The United States must recognize the changing supply as well as political situation in Latin America if it expects to continue importing oil and gas from the region, three experts told a House subcommittee on March 11.

Recent deepwater discoveries off Brazil's coast could catapult that country past Venezuela and Mexico and make it Latin America's leading oil and gas exporter, they told a hearing of the House Oversight and Government Reform Committee's National Security and Foreign Affairs Subcommittee.

But a fourth witness warned that growing government control over energy resources in other Latin American nations could reduce both exports to the United States and US contributions to their overall economic development.

Paulo Sotero, director of the Brazil Institute at the Woodrow Wilson International Center for Scholars in Washington, said that US relations with Brazil reached a new level of maturity in the past two decades because of the South American nation's consolidation of democracy and economic stability, and the United States being able to pay more attention to Latin America with the end of the Cold War.

Brazil also has emerged as the world's leader in ethanol fuel production, he noted. But the discovery of huge offshore oil and gas reserves off its southern coast could potentially be as important, Sotero said. "When fully developed, which should happen in approximately 10 years, the new reserves will make Brazil both a major global oil exporter and Latin America's leading producer, supplanting both Venezuela and Mexico," he said.

Petroleo Brasileiro SA (Petrobras), Brazil's national oil company, explores for and produces oil in 25 countries, including the United States, Sotero said. "The potential geopolitical implications of Brazil's success in the energy field should not be lost on those who believe that the Americas should be and can be a space of peace, democracy, justice, stability and economic progress," he said.

Brazil's export potential

Ray Walser, senior policy analyst for Latin America at the Heritage Foundation, and Eric Farnsworth, vice president of the Council of Americas, each confirmed Sotero's assessment of Brazil's potential to become Latin America's leading oil and gas exporter.

The country already is Latin America's third biggest oil producer, although most of its production is consumed domestically, Farnsworth said in his written testimony. "But this may change. Just last year, Brazil discovered Tupi which, with an estimated 5-8 billion bbl of oil, is what some believe to be one of the largest oil fields found in two decades. And just this year, Brazil made another discovery off its coast, an oil field it calls Jupiter. Its size has not yet been determined but Petrobras believes it could be as large as Tupi," he said.

Both fields are in deep water, which could make extraction difficult and costly, Farnsworth conceded. But if predictions of their size are correct, Brazil would have more proven reserves than Mexico and as much or more than the United States, he said.

Walser pointed out that Petrobras plans to invest some $112 billion worldwide and $5 billion in the Gulf of Mexico. Meanwhile, the recent Tupi and Jupiter field discoveries "have substantially raised the hope that Brazil may actually equal or surpass the reserves of Venezuela and become a net exporter of oil. Petrobras could become one of the five biggest integrated energy companies in the world by 2020," he suggested.

The three witnesses also said that US responses to Brazil's pre-eminent position as a fuel-grade alcohol producer could improve relations with other South and Central American nations. They applauded the US-Brazil Memorandum of Understanding on Biofuels Cooperation, which the two countries signed to share research and promote biofuels use globally.

"By working with Central American and Caribbean countries – currently with the Dominican Republic, El Salvador, Haiti, and St. Kitts and Nevis – to help them develop or advance biofuels production capacity, the United States and Brazil seek to promote development in these countries and decrease their dependence on traditional fuels," Farnsworth said.

Issues beyond energy

But a fourth witness warned that US-Latin American relations will not improve if they are focused only on energy.

"In the [Western] Hemisphere, US influence on markets, democracy and security is declining fast. Most of our long-standing and multilateral energy dialogues are not functioning. We have no sustained engagement on energy with two of the three key producers: Venezuela and Brazil. With this diplomatic neglect, we have seen overall investment decline, production flatten and resource nationalism rise in some key producing nations," said David L. Goldwyn, president of Goldwyn International Strategies LLC and former assistant US energy secretary for international affairs during the Clinton administration.

