South America's Southern Cone becoming integrated energy center

Jorge Bacher, Ezequiel Mirazón
Price Waterhouse South American Energy Group
Buenos Aires

• Gas movement trends in the southern cone [78,568 bytes]
• Privatization progress in Latin America [54,681 bytes]
• Planned southern cone gas pipelines [89,925 bytes]

The 1990s will almost certainly be remembered in Latin America as the decade of privatization and deregulation, as governments and regulators have sought economic growth, increased employment and tax revenues, and a reduction in the deficits caused by inefficient state sectors.

Now, as the end of the decade draws near, remarkable progress has been made toward privatizing the energy sector, particularly in Latin America's Southern Cone. This progress has advanced more slowly in some industry segments than in others, and more slowly than some optimists had anticipated.

The recent formation of mergers and strategic alliances in the region has redefined company roles. As these new firms and partnerships search for added value, an integrated energy industry is emerging.

Privatization progress

The main privatizations in the energy sector in the region have been:

• Argentina-State firm Yacimentos Petroliferos Fiscales SA (YPF), with a 50% share in both upstream and downstream markets, was privatized early in the decade. Gas del Estado, which held the gas transport and distribution monopoly in Argentina, also was privatized at that time. In addition, markets were completely deregulated, leading to a significant increase in production during the period and a higher level of investment.
• Bolivia-The government divided state firm Yacimentos Petroliferos Fiscales Bolivianos into two companies, one for exploration and production and the other for transport. Fields were opened to tender, and refining will soon be deregulated.
• Brazil-Although Brazil's privatization process began only months ago, the scope of it is capturing the world's attention. Some electricity utilities have already been privatized, yielding a total of $11.6 billion, and there is a strict program for the privatization of the rest of the sector in the short term, which is expected to yield not less than $55 billion. Petroleo Brasileiro SA (Petrobras) will begin to place oil fields out to tender, in association with other companies (prequalified companies include ARCO, BG plc, Conoco Inc., Chevron Corp., Exxon Corp. and Royal Dutch/Shell). And, following recent government measures, the refining business will cease to be a government monopoly. Although Petrobras will remain under the control of the state for the present, a public offering of its shares was made recently. CEG and Riogas also have been privatized, and Comgÿs will be privatized next year.
• Chile-This was the first country in the region to privatize and deregulate its energy industry.
• Colombia and Ecuador-Although these countries' state oil companies are not expected to be privatized, they are carrying out joint ventures with companies in the private sector to develop hydrocarbon fields. In addition, Colombia has begun to privatize its electricity sector with the recent sales of Condesa and Engesa (the distributors and generators in Bogot ) for $2.1 billion, as well as gas distribution services.
• Peru-Petroleos del Peru SA has begun its privatization process by spinning off or selling its principal assets. The leading companies in the electricity sector also are being prepared for privatization.
• Venezuela-Three rounds in the tendering process for marginal and central areas have already been held, and development by private companies is under way. Private sector participation in the oil and gas industry will involve a very significant investment commitment. The process has not yet concluded and will continue for a number of years. Petroquimica de Vene- zuela SA (Pequiven), the petrochemical monopoly, will be privatized shortly, and the gasoline refining and sale markets-currently a Petroleos de Vene- zuela SA (Pdvsa) monopoly-will be deregulated.

Alliances, mergers

At the same time that privatization has been accelerating, the pace of strategic alliances and mergers in the Southern Cone energy sector continues to quicken. Both public and private entities realize that today's adversary is tomorrow's strategic partner, and a strategic partner in southern markets can be a rival in the northern hemisphere.

This new way of doing business suits the industry, and in recent years the region has seen a significant number of such associations:

