Research ProjectResearch ProjectDeterminants of the Evolution of Determinants of the Evolution of the Hydrocarbons Sector in LACthe Hydrocarbons Sector in LAC

Osmel Manzano and Francisco MonaldiCoordinators

Kick-off Seminar IESA, Caracas, October 1st, 2007

Project Objectives

• Analyze how determinants such as: economic variables, political and institutional variables, and technological and endowment variables; have influenced the development of the oil and gas sector in LAC.

• An alternative way of organizing the analysis is to understand how external variables (technology and world markets) have interacted with domestic (institutions, endowment, etc.) to influence the evolution of the sector

• Developing cases studies to understand the presents situation and history of the sector in nine key countries of the region, and make a comparative analysis based on these studies

Project Activities

• Kick-off seminar, October 2007

• First full drafts, January-February 2008

• Comments to first drafts, March-April, 2008

• Conference, presentation of second drafts, May-June 2008, Caracas

• Final Draft July 2008

•Two publications one in English, one in Spanish (IESA) :

• Nine case studies plus comparative chapters

THE POLITICAL ECONOMY OF HYDROCARBONS EXPLOITATION IN

LATIN AMERICA

Osmel Manzano and Francisco Monaldi

Kick-off SeminarIESA,Caracas, October 1st, 2007

Motivation

• The 1990s: In many countries of the region, the oil sector was opened toprivate investment and privatized, investment significantly increased, in most cases driven by private companies

• 2002-2005: A new wave of resource nationalism in Latin America, withincreases in government-take and state control

• Historically the evolution of oil & gas production in Latin America has seen cycles of investment and expropriation

Motivation

• Political economy factors explaining these patterns:

• Prices of oil & gas

• Net exporting countries, rents and fiscal revenues (Bolivia, Ecuador, México, Venezuela)

• Taxation systems are typically not progressive

• Existence of high sunk-costs

• Net importers or countries with declining reserves have incentives toprovide attractive investment conditions (Brazil, Colombia, Perú)

• Managing of resource wealth & volatility of government expenditures

Political Economy ofOil Exploitation

Features of oil production and its implications

• Significant rents in oil extraction (and to lesser extent in natural gas extraction): Production cost in the region from $1 to $15

• Sunken investments: exploration, production wells, pipelines, etc.

• High proportion of oil reserves in countries with weak institutions andhigh political risks:

• Commitment and property rights

• Reputational costs, expropriation and investment cycles

• Expropriation and the discount rate of politicians

Political Economy ofOil Exploitation

Features of oil production and its implications (Cont.)

• High geological risks involved in exploration: Ex-ante and ex-post government incentives.

• Oil products are massively consumed and therefore politically salient: Politicians are pressured to avoid significant increases in domestic energyprices. To note, oil products (inelastic) and consumption taxes.

• International oil prices are highly volatile: Impact on oil dependantexporting countries.

Political Economy ofOil Exploitation

Institutional Framework

Political Economy ofOil Exploitation

Tax and contractual framework

• Tax regime: Typically includes a mix of signing bonuses, royalties andincome taxes

• Contractual regime:

• Concessions: The producer has the ownership rights over the oil field

• Risk-service contracts: The service provider receives a fee related tothe price of oil

• Production sharing contracts: The state receives a share ofproduction

• Joint ventures

• Technical assistance contracts

Political Economy ofOil Exploitation

Indicators to analyze the tax and contractual framework

• Tax and contractual regimes determines the government take: Portion of the net present value that the State appropriates

• Operator take: Portion kept by the operator

• Effective royalty rate: Minimum proportion of annual revenues that the government takes in a given year

• Duration of the concession or contract

• Domestic prices

• Conditions to export

• Dispute resolution mechanisms

• NOCs: Governance structure, private stockholders, autonomy

Political Economy ofOil Exploitation

Some Criteria for evaluating the contractual tax framework

• Neutrality

• Progessivity and rent capture

• Competitiveness

• Simplicity and transparency

• Incentives to limit costs

• Fiscal income stability

• Credibility / Commitment

• Use as tool coordinating price floor

Political Economy ofOil Exploitation

Actors and Incentives (Government)

Net Exporters

- The government maximizes rent extraction from oil exports. Depending among other factors on: (i) discount rate of politicians’, (ii) level of the country’s oil reserves, and (iii) future market expectations

- The government is typically reluctant to privatize NOCs, as they can more easily extract revnues fromthese than private companies