"All of this is evidence that the US needs a fresh approach to energy diplomacy in the hemisphere. The United States will enhance its energy security by engaging the region on issues that concern its people: job creation, poverty alleviation, migration and trade promotion. An asymmetrical approach [which] addresses a broad range of issues . . . may pay dividends equal to or greater than one focuses solely on energy," he said in written testimony submitted to the subcommittee.

The United States also must be ready to use sub-regional energy dialogues and make certain that any new framework strengthens, instead of weakens, DOE's energy diplomacy mission, Goldwyn added.

He said that Brazil, Colombia, Peru, and Trinidad and Tobago are part of a positive trend of Latin American countries adopting creative fiscal regimes that welcome foreign investment, require national oil companies to compete with publicly traded multinational energy firms, and use independent regulators to promote fair and efficient resource development.

Resource nationalism

But the region also features a more negative trend toward rising state control of energy resources in Venezuela, Argentina, Bolivia and Ecuador which could limit global oil and gas supply growth by undermining the value of existing investments, discouraging future commitments or barring foreign investment altogether, Goldwyn continued.

"When we consider that Mexico so far continues to bar foreign investment in its upstream oil and gas sector, and the size and reserves of the countries practicing the resource nationalism model, the net effect is negative. Foreign investment in the oil sector is shifting away from South America to North America, particularly to Canada's oil sands. When we compare 2005 to 2006, only Brazil and Trinidad managed to increase production significantly while other countries faced decline or very modest gains," he said.

Walser said that the United States is fortunate to have Canada and Mexico as partners in the North American Free Trade Agreement. "In North America, we remain energy interdependent. As long as we stick with our NAFTA commitments, as long as we recognize that a prosperous Canada and a more prosperous Mexico are in our national interest, we can have strong confidence in our neighbors, north and, hopefully, south," he said.

Alberta's oil sands represent a reliable, adjacent petroleum resource from a reliable trading partner although issues such as transnational electricity and pipeline systems will need to be addressed, he continued. The petroleum situation in Mexico is not as healthy because the country is paying a heavy price for 70 years of its oil and gas resources being under control of Petroleos Mexicanos (Pemex), its national oil company, Walser said.

"Today, earnings from Pemex cover 42% of Mexico's national budget. State ownership of subsoil wealth and hydrocarbons remains firmly embedded in the Mexican psyche and political ethos. A majority of Mexicans continue to oppose opening Pemex to private and foreign investment. But most oil experts say Pemex is in trouble. It is the world's most indebted oil company," he said.

Output from Mexico's flagship Canterell oil field in the Gulf of Mexico, which once produced 60% of Mexico's petroleum, now yields 42% of national output, dropping by 5.7% in 2007, he added. The government estimates that Mexico has approximately 100 billion bbl in various categories of reserves, or about a 60-year domestic supply. But Pemex is running short on investments and will need strategic partners as it ventures deeper into the Gulf of Mexico, according to Walser.

'Sounding the alarm'

"Mexico's leadership is awakening to its dilemma but will it do so fast enough? President [Felipe de Jesus] Calderon is sounding the alarm bell and some within the Mexican political class appear open to modifications of the constitution to permit private Mexican, if not foreign investments, in Pemex. Mexican telecommunications billionaire Carlos Slim is often identified as a potential investor. But there are also signs that populist leaders, such as defeated presidential candidate Andres Manuel Lopez Obrador, will employ disruptive tactics to derail any legislative initiative," he said.

While the United States can't alter what Mexicans clearly consider a sovereign decision, it can demonstrate a constructive approach to bilateral relations and promote a friendly climate for energy cooperation, he suggested. "The United States can work in other ways with Mexico, notably through the passage of counter-narcotics assistance known as the Merida Initiative that can help President Calderon beat back the threats posed by dead drug cartels," Walser said.