• Bridas SA/Amoco Corp.-Am- oco holds 60% of the newly formed Argentine oil company Pan American Energy, while Bridas holds the remaining 40%. The new company will be the second largest in Argentina, with an output of 140,000 b/d and reserves of 1.5 billion boe.
• Capex SA/El Paso Energy-El Paso Energy has acquired a significant portion of the capital stock of Capex, an Argentine company with sales of $100 million/year. This strategic alliance will enable Capex to obtain the funds it needs to finance its new undertakings while providing El Paso with an entry to the Latin American market, which it had not previously been able to achieve.
• Shell/Mobil Corp.-Shell and Mobil have formed a combine to explore and develop the gas reserves at Camisea in Peru. This field, in which the combine will invest $2.7 billion, holds reserves that were originally estimated at 10.8 tcf of gas and 725 million bbl of condensate. These reserves are of great importance to the region. They may supply the Brazilian market through a gas pipeline that is under construction.
• CMS Energy Corp./Endesa-CMS and Chilean power generator Endesa have set up a joint venture to invest $900 million in the construction of generating stations in the Atacama copper fields in northern Chile (OGJ, Jan. 5, 1998, p. 29). Endesa, Chile's largest electric power generator, sees great potential for this project because it is estimated that copper production will double over the next decade. It has found an ideal partner in CMS, which brings experience and capital.
• Chevron/Statoil/ ARCO/Phillips Petroleum Co.-This group is one of the many that made offers totaling more than $8 billion in the third round of bidding for Venezuela's marginal fields. The group's bid was $251 million, and its production there currently totals 12,000 b/d.

The use of strategic alliances seems destined to grow as energy companies look to combine technologies, information, and skills; make long-term capital investments; take advantage of major business opportunities offered by privatization and economic liberalization; reduce risk; and gain strategic partners with knowledge of the target country or the new business.

Energy integration

What is happening now in Latin America's Southern Cone cannot be understood in isolation from larger global energy trends.

Simply stated, the future of the global energy industry lies in integration. This global integration process began a few years ago.

As a result, today Europe is supplied with gas from North Africa and the former Soviet Union, the U.S. imports much of its gas from Mexico and Canada, and Japan is supplied with fuel by several other countries in Southeast Asia.

At the same time, stand-alone oil, gas, and electricity companies that restructured as separate utilities are disappearing as they redefine their objectives and seek to integrate their activities. Instead, they are becoming entities that sell energy with added value.

In Latin America, with little notice and attention from outside of the industry, the same process is well under way.

Argentina, Bolivia, Co- lombia, Peru, and Venezuela have significant hydrocarbon reserves and are seeking new markets. Meanwhile, Brazil, Chile, and Uruguay have significant unsatisfied energy demand. Lacking natural gas, these countries must use more expensive, less environmentally benign fuels.

The solution to the needs of both groups was simple: integration. Private-sector companies have, in a very short time, managed to achieve what governments have been discussing for years without results.

Although, for some years, Argentina imported gas from Bolivia by pipeline, and Venezuela supplied areas in northern Brazil, the starting point for this new era of integration was the construction of the oil pipeline between Argentina and Chile, which began operating 2 years ago. In addition, Argentina and Venezuela have begun to export significant volumes of oil to Brazil, becoming, respectively, the first and third largest suppliers of crude to that country.

It is quite possible that, in a few years' time, an oil pipeline might be built between Venezuelan fields and Florida.

Convergence

Integration is most evident in the gas market.

Argentina, Bolivia, and Peru are to provide gas for a pipeline network that will supply Chile and Brazil, countries in which gas currently accounts for less than 10% of available energy sources. This network has begun to take shape through the construction and operation of two gas pipelines from Argentina to Chile: Tierra del Fuego and GasAndes (OGJ, Jan. 23, 1995, p. 18; Apr. 21, 1997, p. 61).

The most ambitious project is intended to supply the Brazilian market. Argentina, Bolivia, and Peru each have plans to provide gas to that country. Although these projects seem to overlap, they are, in fact, complementary, as none of these countries has sufficient reserves to meet Brazil's demand. As a result, the countries will undertake a joint development project.

A list of planned Southern Cone gas pipelines is shown in Table 1. Although several of these projects are mutually exclusive, the implementation of just some of them will ensure the effective integration of gas supplies in the region.

In the last few months, an analysis has been carried out on the linking of the electricity networks of Southern Cone countries. This process will take longer than the integration of the gas market, but a major precedent has been set for electricity integration.

Enron Corp. recently was awarded a contract to export electricity from Argentina and Bolivia to Brazil. This 20-year contract will enable Brazil to purchase 1,000 MW at a price 30% less than it pays for energy from the Itaip# hydroelectric plant, the largest in Brazil.

This process of integration taking place in Latin America has been facilitated by the transformation of the companies themselves.

Oil and gas corporations are redefining themselves as energy companies in a single integrated energy industry. These new companies cover everything from hydrocarbons to electrons.

Although some companies seek opportunities only in certain segments, most do their best to take advantage of opportunities arising along the entire value chain.

