Background: Oil prices have plunged in the last 18 months. Yes, they rebounded sharply on January 21 and 22, but the uptick is far from cleaning the mess. After WTI crude prices fell to a 12-year low of $26.55 on January 20, they surged and closed the trading week at $32.25 per barrel. That is a 21.5% upturn in about 48 hours. That is how volatile prices have been. But the comeback is recent. Long-run figures still look scary:
Crude Oil -Electronic (NYMEX) March 2016- Performance*
* As of January 24, 2016.
With the $100-a-Barrel Era gone for a while, how are Latin American countries coping with the new normal?
BRAZIL. This country is the 9th largest oil producer in the world. But it is also the 8th largest consumer, according to the U.S. Energy Information Administration (EIA). The South American giant has boosted oil output in the last two decades, but it is still a net importer and will partially benefit from price declines. According to the EIA’s 2014 numbers, Brazil’s consumption of oil and related fuels was 3.2 million b/d and output was 3.0 million b/d. However, this does not mean that state-owned Petrobras navigate through calm waters. Production costs in Latin America’s biggest economy are among the highest in the world, estimated at $48.8 per barrel. The world’s largest oil discoveries in recent years are in Brazil’s offshore, pre-salt basins. Pre-salt extraction is expensive, as it is situated deep under thick layers of rock and salt, requiring substantial investment. According to Petrobras, from 2010 to 2014, the average annual daily pre-salt production grew almost 12 times, from an average of 42K barrels per day in 2010, to 492K barrels per day in 2014. This figure account for about 20% of total production, and in 2018 it is expected to reach 52% of output, further increasing average extraction costs.
High costs, corruption scandals, and currency depreciation—the real is down nearly 50% since mid-2014—are severely hurting Petrobras and raising questions on the company’s capacity to honor its debt. On November 18, 2015, Bloomberg published a note titled “Petrobras’s Dangerous Debt Math: $24 Billion Owed in 24 Months”. The title is self-explanatory: Petrobras has massive debt and will struggle to pay it if prices do not rebound soon or its divestment plan accelerates drastically (unlikely). On October 12, Morgan Stanley published a note arguing that without extraordinary measures like asset sales, Petrobras could run out of cash by the end of 2016. And that was back in October, when oil prices were at $45.54 per barrel, not $32.25.
In November, Petrobras had a $128 billion debt—84% of it in foreign denomination, making it the most indebted oil company in the world. Things could get pretty ugly for the oil behemoth. To help Petrobras whether the storm, the government could free the company from a policy of fixed gasoline and diesel prices. But the political cost of doing so abruptly is high—especially with inflation currently running at an annual pace of 10.74%, which is well above the central bank target of 4.5% ± 2%. Expect more news later this year, as the company’s yields keep deteriorating and a government credit line (or bailout) is gaining likelihood.
MEXICO. The country is in the midst of opening the sector to private investment. Probably not the best time to do so. But life happens and the government will stick to its auctions agenda as planned. Reasons: (1) government credibility is at stake; (2) Mexico has low production costs, making it attractive for multinationals to incorporate these reserves to their books; (3) oil prices will likely recover by the time the first deep-water barrel is extracted; (4) domestic output is rapidly declining, so any long-run boost is more than welcome; and (5) additional fiscal revenues are welcome too, of course.
This said, the bidding process will surely be less sexy than expected. But there is life beyond the sector’s opening to private capital, and Pemex needs to adapt to a challenging scenario. Its CEO declared in Davos, at the WEF, that the state-owned company’s production costs are among the lowest in the world. Moreover, he declared on January 18 that “for Pemex, the average cost of production at the fields already established is slightly less than $10 per barrel.” However, costs at new deposits are estimated at $23 per barrel, which compromises much-needed investment to curb declining production.
For 2016, although half of Mexico’s oil output is hedged at around $44 free of fees, production decline hurts real economic activity. Oil used to account for 33% of Mexico’s fiscal revenue, but the figure is quickly declining and now about 20%. Although fiscal reform has boosted tax collection, some of the missing revenues have been filled with additional government debt, which has escalated since President Peña Nieto assumed office. A prolonged decline of oil prices (beyond 2016) could deeply hurt government credibility. This topic will heat up later in the year.
VENEZUELA. Oh, boy. President Maduro decreed “economic emergency” on January 15. According to OPEC, Venezuela’s oil revenues account for about 95% of export earnings. The oil and gas sector is around 25% of gross GDP. No wonder why the economy is contracting at a 7% rate and why President Maduro insists on an extemporary OPEC meeting, which has not been granted. This oil romance was destined to fall out of grace sooner rather than later. The commodity cycle is cruel and Venezuela forgot past regional lessons—like Mexico’s default in the 1980s. Venezuela’s outlook looks grim, as the stickiness of the domestic price of gasoline eliminates the option of boosting domestic sales.
