Saturday, December 04, 2010

Ecuador Renegotiates Contracts with Foreign Oil Companies

Sources:
Economist.com: If it Ain’t Broke…
Elciudadano.gob.ec: Presidente Correa: Renegociación de contratos petroleros fue todo un éxito
FT.com: Quito Takes Over Petrobras Fields
Reuters.com: Ecuador in Final Stage of Oil Contract Talks
Telegrafo.com: Termina renegociación de contratos petroleros

The government of Ecuador recently finished negotiations with foreign oil producers to help maximize its profits in the country’s most lucrative business. The new contracts completely change the rules of business for the oil sector. Now, instead of being forced to pay over a percentage of their profits to the national government through taxes, foreign oil companies will become service providers—meaning they will be paid a set price for each barrel of oil they extract, with most agreements requiring that the government pay about $35 per barrel. The national government will then keep the profit above that amount, ensuring that the government will profit when oil prices increase. This has lead President Rafael Correa to claim that the negotiations were a resounding success, though it has been hard for the companies to swallow, and has even pushed Brazil’s national oil company Petrobras to end production in Ecuador.

The process of changing the way foreign oil companies do business in Ecuador began earlier in the decade when oil prices first exceeded $70 per barrel. The previous set of oil contracts, signed in the mid-1990’s, gave the government the rights to 17-27% of the first $15-$17 in revenue for each barrel of oil sold; a paltry figure considering today’s oil prices. In 2006, the government added an additional 50% tax on oil company’s profits above the contract cut-offs as oil prices began to soar. In 2008, that tax was increased by the current government to 99% when oil prices reached record levels of nearly $150 per barrel. That year the government also seized the oil fields from the French company Perenco over a tax dispute, further straining relations with foreign oil companies.

Since the first change in 2006 the foreign oil companies have been wary of the government. Some companies threatened international arbitration over the changes, though little more than posturing ever happened. Unfortunately for the government, its actions have all but halted exploration and investment in the national oil sector because companies fear being kicked out of the country like Perenco. The number of barrels of oil produced per day in Ecuador has dropped from 255,000 to 162,000 just since President Correa took power in 2007. That drop has cost the country $2.3 billion per year at current prices.

Ecuador hopes the trend of declining oil production will reverse in light of the new contracts. In theory, the companies will no longer be concerned about losing their investments entirely through expropriation and will therefore expand production and exploration activities. If that is coupled with an increase in global oil prices, a prospect Ecuador is surely banking on, Ecuador’s profits from the new contracts could be enormous. However, when coupled with the country’s 2008 international debt default of $3.2 billion, the new contracts could further drive down foreign investment in a country that is already lagging behind its Latin American peers in that category, which would continue to be a drag on growth.

Discussion:
1) President Correa claimed that the new contracts will ensure that oil profits go to the people that own the oil—the Ecuadorean people. How might foreign investors react to this statement?
2) Though Ecuador’s economy is expected to grow by about 3% this year, ever other country in Latin America (excluding Ecuador’s oil dependent neighbor, Venezuela) is booming with much higher growth rates and levels of foreign investment. Considering that foreign investors were already wary of investing in Ecuador because of the 2008 default, is this the right time for Ecuador to have a major shakeup in its largest industry?

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