Several companies in the region are active in the different segments of the industry, with the aim of selling energy with "added value." Examples include:

• Pérez Companc (Argentina), which produces, transports, and distributes gas and generates and transports electricity.
• Astra Capsa/Repsol SA, which produces and sells crude oil and soon will transport and distribute gas.
• Shell, which is preparing to transport to Brazil the gas it produces at Camisea (Peru).
• Endesa (Spain), which produces and distributes gas in Chile and Colombia.

There can be no doubt. The trend toward convergence will continue and accelerate with the privatizations that will take place in the energy sector.

Outsourcing

Outsourcing is not new to the energy industry. Oil and gas companies have been pioneers, farming out processes from drilling to well completion for decades.

But, in recent years, growth in outsourcing has been staggering. According to Dataquest, during 1990-94, the world market for outsourcing services in all industries grew to $28 billion from $9 billion.

Latin America has experienced this trend in recent decades, but much more so as a result of privatization. Companies such as Argentina's YPF and Petroper# have divested themselves of their vessel fleets and today contract a more efficient service. And Pdvsa has outsourced the operation of several of its oil fields to the world's leading operators.

Major corporations also have outsourced administrative functions. BP Exploration Co. Ltd., for example, has outsourced the financial and administrative functions of its Colombian and Venezuelan business units to Price Waterhouse World Energy Group.

Information technology

One of the factors that has contributed most to the growth of the industry has been technological progress. Computer software, in particular, has improved exploration and production in natural resource industries.

New software that delivers more accurate, real-time information has improved decision-making at energy companies.

Frontier resources that, a few years back, generated little interest in the industry now have become the object of considerable investment. For example, in the Gulf of Mexico and in some North Sea areas, the success of exploratory efforts has significantly improved as a result of the use of 3D and 4D seismic technology. Further, production costs have been reduced and drilling methods improved.

In Latin America, complex offshore drilling techniques developed by Petrobras have allowed Brazil to triple its Santos area production in 15 years.

Latin America has been involved in all the technological upgrades that have taken place in recent years. Today, companies such as Petrolera Argentina San Jorge and YPF are regular users of 3D seismic. Shell (in Brazil), Gas Natural (in Colombia), Tecpetrol (in Argentina), and Pequiven (in Venezuela) are implementing SAP enterprise-wide software systems with the help of Price Waterhouse.

This technological renovation has enabled the industry to grow efficiently and profitably in the region.

Risk management

Risk management is a common topic among Latin American companies. It is hard to find companies today that are not hedged with derivatives against price volatility or that have not reviewed the advisability of doing so.

Health and safety records have improved considerably. Care of the environment has increased significantly. And, today, companies in the region are substantially in compliance with all laws and regulations.

Significantly, companies are performing these tasks not as a result of current legislation but because they are firmly convinced of the importance of preserving the environment and the communities close to exploration sites. In Argentina, for instance, all of the open pits at oil fields that, in the past, caused the death of thousands of birds have now been restored and covered.

The principal matter pending resolution that requires risk-management analysis in the region today is the problem of guerrilla attacks in Colombia and Peru.

Respecting cultures

One of the first problems encountered by foreign investors in Latin America is that of cultural differences.

Initially, foreign companies tendered bids on their own or with other foreign companies. They then came to realize the importance of understanding and respecting the culture, language, and business practices of the countries in which they wished to operate. This led to a new breed of combinations of foreign and local companies. These consortia have been able to exploit synergies in global technologies and local practices.

BG, for example, which distributes gas in Buenos Aires and to Argentina's national grid, together with its Argentine partners, has begun to perform much of the electricity transmission in the region.

Going forward, such synergies promise to speed and improve energy development throughout the region.

Latin America's progress

Latin America has changed. It has ceased to be an underdeveloped continent and is now a developing region with attractive opportunities for business in an industry that is growing rapidly.

Previously, oil, gas, and electric power were three separate industries. But the redefinition of company roles as they seek added value is driving the convergence of a single, integrated energy industry.

This new industry is based not only on economic resources but also on the added value of "brain power," in the words of noted M.I.T. economist Lester Thurow, the keynote speaker at Price Waterhouse's 1997 World Energy Conference.

Privatization, technology, outsourcing, and strategic alliances-vital trends in the petroleum, mining, and power industries-have placed Latin America front and center in the competitive race for capital in the energy industry.

The Authors