Resource nationalism in four South American nations could potentially backfire, Goldwyn maintained. "The recent wave of changes in contractual terms and dramatic changes in tax regimes in Venezuela, Bolivia, Ecuador and, in recent years, Argentina threatens to slow new investment and eventually deepen instability and poverty in these nations as well as destroy shareholder value for the companies invested there. The deterioration in the investment climate for energy in these countries is primarily an economic threat, helping to lock in constrained supply and high prices," he said.

He said that Venezuela's passage of a hydrocarbons law that mandates a 51% share for the national oil company, Petroleos de Venezuela SA (PDVSA), and a higher royalty rate, its strict and adverse interpretations of operating service agreements when they appeared to be poor revenue generators, and revival of the export tax and other formerly renounced levies have led to massive flights of foreign capital to other countries. Deutsche Bank and Wood Mackenzie say this is particularly true of Venezuela's heavy oil reserves, where development of the hemisphere's largest oil resource essentially has been frozen as investment in Canada's oil sands has taken off, Goldwyn said.

"The forced restructuring of Venezuela's heavy oil joint ventures has led to serious commercial disputes. Some have been settled. Others are in negotiation or arbitration. The net impact on Venezuela's credit and credibility are quite negative, again with serious negative long-term consequences for the global oil market and Venezuela's own economy," he said.

'Massive ATM machine'

Walser said that Venezuela's problems are aggravated by President Hugo Chavez's tendency to treat oil revenues "as a massive ATM machine for domestic spending and to prop up the Castroite Communist regime in Cuba ($2-4 billion annually); to purchase influence with smaller, energy-dependent Caribbean and Central American nations via PetroCaribe and to acquire substantial quantities of Russian arms ($5 billion.)" Chavez also is trying to influence elections in Argentina and El Salvador, while his recently increased support of the Revolutionary Armed Forces of Colombia (FARC) and momentary flirtation of war threats against that country raise serious questions about his long-term ambitions, the Heritage Foundation official said.

"While Chavez pursues his aggressive agenda and erodes the efficiency and long-term viability of his energy sector, Washington understands that a sudden reduction in the price of oil would ripple through PDVSA and Venezuela, severely undercutting Chavez and his ability to govern. Mounting inflation, widespread food shortages and violent crime have lessened Chavez approval ratings and his domestic grip appears to have slipped. The failure to achieve popular approval of a package of constitutional reforms in December 2007 has raised hope in opposition circles that the Venezuelan people may be able to select new leadership in 2012. Whatever steps the US takes regarding Venezuela and our energy relationship, we need to keep in mind the enduring need of the friendship of the Venezuelan people in a possible, post-Chavez world," Walser said.

But he added that Chavez has inspired two other South American leaders, Evo Morales in Bolivia and Rafael Correra in Ecuador, to adopt their own forms of resource nationalism. He said that Bolivia's nationalization of gas fields in May 2006 has set in motion strong regional tensions and divisions within the country, while Correra has tackled Occidental Petroleum Corp., withdrawn from free trade negotiations and reduced anti-drug cooperation.

Goldwyn said that the net effect of developments in the three countries has been to virtually freeze new investment at a time when unusually high prices should be driving new exploration and production. "It is notable that even China, which is aggressively competing for exploration acreage worldwide, is not even a major player in the hemisphere," he said. As of 2006, it held less 10% of the hemisphere's upstream assets, primarily recent acquisitions of Western holdings in Ecuador and Peru, while it presently enjoys no preferential access in Venezuela, the former DOE official said.

"No new investment has been made under Venezuela's 1998 hydrocarbons law. New investment is unthinkable in Bolivia until existing companies can determine the extent of their losses. Ecuador's investors are mulling legal action for expropriation and suspension of existing investments. The future growth potential of the hemisphere is being undermined and the region's economies risk a major contraction if oil prices drop significantly any time over the next decade," he said.

Contact Nick Snow at nicks@pennwell.com