Amid falling production, Latin American oil is caught in the doldrums

By Sjoerd ten Wolde

Latin America’s oil industries, long seen as a relatively safe investment, are now caught in a squeeze between low oil prices, intra-hemisphere competition, corruption scandals, and increasingly vocal local communities. Despite a recent surge in production in some countries, all major producers are struggling to get more oil out of the ground.

Over the past decade, small oil producers like Colombia and Brazil have been circling like sharks around Venezuela and Mexico, Latin America’s two prime producers, where production has steadily fallen.

In the case of Colombia, streamlined regulations attracted investors, while Brazil betted heavily on its offshore industry and the promise of pre-salt layers. Compensation by smaller producers partially offset the decline in Latin American oil production, but extraction still fell from almost 11 million barrels per day in 2004 to 10.2 million barrels per day in 2013. Other minor producers such as Peru and Argentina had largely stagnant or slightly falling production.

The democratic dilemma

The principal problem facing minor producers is that they are squeezed between politics and economics. From a company’s point of view, crude in these countries is relatively expensive to get out of the ground. This is all the more salient now that have oil prices have dropped to below $60 per barrel, a point at which countries like Brazil are operate below cost oil price.

But while the economics leave little room for maneuver, democratic politics is increasingly asking for a larger share of the pie and less pollution. Though imperfect, most minor producers have stable and well-functioning democracies, where one cannot simply bypass environmental concerns and local communities. As a result, environmental regulation, community consultation, and local-content laws have been made more stringent in most countries.

In Brazil, for example, local-content requirements have grown steadily over the past decade, as the call for involving homegrown industries has grown louder. While this has generated a nascent offshore-centered industry, producing high-quality products such as ships and drilling parts, it has also added to the country’s already high production costs.

With Brazil’s civil society already agitated, the government is unlikely to soften conditions.

A new balance

In recent years, Colombia, Ecuador and Peru have adopted consultas previas, giving local communities a pseudo veto on projects in their territory. This procedure has shifted the balance of power towards local inhabitants, and it is likely to make oil production in those places a more responsible and harmonious business.

But the drawn-out consultas have also slowed down licensing, and the demands that communities make, such as schools and infrastructure, can weigh heavily on production costs. Partly as a result of these problems, oil production in Colombia has been tapering off recently.

At the same time, Latin America’s courts, long slanted in favor of multinationals, have issued a number of rulings against multinationals. Ecuador’s courts ruled against Chevron for not cleaning up after oil spills in the region of Lago Agrio, though the Ecuadorian state was never able to seize any assets, as the US Supreme Court deemed the evidence corrupted.

And recently, Occidental Petroleum came to a settlement with Peru’s indigenous Achuar tribe after it seemed like Occidental was about to lose a legal battle over local pollution. Such rulings are likely to have a positive bearing on oil companies’ environmental behavior, but also make production more costly, as safety and environmental standards have to be increased.

These examples illustrate the current dilemma Latin American governments face. Civil society is increasingly critical of the terms under which oil is drilled, but under the current oil prices, drilling for oil is simply not attractive for oil companies.While some national oil companies, such as Ecopetrol, increasingly have advanced technical capabilities, this is not enough to exploit the more difficult reserves needed to sustain and increase production.

But ignoring local communities is increasingly costly for governments as well. The Ecuadorian government’s decision to drill for oil in the Amazon region of ITT-Yasuní has provoked widespread protest, and is likely to remain a sensitive topics for years to come.

Caught in the doldrums

At the same time, Latin America’s prime producers, Venezuela and Mexico, have seen their production decline precipitously over the past ten years.

In Venezuela’s case, this is primarily the result of bad and politicized management of its national oil company PDVSA, as well as Hugo Chávez’s wave of nationalization, leaving PDVSA to fill the void. With Venezuela’s current political and economic turmoil, oil production is unlikely to go up anytime soon.

Mexico’s decline was driven primarily by the incompetence of national oil company PEMEX, in combination with declining oil fields, little investment, security issues, and laws that prevent foreign oil companies from production sharing. With a comprehensive energy reform pushed through last year, however, the tide may be turning.

The Mexican government is now auctioning off both onshore and offshore blocks to foreign companies. This is likely to boost production, although many obstacles remain. Many blocks are still in the hands of PEMEX, Mexico’s security situation is difficult, and not all secondary legislation is hashed out yet. Moreover, investors are less likely to take on large risks with the current low oil price.

Low oil prices will not be a permanent feature of the hydrocarbons industry and demand may soon surge again. But Latin America’s democratic oil dilemma continues to exist. Though the region’s countries will keep on producing oil, most of them are unlikely to become more than fringe producers.

This may be for the best, as community and environmental concerns are more respected these days. One way out of the dilemma, though, is would be for Latin American countries to provide the same political and institutional certainty as the developed countries. But this is unlikely to happen anytime soon.

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