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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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Ecuador Looks To Double Its Oil Production

The oil-dependent South American country Ecuador, which left OPEC in January 2020 to avoid production quotas, has embarked on an ambitious plan to double its oil output. The tiny Andean nation with a population of nearly 18 million has struggled for years to grow its hydrocarbon sector as a means of bolstering a fragile economy that has been hit hard by the COVID-19 pandemic with its 2020 gross domestic product shrinking 7.5%. For decades, Ecuador has struggled to boost oil production with heavy-handed regulation, frequent environmental catastrophes, and endemic corruption weighing heavily on industry operations. After a surprise electoral victory, where millionaire banker Guillermo Lasso defeated leading socialist candidate Andres Arauz, a sense of optimism over the outlook for Ecuador’s beaten-down petroleum industry emerged. 

Last month, Lasso signed Executive Decree 95 (Spanish) authorizing various actions to expand Ecuador’s flailing oil industry and bolster production. This forms part of the president’s plan to rebuild Ecuador’s shattered economy by doubling the Andean country’s crude oil output, although he has his work cut out for him. During June 2021 Ecuador pumped on average 473,555 barrels of crude oil per day which was 8% lower than the same period a year earlier and significantly less than the one million barrels per day targeted by Lasso. Ecuador’s petroleum output has essentially been stagnant for decades with its June 2021 production not much higher than the 420,000 barrels per day pumped during 2003.

Source: Ministry of Energy and Non-Renewable Natural Resources.

Ecuador’s proven crude oil reserves have also flatlined, remaining stuck at around eight billion barrels since 2016. 

The key to significantly increasing Ecuador’s petroleum output is attracting urgently needed investment in the Andean country’s beaten down hydrocarbon sector. Under the changes implemented by Lasso’s predecessor Moreno, state-owned petroleum companies Petroamazonas and Petroecuador merged to simplify operations and unlock synergies as part of the effort to rationalize the hydrocarbon sector. Moreno also embarked on a series of industry reforms aimed at attracting greater private investment. Among the most important developments was the reintroduction of production sharing contracts to replace the flat fee service agreements that former President Rafael Correa ushered in during 2010 to replace them. This was because production sharing agreements allow oil companies to access reserve-based lending, thereby giving them greater capital to develop their operations. Correa’s fee-based contracts were a major deterrent to petroleum investment causing it to fall by a whopping 44% between 2010 and 2017 according to government numbers. 

Lasso announced the introduction of risk-sharing agreements which will allow petroleum companies to recoup a portion of the capital invested to develop energy assets from oil sales. Those contracts also offer greater operational independence and financial upside than existing agreements. This decision, Ecuador’s national government in Quito hopes, will act as a powerful incentive to attract urgently needed private investment in Ecuador’s beaten-down hydrocarbon sector. Lasso also proposed creating a new crude oil grade for export aimed at attracting new customers.

A serious problem is that Ecuador’s two main export crude oil varieties Napo and Oriente are heavy and sour which is makes them increasingly unpopular among refiners, particularly in Asia, because they are more difficult and costly to process. The declining popularity of heavier sour crude oil grades, notably in Asia which is a global shipping hub, was further accelerated by the January 2020 introduction of IMO2020 which sharply reduced the sulfur emissions of maritime fuels.

Napo is heavy and very sour with an API gravity of 19 degrees and 2% sulfur content, while Oriente is a medium sour variety with an API gravity of 24 degrees and a sulfur level of 1.4%. Oriente accounts for around two-thirds of Ecuador’s oil exports with the remainder comprised of Napo. Any move by Quito to introduce a lighter sweeter export variety will boost oil exports, particularly to the key Asian refining market, where China surpassed the U.S. during 2020 to become the world’s largest refiner. 

Quito is also working on boosting production from existing oilfields operated by national oil company Petroecuador. The state-controlled energy company is drilling wells in the Sacha oilfield, one of Ecuador’s most important, to bolster petroleum output by around 3,000 barrels per day which will see the field on average pump over 640,000 barrels each day. Petroecuador is also subject to a series of reviews aimed at identifying how to improve operations and eliminate corruption with the company embroiled in a series of bribery scandals over the last decade. 

To reduce community dissent, notably within Ecuador’s Amazon Basin where most oil reserves and industry operations are located, Lasso announced the introduction of a sustainability fund. The fund, he claims, would see some petroleum revenue spent on social programs within the communities close to Ecuador’s oilfields which are some of the Andean country’s poorest. Those communities have also been subject to significant environmental degradation with oil spills and flaring regular occurrences in Ecuador’s Amazon.

The SOTE and OCP pipelines were fractured by landslides during April 2020 spilling nearly 16,000 barrels of crude oil into the Coca River and surrounding countryside. This was Ecuador’s worst spill in decades and crude oil threatened to contaminate the water supply of the city Coca and flowed into the Napo River a tributary of the Amazon. Due to further land subsidence in the region, Petroecuador is working on diverting segments of the SOTE pipeline and similar work is being conducted on the OCP pipeline which is owned by a private consortium of foreign energy companies. This should lessen the risk of further pipeline ruptures which not only caused substantial environmental damage but led to Ecuador’s April 2020 petroleum output plunging to 208,602 barrels daily.

Lasso’s oil industry initiatives will build on the reforms undertaken by his predecessor Moreno and make investing in Ecuador’s troubled hydrocarbon sector far more attractive for foreign energy companies. The introduction of risk-based production sharing agreements is a key step in securing the required investment and boosting oil production. Quito’s latest reforms will also lead to greater industry efficiency while dialing down community opposition, further enhancing the investability of Ecuador’s petroleum industry. Nonetheless, reaching one million barrels per day within five years is an ambitious and potentially unachievable target. Ecuador’s ailing petroleum industry has been impacted by corruption scandals, environmental catastrophes, and heavy-handed state intervention for over a decade. Those events have discouraged foreign investment and led to a sharp deterioration in performance and the viability of industry infrastructure, including crucial oil pipelines and refineries.

By Matthew Smith for Oilprice.com

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