At the beginning of the 1990s all producing countries in Latin America permitted limited participation of the private sector in the oil and gas industry. The general rule was that the participation was through some form of association with the state-owned oil company with the outside investor bearing all exploration risk. The fiscal regime consisted either of service fees and taxes or of profit oil and taxes. As the decade progressed, all those countries, to varying degrees, introduced policy or legal reforms to allow more private sector participation in the industry. Privatization and deregulation were in vogue. Some countries went as far as dismantling or selling off their state-owned oil companies (Bolivia, Argentina, and Peru). Other countries kept their state companies but broke their monopolies and allowed private companies to come in on a stand-alone basis (Brazil, Colombia). Companies were granted direct and independent rights by new state agencies, and the fiscal regime for the most part switched to tax and royalty. Ecuador and Venezuela maintained the mandatory association with the state companies but increased the opportunity for participation of the private sector. The only country that was and has remained closed is Mexico.
A few countries have stayed the course, notably Brazil, Colombia, and Peru; in the other countries those new policies didn’t last long. Some have made a U-turn and become more restrictive than they were at the beginning of the 1990s. “Resource nationalism” has replaced privatization and deregulation. This article provides a short country-by-country review of what has transpired in Latin America in the last 10-15 years.
Argentina
The Argentine state controlled all segments of the oil and gas industry and all public services prior to 1990. The state-owned Yacimientos Petrolíferos Fiscales SA (YPF) had the monopoly of the oil industry. Private companies could conduct exploration and production (E&P) only pursuant to service contracts with YPF. Natural gas distribution and transportation were under the exclusive control of the state company Gas del Estado SE (GdE). Oil and gas production had to be delivered to YPF and GdE under controlled prices.
Starting in 1990, Argentina fundamentally changed its energy policy as part of a broader reform of state activities. Most state companies in all industries were privatized. Private companies are now awarded oil and gas concessions directly by a state agency and ownership of production is vested at the wellhead. The fiscal regime for E&P became one of low tax and a maximum 12% royalty at the wellhead, plus certain bonuses and a surface area-based production cannon. Gas and electric production, transmission, and distribution also were privatized and deregulated. All through the 1990s oil and gas companies in Argentina had the right to market freely internally or export all hydrocarbon production at unregulated prices.
The Argentine industry thus attracted billions of dollars in investment in exploration, development, and infrastructure, fueled by both domestic demand growth and demand for exports of electricity and natural gas. But this ended with the economic and currency crisis at the end of 2001. Since then the Argentine oil industry began to experience changes. The government made the private sector shoulder the economic burden of policies designed to curry popular favor and to control inflation. Domestic prices were reregulated, and exports were curtailed and taxed. The result has been a steady decline in exploration investment. Price controls encourage record high consumption at the same time that the country now has known gas reserves only for the next 10 years. Oil, gas, and electric production and transportation are operating at their limits. There are fuel and power shortages throughout the country.
The policy responses to this energy crisis in Argentina are not meaningful so far. The production cannon has recently been raised to $1,088/sq km of land used for crude oil or natural gas production. Relaxation of price controls has been limited. The government has created again a state-owned oil company, Energía Argentina Sociedad Anónima (Enarsa). Fiscal incentives for E&P activities are available only to those who agree to associate with Enarsa. Lacking capital, Enarsa must be carried through the exploration phase.
The government is using Enarsa to import gas from Bolivia in order to make up domestic shortfalls. Bolivia sells its gas at a price higher than the regulated price in Argentina. The difference so far is being made up by squeezing more taxes from the dwindling exports to Chile. Once the goose that lays those golden eggs is finally dead, dependence on Bolivia is going to be more costly.
This overall situation will present two problems. The first is that the government is going to have to make up the price difference unless it is willing to increase controlled prices at home. The government seems to abhor this option. The second problem is that Bolivia is going to have a hard time delivering the needed volumes. In the meantime, Venezuela is offering gas to Argentina, selling it fuels, and buying its bonds. Will Argentina go back to having a market oil and gas economy and rely on a vibrant and prosperous private sector as in the 1990s or walk into the crushing enfold of Venezuela? We’ll know soon; the current situation is critical and can’t last long.
