investors, Lasso stated he will uphold a $6.5 billion IMF loan agreement and maintain payments on Ecuador’s bonds. As a result, the Andean country’s bonds soared, to see them rising by around 25% as markets digested news of the surprise victory. The president-elect will likely focus on improving ties with Washington after the relationship was strained during Correa’s tenure, as well as the U.S.-aligned regional nations Brazil, Chile, and Colombia.

Those measures will benefit Ecuador’s oil industry which is struggling to attract the investment required to overhaul existing infrastructure and develop oilfields. Petroleum is a key driver of Ecuador’s economy, with it accounting for around a third of government earnings, 40% of exports, and around 7% of GDP. By March 2021, the Andean country only pumped an average of 501,680 barrels per day, which while marginally higher than a month earlier was 7% lower than the same month in 2020. Those numbers along with only five operational drilling rigs in Ecuador, one less than a year earlier, indicate there is some way to go before production returns to pre-pandemic levels.

Lasso on assuming office will be under pressure to initiate growth after Ecuador’s economy suffered one of the worst declines ever during 2020 with GDP shrinking by 7.5%. While the outlook for 2021 is optimistic, with the economy is projected to grow by 2.5%, headwinds abound. Oil prices remain volatile and the OPEC Plus consortium has flagged that it intends to gradually unwind production cuts which could force prices lower, especially if U.S. sanctions against Iran are eased. The COVID-19 pandemic continues to sharply impact Ecuador’s economy and that is not being helped by a sluggish vaccine rollout. That further underscores why Quito needs to focus on bolstering petroleum investment to improve infrastructure, ramp up exploration activity, and development of oilfields.

There are also considerable environmental concerns weighing on the energy sector. There are claims that the April 2020 oil spill in the Coca River, considered the largest in over a decade, has yet to be fully cleaned up. The Sucumbios Provincial Court in Sucumbios province, which is in the Amazon Basin on Ecuador’s northern border with Colombia, ruled in January 2021 that natural gas flaring in the region was to cease. This was made on environmental grounds including findings that demonstrated flaring was polluting rainwater, groundwater, and the soil leading to higher rates of cancer. The ruling does not impact oil drilling activities, only how companies manage the natural gas produced as a by-product of their operations. Corruption is also an endemic problem for Ecuador’s petroleum industry, with the country caught up in last year’s Vitol bribery scandal.

Clearly, because of Ecuador’s economic dependence on the energy sector, Lasso will need to drive further reforms and investment to achieve his economic goals. The president-elect has promised to lift the minimum wage by $100 to $500 per month, introduce programs aimed at alleviating poverty and phase out regulations penalizing foreign investment, including a tax on withdrawing money from Ecuador. Those developments highlight the difficult path Lasso must navigate when formulating policy aimed at attracting investment and boosting petroleum industry activity while minimizing environmental fallout to minimize the damage to its social license.

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