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Matthew Smith

Matthew Smith

Matthew Smith is Oilprice.com's Latin-America correspondent. Matthew is a veteran investor and investment management professional. He obtained a Master of Law degree and is currently located…

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Can Ecuador’s Oil Industry Finally Begin To Recover?

Former banker Guillermo Lasso’s surprise victory over favored candidate leftist Andres Arauz in Ecuador’s presidential election last month established a more optimistic outlook for Ecuador’s beaten-down petroleum industry. President Lasso is Ecuador’s first center-right president in almost two decades with the Andean country’s top office being dominated by left leaning administrations.

Lasso is considered a business-friendly alternative to Arauz, the protégé of former leftist President Rafael Correa who was convicted on corruption charges and sentenced to eight years prison last year. It was Correa’s policies centered on resource nationalism and state control of crucial assets which were responsible for the decline of Ecuador’s economically crucial oil industry and environmental degradation.

Before the COVID-19 pandemic Ecuador’s oil output had been declining as a dearth of investment in exploration, well development and industry infrastructure hit hard. Even the significant reforms made by Lasso’s predecessor Lenin Moreno have done little to boost oil industry activity and petroleum production. The dilapidated state of Ecuador’s energy infrastructure is highlighted by the country’s three oil refineries being unable to process enough crude oil to meet domestic fuel demand.

Data from Ecuador’s Agency Of Regulation And Control Of Energy And Non-Renewable Natural Resources shows the Andean country pumped an average 461,784 barrels per day for May 2021. That was around 7% less than a month earlier but a notable 38% greater than for May 2020 where the rupture of the SOTE and OCP pipelines forced operations to be shut-in for nearly two months causing production to plunge.

It was expected that Moreno’s petroleum industry reforms would attract urgently needed foreign investment for the beleaguered sector but that has not occurred. Even exiting OPEC to escape production quotas, and reinstating participation contracts in 2018, which allow reserve-based lending, failed to attract the desired level of investment.

There are a range of reasons for this including environmental pressures, sharply weaker oil prices, high breakeven costs and deteriorating energy infrastructure, but the key deterrent was the considerable uncertainty triggered by Ecuador’s presidential election.

The oil industry feared that Arauz, who in the lead-up to the election was ahead of Lasso in the polls, would on winning the presidency implement similar resource nationalist policies to his mentor Correa.

It was Correa’s policies focused on resource nationalism and state control of energy assets along with significant corruption which were responsible for the dilapidated state of Ecuador’s oil and natural gas infrastructure.

While campaigning Arauz went as far as to state he was opposed to the privatization of the Esmeraldas Refinery, Ecuador’s largest, and would block the planned awarding of a contract to private operators.

For those reasons Lasso’s victory was a relief for an industry which has been weighed down by adverse government policies for over a decade. The newly installed president has taken a positive approach to Ecuador’ oil industry and appears ready to continue building on Moreno’s reforms. He intends to implement policies to attract more foreign energy investment, boost refining output and grow Ecuador’s economically vital oil production. This is particularly important because the impoverished Andean country was hit hard by the COVID-19 pandemic. According to IMF data, Ecuador’s economy shrank by 7.5% last year and the national government in Quito reported a budget deficit (Spanish) of $7 billion or around 7% of gross domestic product. The government expects that deficit to fall to $3.9 billion, or a more manageable 4% of GDP.

Related: High Oil Prices Set Supermajors Up For A Promising Earnings Season

For that to occur, Ecuador must significantly boost economic activity and bolster fiscal income with a focus on the oil industry which is responsible for around 30% of government income, a third of exports by value and 7% of GDP. Lasso prior to his inauguration pledged to double Ecuador’s oil production during his four-year term. To achieve that he will need to grow Ecuador’s oil output from just under an average of 500,000 barrels daily to one million barrels by 2025. This is a significant target which will prove difficult if not impossible to achieve leaving recently appointed energy minister former Petroamazonas chief Juan Carlos Bermeo facing an uphill battle to execute Lasso’s planned expansion of the oil industry. 

Any significant increase in petroleum production would need to occur in the environmentally sensitive Amazon Basin where opposition to the energy industry is rapidly growing. Most of Ecuador’s proved oil reserves, totaling eight million barrels, and production is in its portion of the Amazon Basin located in the Sucumbios and Orellana provinces. The petroleum industry’s rapidly deteriorating social license in the region poses a direct threat to Lasso’s plans to attract industry investment to bolster resources and production. Indigenous communities in Ecuador’s Amazon have long opposed the oil industry, primarily because of the serious environmental damage it is causing. In a surprise January 2021 ruling, the Sucumbíos Provincial Court found in favor of a local community petition which was seeking an end to flaring. The court ruled that energy companies operating in the provinces of Sucumbíos and Orellana cease flaring, an activity which has been occurring since Texaco drilled the first well in the region in 1967. 

The deterioration of the oil industry’s social license in Ecuador is underscored by Petroecuador being forced to declare (Spanish) force majeure at Block 12 in the Orellana province. The indigenous community in El Eden are protesting the exploitation of oil resources in the vicinity of Block 12 demanding that a new agreement be established because according to the protestors it expired in 2019. The protests are preventing Petroecuador from resupplying operations in Block 12 which along with concerns for the safety of employees and equipment saw Ecuador’s national oil company shutter operations. That has taken 28,462 barrels per day of production offline impacting Ecuador’s hydrocarbon output with Petroecuador responsible for around 80% of the oil dependent nation’s petroleum production. 

The deterioration of the economically vital industry’s social license is accelerating primarily because of last year’s devastating oil spill caused by the OCP and SOTE pipelines rupturing near the city of Coca and threatening local water supplies. Land subsidence remains a threat to the operation of both crude oil pipelines meaning further ruptures could occur during heavy rains, while local communities claim that the spill has not been fully cleaned up despite occurring over one year ago.

Ecuador’s unattractiveness as a destination for foreign investment in energy assets is amplified by high breakeven price estimated to be at around $39 per barrel and the heavy sour crude oil grades produced in the country. The former OPEC member’s two main oil grades are medium sour Oriente which has an API gravity of 24 degrees and 1.4% sulfur content and the heavier sourer Napo blend with an API gravity of 19 degrees and 2% sulfur content. The popularity of heavier sour crude oil grades is declining because of ever stricter emission regulations and the increased cost as well as complexity associated with refining them into high quality fuels including gasoline and diesel. Both crude oil blends are price indexed to WTI meaning that producers miss out on the brent premium that drillers enjoy in other South American jurisdiction, because of their sour heavy characteristics they trade at a discount to the North American benchmark.

Quito is also hamstrung by liabilities established through a series of oil-backed loans from China and Thailand taken out by the Correa administration. Sharply weaker oil prices mean that the national government is obliged to ship greater quantities of crude oil to meet repayment than anticipated, leaving less oil available for sale to generate fiscal revenue. That is being exacerbated by declining production volumes. It is estimated that nearly half (Spanish) of Ecuador’s projected 2021 oil output of 481,721 barrels per day is required to meet those obligations, leaving only 260,740 barrels per day able to be sold and generate government revenue. Despite the optimism surrounding the outlook for Ecuador’s beaten down oil industry after Lasso’s electoral victory, recent events point to the considerable difficulties associated with expanding the Andean country’s petroleum production. They demonstrate that Lasso will struggle to increase oil output let alone double production before the end of his term in 2025.

By Matthew Smith for Oilprice.com

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