Bolivia
Bolivia has come full circle in a short 10 years. In 1994 under the first government of President Gonzalo Sánchez de Losada, the E&P, transportation, and refinery assets of state-owned Yacimientos Petrolíferos Fiscales Bolivianos (YPFB) were privatized. Up to that point, following the norm in the region, private companies could operate in the country only through associations with YPFB. The 1996 hydrocarbons law allowed private companies to come in on a stand-alone basis under a tax and royalty regime. Companies became entitled to own and freely dispose of all hydrocarbon production upon commercial discovery. Under this law major international oil companies such as Total SA, BG Group PLC, BP PLC, Petroleo Brasileiro SA (Petrobras), and Repsol YPF SA entered the country and investment in hydrocarbons surged. Within a new framework conducive to investment in exploration and infrastructure, Brazil signed up to buy Bolivian gas over the long term and to finance the construction of a pipeline from Bolivia to Sao Paulo. An LNG project to export additional gas through the Pacific was also in active development and seriously considered.
The abrupt ending in the fall of 2003 of Sánchez de Losada’s second term in office also ended significant new investments. Serious political instability and growing discontent of the indigenous people feeling disfranchised by successive governments came to light and resulted in serious popular unrest. On July 18, 2004, a referendum was held in which the majority of Bolivian nationals voted in favor of recovering for the state full control over hydrocarbon resources.
In 2005 congress approved a new hydrocarbons law that repealed the 1996 law. The new law reconstituted YPFB and radically changed the framework for the industry but lay dormant until Juan Evo Morales Ayma took office as president of Bolivia a year later. Morales was leader of both the Movement for Socialism political party and of Bolivia’s cocalero movement resisting US efforts to eradicate coca crops in that country. Having promised his constituency that the hydrocarbon wealth of the country would effectively go back to the people, Morales issued on May 1, 2006, a decree nationalizing the industry and setting a 180-day deadline for companies to convert their contracts to the new contract regime provided by the 2005 hydrocarbons law or to surrender their operations to YPFB. The new contract regime is that of the “operating contract,” under which all production belongs to the state and the contractor has the obligation to deliver to YPFB all the hydrocarbons produced. All the oil companies operating in Bolivia under the 1996 law have now converted to operations contracts under the 2005 law. Another type of contract permitted by the 2005 law is the joint venture or association contract under which YPFB must have a minimum 51% participation. Reportedly, the first association would be with Petróleos de Venezuela SA (PDVSA), the Venezuelan national oil company.
The operations contract is a sort of service contract with YPFB whereby the contractor undertakes to conduct petroleum operations at its sole risk and expense, assuming all costs and providing all required personnel, technology, facilities, materials, and capital in exchange for the reimbursement of certain costs and a fee. YPFB does not assume any risk or liability for the petroleum operations or its results. The production is sold by YPFB as agreed by YPFB. Proceeds from production are divided as follows: first, royalties at the rate of 18% and a direct tax on hydrocarbons of 32% come off the top, then the contractor is reimbursed for the contractually recoverable costs. A portion of the remaining proceeds is the contractor’s fee, subject to Bolivian income taxes.
Contractors are currently submitting their work programs and development and investment plans to YPFB for approval under the new contracts. Morales has warned the companies that if they fail to meet their investment obligations, the operations contracts will be rescinded without compensation.
Bolivia soon must deliver the maximum gas export volumes contracted with Brazil. It also is exporting gas to Argentina under a contract which requires a large volume ramp up in a few short years. Domestic demand is surging. To meet domestic requirements and export commitments Bolivia needs several billion dollars in investment in exploration, production, and transportation infrastructure$3 billion to almost double current production in the next 4-5 years, by some estimates. YPFB does not have the required economic and technical capacity. The private sector has not exactly been nurtured lately to meet this challenge. Bolivia, despite having the second largest gas reserves of the region, thus has international contractual problems to go with never-ending political instability and social unrest. Enter Venezuela again to support a state with investments in replacement of the private sector.
Brazil
Brazil successfully continues on the course charted at the time of its energy reforms in the late 1990s. The Petrobras monopoly over the industry was broken up via a constitutional amendment in 1995, and by 1997 Brazil put in place regulatory bodies and agencies to govern equally the activities of foreign and Brazilian oil companies, state-controlled Petrobras included. E&P blocks are awarded competitively. Contracts grant E&P rights under a tax and royalty fiscal regime with the average royalty rate being 10%. By the end of 2007 there will have been nine international bid rounds. The energy policy and fiscal regime instituted by the Fernando Henrique Cardoso administration have been maintained stable by current socialist President Luiz Inacio Lula da Silva, formerly a labor leader and organizer of the Workers Party.
Brazil is the tenth largest energy consumer in the world and the largest in Latin America. Brazil is the fifth-largest country by geographical area, the fifth most populous country, and the fourth most populous democracy in the world. It is the world’s eighth largest economy in terms of purchasing power. Between its local oil production and its leading production of sugar-based ethanol, Brazil is self sufficient in liquid fuels. It is on the natural gas front that things remain challenging. Strong economic growth, together with a sensible policy of avoiding overreliance on hydropower for electric generation, require that Brazil find long term, reliable, and ever growing sources of natural gas supply.
