Highlights
– New decree forces foreign oil companies to pay 99 percent of their windfall profits
– Ecuador’s output is declining
– Correa turns to Chavez for assistance
Private oil companies in Ecuador used to deal with the normal threats to the oil industry, kidnappings of workers or sabotage of installations for example. For the past year, and now more than ever, foreign oil investors in Ecuador have had to worry about a new threat: President Rafael Correa. Inspired by Venezuelan leftist policies, the President has been focusing on foreign oil companies in a gamble that likely will lead to further falls in oil output.
A New Decree
As Latin America’s fifth-largest oil producing country, foreign companies account for nearly half the oil production in Ecuador (approximately 265,000 barrels a day). The other half is state run and hampered by mismanagement and approximately US $15 billion foreign debt. In April 2006, the then-government of president Alfredo Palacio passed a law that required foreign oil companies to increase contributions of windfall oil profits to the state from 30 to 50 percent. Foreign oil companies complained and many have yet to pay the extra percentage, accounting for almost $320 million according to government officials. Those royalties are due by the end of this month, and the government has threatened sanctions or worse if the fees go unpaid.
On October 5, 2007 Correa also signed a decree giving the state a greater share of profits from foreign oil companies. According to the decree, foreign oil companies must now give 99 percent of their windfall profits to the state, a move that would increase government income by US $828 million a year.
Though the timing of the latest decree came as a shock to the industry, Correa’s actions are not. Correa’s decision is not unlike the radical measures implemented by Venezuelan President and ally Hugo Chavez. In fact, Venezuela’s government will advise Ecuador on the negotiations for new contracts. The latest hike is a virtual nationalization of the oil sector (Previous Report).
By signing this new decree, Correa has almost guaranteed non-payment of the original royalties and the beginning of a long legal battle with the multinational oil conglomerates. While most of the foreign oil contracts were set to expire in 2012, Ecuador will likely push to renegotiate or even eliminate existing contracts in the near-term, especially if the oil companies refuse to pay “government-owed” arrears. However, by taking such a firm stance, Correa may do more harm than good.
Output Woes
Ecuador’s oil exports have been on a steady downward slide over the last years. Even with the international average price of crude on the rise, Ecuador, from January through August 2007, showed an 8 percent decrease in revenue from the same period 2006. Overall output was down 8 percent as well. The combination of legal battles with the private industry and decrepit, poorly managed state-run facilities has decimated Ecuador’s ability to generate decent revenues from its oil sector. Hence, the new decree. But instead of increasing revenues, Correa will only find himself in long-legal battles and negotiations. The decree will also likely deter further foreign investment in the oil sector.
To offset the impending losses, Correa has already turned to Hugo Chavez for support and the two have signed oil-refining deals in which Venezuela will refine Ecuadorian oil (approximately 100,000 barrels a day) while simultaneously building the necessary refinery infrastructure in Ecuador. Ecuador has little refining capability and imports petroleum-based products, principally from the US.
There are several problems with the Chavez solution. First, it is a long-term solution, with only modest assistance in the short-term. Secondly, with charges of executive corruption and poorly managed production operations, Venezuelan state-run oil has its own internal management problems. Strategic planning, research and development, and production are at their lowest levels in Venezuela since the 1970s and yet the promise assistance in building Ecuadorian infrastructure when it seems they can hardly hold themselves together (Previous Report). Venezuela has seen a decrease in production and we expect an even larger decrease in production into 2008.
A Look Forward
Unfortunately for the people of Ecuador, it seems that Correa is allowing so-called political loyalty to trump industrial efficiency. Correa is systematically developing a national oil industry in Ecuador, much like that of Venezuela, that will depend not on innovation, production, and good management but on the gambit that oil prices will continue to rise. Though oil prices have been on the steady rise we believe that the price will not reach the level needed by these nations to fully sustain their oil infrastructure and maintain high output levels at their current low levels of operating efficiency.
The leftist movement in Latin America however, will continue to influence key economic decisions in the near-term that may prove to have devastating long-term effects for nations, such as Ecuador, that depend on oil profits for a huge proportion of their economic revenue.