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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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Is This The Beginning Of The End For Ecuador's Oil Industry?

Major energy companies are becoming increasingly sensitive to drilling in high-risk environments such as the Arctic, Barents Sea and the Amazon Basin. A combination of highly volatile oil prices, a prolonged global supply glut, the arrival of peak oil demand, the push to decarbonize the world economy and growing environmental consciousness makes drilling in those locations costly and risky. One environmentally sensitive region which has been at the center of oil exploration and production for decades is Ecuador’s section of the Amazon Basin. This region is responsible for most of the Andean country’s eight million barrels of oil reserves and production.

Since the 1970s, when the petroleum industry became Ecuador’s economic engine, it has suffered significant environmental degradation attracting considerable ire from local indigenous communities. Latest events, including Ecuador’s presidential election, have sparked considerable apprehension that not only will recent industry reforms be rolled-back, but economically crucial oil operations could be wound down. This would once again make Ecuador a highly unattractive jurisdiction for foreign energy investors, preventing the investment of urgently needed capital for infrastructure refurbishment and oil field development. Such an outcome would make it near impossible for Ecuador to continue using crude oil to drive its economy while potentially exposing its Amazonian region to greater environmental harm over the short-term.

The unpopularity of Ecuador’s oil industry and rapidly deteriorating social license is underscored by growing protests against its operations and legal action from Amazonian indigenous communities. This can be blamed on significant damage to sensitive and highly biodiverse local environment. The worst incident, in roughly two decades, was the April 2020 15,000-barrel oil spill into the Coca River after landslides ruptured the Oleoducto de Crudos Pesados (OCP) and Sistema de Oleoducto Transecuatoriano (SOTE) pipelines. Those crucial pieces of energy infrastructure connect Ecuador’s Amazonian oilfields to the Pacific port city of Esmeraldas. The spill endangered the city of Coca’s water supply and spread into the Napo River, an Amazon tributary. In response, indigenous communities launched legal action against the oil companies involved and Ecuador’s national government. In September 2020, this was dismissed by the Provincial Court of Orellana, the department in Ecuador’s Amazon where the spill occurred. In December 2020, the indigenous Waorani people filed a lawsuit against Chinese government controlled PetroOriental for environmental damage caused by flaring of natural gas at their oil producing blocks. During November 2020 there was yet another oil spill, this time from a Petrobell pipeline crossing the Shiripuno River in Ecuador’s Orellana Province. That spill, it is alleged, was only cleaned up two months after it occurred. 

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Oil spills are plaguing Ecuador’s Amazon and can be attributed to geological instability, climatic events, poor pipeline maintenance and a lack of regulatory oversight. These incidents are generating substantial resentment among local indigenous communities toward the central government in Quito and the oil industry, including private operators. Ecuador’s oil industry has been dogged for decades by environmental catastrophes, corruption and malfeasance, which according to some industry insiders worsened under the administration of President Correa who was in office from 2007 to 2017. The most prominent environmental disaster were allegations that Texaco dumped up to 428 million barrels of crude oil and toxic waste in Ecuador’s Amazon during its decades of operations in the region. 

There could be a reckoning ahead for the Andean country’s petroleum focused growth model embraced by former President Rafael Correa and current President Lenin Moreno. Ecuadorean indigenous environmental lawyer Yaku Pérez, who is campaigning on an anti-commodity extraction pro-environment platform, last week recorded a stronger than expected result in the first round of Ecuador’s presidential elections. Perez is neck-in neck with conservative banker and third time presidential candidate conservative former banker Guillermo Lasso. A close vote tainted by allegations of fraud makes it unclear who will run-off against left-leaning economist Andrés Arauz, a relative of former President Correa, who won the first round with 32% of the vote falling short of the 40% needed to win the presidency outright. If Perez wins the election, he will be Ecuador’s first indigenous president. His party Pachakutik, which represents Ecuador’s indigenous population and the environment offering a leftist anti-commodity extraction alternative to Ecuador’s traditional leftwing, is experiencing a notable increase in popularity. After the 2021 National Assembly elections, Pachakutik held 27 seats, or more than five-times the seats held before the vote. Perez and his party’s sudden rise in popularity highlights rising domestic disquiet with Quito’s petroleum focused policies and growing awareness of the damage being done to the Amazon.

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The appalling state of Ecuador’s petroleum industry is not only highlighted by corroded pipeline infrastructure, lax regulation and regular oil spills as well as other hazardous emissions but also by the deterioration of the country’s refineries. Ecuador’s most important is the 110,000 barrel per day Pacific coast Esmeralda’s refinery. The facility operates intermittently despite a 2016 $1.2 billion refurbishment, which was tainted by allegations of serious corruption, and considerable investment in critical maintenance. The deterioration of the refinery’s processing capabilities is illustrated by its inability to produce IMO2020 low sulfur content maritime fuel nor high-quality gasoline or diesel. Regardless of Ecuador’s copious eight billion barrels of oil reserves the Andean country lacks sufficient refining capacity to meet domestic gasoline and diesel demand. To address those issues, Moreno’s government reformed the economically vital hydrocarbon sector and sought tenders from private energy companies to take control of the Esmeraldas refinery on the condition that they undertake the significant investment required to make the facility fully functional. A proposal is expected later this month from a consortium led by South Korea's Hyundai and US engineering contractor KBR for the $3 billion 25-year lease. The scale of Ecuador’s crisis is underscored by claims that national oil company Petroecuador, which absorbed state-controlled upstream producer Petroamazonas earlier this year, needing to purchase (Spanish) 7.5 million barrels of crude oil during 2022 if it is to meet its contractual supply obligations. In another blow for a fiscally fragile Quito and the country’s environmentally crisis-prone petroleum industry three major European banks BNP Paribas, Credit Suisse and ING, have committed to cease funding the trade of oil from Ecuador’s Amazon.

Ecuador’s latest elections threaten that process as well as Moreno’s broader petroleum industry and economic reforms. Leading presidential candidate Arauz is a protégé of former President Correa who implemented a range of policies focused on resource nationalism and wide-ranging state intervention in the economy. According to an Argus article from earlier this month, Ecuador’s business sector fears that if Arauz is elected he will rollback Moreno’s pro-business policies and economic reforms including changes to the economically vital petroleum industry and re-embrace a form of leftist populism. It was Correa’s earlier policies that were responsible for the sharp increase in corruption and mismanagement that accelerated the deterioration of Ecuador’s oil infrastructure and made the country’s energy sector unpopular with foreign investors.

By Matthew Smith for Oilprice.com

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