The chances of sovereign debt default are closely tied to oil prices. If they remain depressed through mid-2016, Venezuela could stop honoring its debt by yearend, as maturities pile up. Venezuela’s reserves currently stand at a 12-year low of $14 billion, according to official data. The central bank has sold gold reserves and Special Drawing Rights (SDR) with the International Monetary Fund (IMF). Venezuela’s 5-year credit default swap (CDS) —debt insurance— spiked to over 5,000 after President Maduro’s “economic emergency” announcement. This means that markets are pricing the chances of default at over 50%. UBS is one of the most bearish on Venezuela, predicting that the country has an 82% chance of defaulting within a year. Bad news keep feeding the negative feedback loop the economy is immersed in. If oil prices do not make a stellar comeback soon, the recession could quickly turn into a depression.
COLOMBIA. The country doubled its crude oil production between 2008 and 2013, result of the 2003 regulatory reform. Output now surpasses 1 million barrels per day, placing Colombia among the world’s top 20 producers. This output is not as big as Mexico’s or Brazil’s, but the share in GDP is higher in Colombia than in those countries—although it is still lower than in Venezuela or Ecuador. Oil is Colombia’s No. 1 export and source of U.S. dollars, and it accounts for around 20% of government revenue.
The decline in oil prices is a serious concern for public finances. Colombia relies on a fiscal rule that buffers the adjustment to shifts in oil prices. According to the IMF, “the fiscal deficit will widen with the fall in oil-related revenues.” The Fund recommends raising non-oil revenues to reach the legal targets for the structural fiscal balance—a move that Mexico implemented just before the oil rout began, although the imbalance persists. In response to the oil rout, Colombia plans to increase the frequency of oil license auctions to at least two a year and offer bidders more data and fewer rules. The first auction under the new rules is scheduled for March. Much needed to relief fiscal strains.
ARGENTINA. The country recently claimed a billion-barrel shale oil find in the Vaca Muerta formation. Optimistic forecasts point to 6 billion barrels of shale oil. However, the estimated cost to extract this oil is about $84 per barrel, according to Chevron—associated with state-owned YPF in the project. Current prices make shale extraction in Vaca Muerta unprofitable. But aside from this (momentary) unexploitable formation, YPF has a pretty good deal with the government. Back in the Kirchner days, the domestic oil price sold to refineries was fixed at $67.5 per barrel. That is double the international price—a breather, under current circumstances. Add to the equation that the country is a net oil importer, like Brazil. Argentina should be fine.
ECUADOR. According to OPEC, oil accounts for 42.9% of total exports. President Correa declared recently that the country was producing oil below breakeven, urging OPEC to meet and agree to cap supply. Ecuador, the other Latin American member of OPEC besides Venezuela, is not as dependent on oil as its regional peer, but a prolonged decline of prices will deeply hurt fiscal accounts. Ecuador is in a mild recession and running out of money. The dollarization of the economy increases dependency on foreign loans and prevents depreciation/devaluation to absorb the shock of a drastic decline in the value of exports. China could come to the rescue. Positive government move: The 2016 national budget was planned assuming $35 per barrel, which is a conservative estimate.
BOLIVIA. The country is the third-largest national producer of hydrocarbons in South America. According to state-owned YPFB, natural gas production has increased from an average of 35.72 million cubic meters per day (1.26 billion cubic feet per day) in 2006 to 60.15 million cmd (2.12 billion cfd) in 2014. A significant loss in revenues is expected for 2015 and 2016, as the price of its natural gas exports are linked to spot world oil prices. Bolivia has ambitious plans for gas, and low prices could slow them down. YPFB has a $30 billion investment program for the next 10 years, with plans to export gas to Brazil and Argentina. Declining revenue could scale down strategic projects. Still, the long-term outlook has hardly changed.
LATAM PM’S REGIONAL VIEW: It is noteworthy that each country’s oil affaire is quite unique. Mexico is the only hedged country; Brazil’s Petrobras is the world’s largest indebted oil company and the likelihood of default keeps increasing; Colombia’s output surged in the last decade, but fiscal accounts are struggling; Argentina is focused on extracting shale and Bolivia on natural gas; Venezuela decreed “economic emergency” mainly because of the decline in oil prices, and markets are now pricing a default; and Ecuador’s pegged currency inhibits depreciation/devaluation as a shock-absorber mechanism to counter lower prices. Of course, the biggest problems are in Venezuela, as a whole, but Brazil’s Petrobras is the most vulnerable company. Mexico, Colombia and Ecuador have still high fiscal dependency on oil—although declining in the first country, as car exports have taken by far the spot as No.1 source of U.S. dollars. Finally, Argentina and Bolivia are less worried than the rest, but still keeping an eye on the long run. All in all, we urge our readers to stay tuned, as things could get nasty if the current oil rout continues through mid-2016.