- Governments have the upper hand in their negotiation with IOCs when the price on oil goes up andonce the investment cycle matures

Net Importers

- Governments are skewed towards increasing investment and production, providing more attractiveterms

- Rent extraction is less attractive, bacuse production is domestically consumed

- Typically offer fewer subsidies to the domestic consumption of energy

- Governments are typically more willing to privatize their NOCs. Since they do not obtain external rentsand can more easily generate net losses

Political Economy ofOil Exploitation

Actors and Incentives (NOCs & IOCs)

National Oil Companies (NOCs)

- NOCs managers generally have different incentives from their governments

- NOC management’s incentives depend significantly on the company institutional and governance structure

- The political costs for the government of expropiating the NOC will depend on how autonomous andinstitutionalized the company is and how discretional the fiscal regime is

International Oil Companies (IOCs)

-There are only few relatively small domestic oil companies in the region

- The IOCs maximize global profits, typically with longer horizons than those of the developing countriesgovernments’

- Provide capital know-how, technology, and human capital in exchange for oil profits

- After the rise of the independent oil companies and the increase in the sovereignty of many developingproducing areas in the 1960s, the capacity of external enforcement greatly diminished

Political Economy ofOil Exploitation

The Latin American Oil and Gas Sector (Reserves)

Proven Natural Gas Reserves

(trillion cubic meters)

1985 1995 2005

Argentina 0.7 0.6 0.5

Bolivia 0.1 0.1 0.7

Brazil 0.1 0.2 0.3

Colombia 0.1 0.2 0.1

Ecuador 0.0 0.0 0.0

Mexico 2.2 1.9 0.4

Peru 0.0 0.2 0.3

Venezuela 1.7 4.1 4.3

Total 4.9 7.3 6.7

Proven Oil Reserves

(billion barrels)

1985 1995 2005

Argentina 2.2 2.4 2.3

Bolivia 0.0 0.0 0.0

Brazil 2.2 6.2 11.8

Colombia 1.2 3.0 1.5

Ecuador 1.1 3.4 5.1

Mexico 55.6 48.8 13.7

Peru 0.6 0.8 1.1

Venezuela 54.5 66.3 79.7

Total 117.4 130.9 115.1

Source: BP Statistical Review of Energy 2006 Source: BP Statistical Review of Energy 2006

Political Economy ofOil Exploitation

The Latin American Oil and Gas Sector (Oil Production)

Source: BP Statistical Review of Energy 2006

Political Economy ofOil Exploitation

The Latin American Oil and Gas Sector (Gas Production)

Source: BP Statistical Review of Energy 2006

Political Economy ofOil Exploitation

The Latin American Oil and Gas Sector (Rig Count)

Source: Baker Hughes (August 2006)

Political Economy ofOil Exploitation

The Latin American Oil and Gas Sector (Institutional Indexes)

Source: IDB 2005

Source: World Bank 2005

Some Country Cases

• Venezuela:

• Cycles of high investment in 1940-1958 and 1992-2003; followed by contract renegotiation (including nationalization).

• PDVSA went from being highly autonomous to have very little autonomy

• México:

• Nationalization and decline in 1930’s (endowment or expropriation?)

• PEMEX’s has had low autonomy

• Ecuador:

• Volatile institutional framework

• Petroecuador has low autonomy

Some Country Cases

• Brazil:

• Institutional reforms to promote private investment, autonomy of Petrobras

• Successful reduction of foreign energy dependency

• Colombia:

• Recent decline in reserves

• Investor-friendly institutional framework

• Perú:

• Institutional framework to attract investments / tax stability

• Natural gas reserves create new incentives

Some Country Cases

• Bolivia:

• Success of opening in adding gas reserves

• Contract renegotiation

• Argentina:

• Success of opening in increasing production

• Contract renegotiation

• Trinidad:

• Significant success in developing LNG industry

Concluding Remarks

• The institutional framework of the hydrocarbon sector in LAC has suffered important transformations in the last two decades. A trend towards resource nationalism has returned, but some countries have a different policy orientation

• In general taxes have been increased, generally a result of lack of progressive tax systems.

• These situations reflect the particulars of the oil sector, which is characterized by highly specific investments and a volatile prices in a context of a region with weak institutions

• It is important to design better institutions and policy instruments for the sector, in order to avoid the cycles of investment and expropriation in the future