There are three such sources. The first one is local production, but most scenarios show that in the short to medium term it is not going to be near enough to satisfy projected demand. The second source is imported gas from Bolivia. These volumes are limited, however. Bolivia attempted unilaterally to renegotiate the price Brazil pays for this gas. Additionally, Bolivia nationalized refinery assets of Petrobras and forced the conversion of Petrobras’s E&P contracts into service contracts at far less favorable terms. Brazil therefore does not view Bolivia as a reliable source of supply or as a country in which long-term investments can be made with confidence. Brazil will continue receiving gas from Bolivia under the current contract but will not seek to increase volumes or to extend its term. Bolivia’s populist energy policy is going to cost it its biggest costumer.
The third source is LNG. Petrobras is currently developing two LNG terminal projects and is talking about a third. For Brazil, LNG is the only real solution to long-term reliable gas supply to supplement domestic production. The interconnection with Argentina and Bolivia never translated into real integration. The policies in these countries are devised for short-term political gain and are too disparate with that of Brazil’s. The conditions for true integration do not exist.
Colombia
Colombia has followed and successfully maintained a policy similar to that of Brazil. Up to 2003, private sector companies could operate in the country only through production-sharing agreements with state-owned Ecopetrol SA. Now private sector companies can obtain E&P rights directly through the Agencia Nacional de Hidrocarburos (ANH). The fiscal regime is one of tax and royalty. Ecopetrol has been stripped of any regulatory and policy roles, and it operates along side other companies under the same rules and contract terms. The government has sold a minority interest in Ecopetrol in the local stock market.
Colombia is benefiting from better internal security and legal stability. After the reelection of President Álvaro Uribe Vélez for a second 4-year term in May 2006 [making him the first president to be consecutively re-elected in Colombia in more than 100 years], the local economy has continued growing steadily, and foreign direct investment in hydrocarbons is soaring, having reached the record level of $1.8 billion in 2006 and $582.6 million in the first quarter of 2007. In its fourth year of activities as a licensing entity, ANH has proven that the new fiscal regime and model contract are effective tools to attract new foreign investment. Such new fiscal regime includes royalties on production of 8-25% for crude oil, 6.4-20% for onshore and offshore natural gas to 1,000 ft depth, and 4.8-15% for offshore gas at greater depths. There also is a windfall profits payment to ANH that applies when the accumulated production exceeds a certain volume and the price exceeds a predetermined benchmark. Colombia has among the most competitive terms in Latin America, having signed a total of 105 new E&P contracts as of Aug. 31.
Colombia’s oil reserves, production, and exports have been declining for years, and the government is determined to arrest this trend before the country becomes a net oil importer. New policies in dealing with the guerrillas are resulting in fewer reported attacks on production and transportation facilities. The kidnapping count also is down. As a whole, the investment climate for oil and gas companies in Colombia is better now than it has been in recent memory.
Ecuador
Ecuador has maintained the dominant role of state-owned Empresa Estatal Petróleos del Ecuador (Petroecuador). Companies operate there through production-sharing contracts with Petroecuador. The fiscal regime is one of profit oil and tax. Up until a few years ago the government intended to reform the role of Petroecuador, simplify E&P contracting, and improve the fiscal regime. Those initiatives never materialized, as they were routinely blocked and boycotted by nationalist and populist politicians, indigenous groups, the military, environmentalists, labor unions, and other interest groups. Private companies have been involved in tax and environmental disputes and contract cancellations.
The bad news became worse recently with the announcement by President Rafael Vicente Correa Delgado that the windfall profits tax rate was going to be increased to 99%, on the basis of oil revenues from sales at prices exceeding those in effect at the time the original contracts were signed. This tax was created with a 50% rate in early 2006. “We are not going to be cheated again,” said President Correa, an economist who previously served as finance minister. This comes at a time when Ecuador exports crude oil and imports almost all the oil products it uses and is looking at having to import natural gas from Colombia and Peru.
Ecuador recently elected members of an assembly that will rewrite the constitution. Allies of the president won a majority. The stated aims include having a new framework to increase social spending, strengthen the government’s control over natural resources, and reform property rights.
It is not expected that Ecuador will become closed to foreign investment, but the government is expected to turn existing contracts into service contracts through which companies would be paid a production fee and reimbursed for investment costs. All production would be owned by the state. Similar to Bolivia, Ecuador is not creating the conditions necessary to have the private sector contribute to meeting its challenges. But although he and Venezuelan President Hugo Chavez are friends, Correa has said he is not part of the Venezuela-Bolivia movement. PDVSA has said that it will build a refinery in Ecuador and invest in exploration there.
Mexico
Mexico remains closed. It is illegal for private companies to risk investment capital in the oil and gas business in Mexico. The state monopolizes all segments of the industry and operates through Petróleos Mexicanos (PEMEX). This monopoly is maintained in the face of declining oil reserves, soon-to-occur declining oil production and export revenues, inadequate capital investment in infrastructure, and continued increases in domestic demand for gas and oil products. Mexico exports crude and imports oil products and natural gas.
The multiple service contracts (MSC) for exploration, development, and production of nonassociated gas reserves in the Burgos basin in northeastern Mexico are as much as the law permits. These are not true E&P contracts in the traditional sense. They are fee-based service contracts for units of work performed. There is no upside, but there is downside: the contractor receives its fees only if there is enough increased production sold by Pemex in exchange for funds that are sufficient to cover the fees. Production under the MSC regime is not going to bridge the gap between gas demand and production in Mexico.
Peru
Until the early 1990s, E&P contracts in Peru were in the form of risk service agreements with state owned Petróleos del Peru SA (Petroperu). The fiscal regime was one of service fee (in cash or kind) and taxes. Peru’s system changed with the privatization of Petroperu’s assets and the passage of the hydrocarbons law of 1993. This law created an independent licensing agency, Perupetro, which grants E&P rights to private companies under a tax and royalty regime with royalty rates of 5-20% based on production levels. Peru has had remarkable policy continuity and stability through succeeding presidents since then. The country has made a genuine effort to improve the terms and conditions offered to oil companies and to provide incentives for investment. These include alternative methods for calculating royalties, free sharing of technical information, reimbursement of sales taxes incurred during the exploration period, accelerated bidding procedures, etc. The result has been a noticeable revival of interest in upstream activities. Together with Colombia, Peru offers the most attractive fiscal terms in the region.
The biggest testament to policy continuity was the arrival of Camisea gas in Lima in August 2004 and the subsequent development of an LNG export terminal. The LNG production facility just south of Lima, the first in Latin America, is currently under construction. Output from this project has been committed to Mexico. Additional gas availability in the country also is generating strong investor interest for petrochemical projects.
Venezuela
Venezuela first nationalized its oil industry in 1975, when PDVSA was created. Under the nationalization law of that time, exploration and production rights could be obtained by private companies only if authorized by an act of congress. This law was used only for four heavy crude oil projects in the Orinoco Belt under a tax and royalty regime with low rates. Under the administration of President Rafael Caldera in the early 1990s, Venezuela subsequently started a policy of increasing investment opportunities to the private sector and thus attracted numerous foreign and domestic oil companies under “operating service” contracts with PDVSA. The objective of these contracts was to grant operating rights over marginal fields (by PDVSA standards) and compensate the contractor with a cash fee per barrel of oil produced and delivered to PDVSA. In practice these contracts did not impede exploration.
After President Chavez first took office in December 1998, several energy policy changes have taken place in Venezuela. He started by raising taxes and royalties, then decided to alter fundamentally the contract regime. All private sector companies had to convert their contracts into joint ventures with PDVSA, with PDVSA taking more than 50% participating interest. This was done under threat of total nationalization. Most companies complied, but a few did not. Those that did not are no longer operating in the country.
The oil E&P framework today in Venezuela is that of a joint-venture company with PDVSA, where PDVSA must have more than 50% participating interest. All production is acquired by PDVSA. The joint ventures pay taxes and royalties.
The author
Jose L. Valera is a partner in King & Spalding LLP’s Global Transactions Group. Valera’s practice focuses on project development, mergers and acquisitions, privatizations, and financing of oil and gas and electric energy projects. He is a native Spanish speaker and is fluent in French. Valera has provided counsel to the Angola LNG project on all feed gas supply matters and development of gas gathering pipeline network. He has provided presentation of major and independent oil companies in the negotiation and drafting of operations, production sharing, and license agreements throughout Latin America as well as representation of electric utilities and independent power producers in the development and construction of electric generation facilities, the purchase and sale of electric generation, transmission, and distribution assets, and the privatization of electric generation and distribution companies. Valera obtained his first JD in 1981 from Catholic University in Lima, Peru. He received his second JD from the South Texas College of Law in Houston, Texas, in 1986. He is a member of the Lima, Texas, and Louisiana Bar Associations.