POLITICAL ECONOMY IN ECUADOR S OIL SECTOR Simon Cueva Universidad de las Américas - September 2009 World Bank Workshop on Commodity Dependence Preliminary draft
When became an oil country Small limited oil production since early 20 th century Economy based on successive commodity exports: cocoa, bananas, coffee, oil, flowers & shrimps Major oil discovery & exploration in the early 1970s Oil quickly became the main export product Crude Oil Bananas Coffee & related Shrimps Cocoa & related Flower crops Other Real GDP (right scale) 70% 60% 50% 40% 30% 20% 10% 0% 1927-1936 1937-1946 1947-1956 1957-1966 1967-1976 1977-1986 1987-1996 1997-2006 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
Significant economic changes in a few years Military nationalistic (but soft) regime since 1972 First Hydrocarbons Law 1973 Setup of national company (CEPE, then Petroecuador) Own exploration, production, refining & commercialization Managing relations State - other companies Large production start coincided with higher international prices (first oil boom) Oil fields initially developed by foreign private companies (Texaco Gulf) Oil revenues as share of budget: 0% in 1970-35.6% in 1980 Large public investments, import substitution, tax exemptions, increased trade protection; fixed exchange rate regime; subsidies to fuels, public services & transportation Return to democracy in 1979
Oil trends in recent years By 2008, the oil sector represented 18% of nominal GDP The growing oil share reflected higher international prices rather than increased production volumes Over the last decade: 30% annual nominal growth of the oil sector but only 3% average annual growth of crude oil production Oil exports were 47% of total exports, with a 63% peak in 2008 Oil revenues were 28% of NFPS revenues, with a 42% peak in 2008 Lower growth than other economic sectors in real terms: share of real GDP (2000 prices) fell -13.5% in1998 to 10% in 2008 Enclave sector: 0.3% of total employment, linkages with just a few economic sectors (transportation, construction, insurance services). Most direct channel is through fiscal revenues No clear evidence of Dutch disease in the past two decades
Private vs. public oil production Private companies production: 46 mb in 1998 to 123 mb in 2005 Introduction of production sharing contracts allowed Petroecuador to successfully allocate oil fields to private companies in the 1990s 1998-2004: private investments 8 times larger than Petroecuador s OCP pipeline in 2003 lifted heavy oil transportation constraint Petroecuador production: from 101 mb in 1998 to 71 mb in 2005 Transfer to Petroecuador in mid 2005 of Occidental s fields (termination by the government of the contract) Petroecuador production moved up to 98 mb in 2008 Private production fell to 87 mb in 2008 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 1992 Crude Oil Production by Type of Company (thousand barrels) 1993 1994 1995 1996 1997 1998 Petroproducción 1999 2000 2001 2002 2003 2004 Private Companies Effect of the termination of Oxy's contract 2005 2006 2007 2008
Reserves are not the binding constraint has one of the lowest production to reserves ratio (4.4% in 2007) among oil countries with similar reserve levels Production to reserves ratio is six times higher for private companies (11.4%) than for Petroecuador (1.9%), Additional investment could double Petroecuador production levels Some environmental issues (in particular ITT): proposal leave it unused against pay Since the Octava Ronda Petrolera in 1995, has failed to attract a large investors interest for exploration or for a large overhaul of existing oil exploitation facilities Since 2006, private production decline as companies have reduced or postponed preexisting investing plans (Occidental litigation, renegotiation of contracts) Sustainability perspective: loosing net savings without spending them
Instability of oil contracts Mixed Economy companies: partnership Petroecuador company Service contracts: Petroecuador covers expenses & margin. Introduced in 1982, now only one case (AGIP) Production sharing contracts: company covers costs, revenues shared. Introduced in 1993 with low prices. Most existing contracts. Marginal Fields: boosting production of existing small fields Joint ventures w. foreign public companies (PDVSA, ENAP, SINOPEC) Rising prices in 2003: push to raise State share of contracts May 2006 Law raising govt share to 50% of windfall revenues July 2007 Decree 99% share; New Tax Law establishing a 70% share Production sharing contracts temporarily extended as the government prepares negotiations on a new service contracts 5 arbitration procedures before the ICSID Short-term perspective hurting long-term development
Weak Institutional Quality Freedom House Political Rights Index World Bank Political Stability Index 45 40 35 30 25 20 15 10 5 0 1.50 1.00 0.50 0.00-0.50-1.00-1.50-2.00-2.50 World Bank Government Effectiveness Index World Bank Regulatory Quality Index 1.50 2.00 1.00 0.50 0.00-0.50-1.00 1.50 1.00 0.50 0.00-0.50-1.00-1.50-1.50
Weak Institutional Quality World Bank Control of Corruption Index Heritage Foundation Trade Freedom Index 2.00 90 1.50 1.00 0.50 0.00-0.50-1.00 80 70 60 50 40 30 20 10-1.50 0 Heritage Foundation Investment Freedom Index Heritage Foundation Property Rights Index 90 80 70 60 50 40 30 20 10 0 100 90 80 70 60 50 40 30 20 10 0
Petroecuador: underinvestment, governance Longstanding underinvestment; almost nil for exploration Technology from late 1980s Weak corporate governance & coalition of vested interests 18 CEOs since 1998 Inefficient investments inhibits a recovery of mature fields production Old and inefficient refineries Operations: no mathematical model to forecast field production; no inventory reposition system Use of heavy & light crude pipelines not optimized Postponed decisions: Derivative pipelines not built for decades leading to higher transportation costs Large swings in oil price differentials with WTI hard to explain by quality/market fluctuations Crude oil & derivatives sold mainly to a local cartel of intermediaries Excluding transferred fields, 14 years of falling production
Oil derivatives & untargeted subsidies Since 2003 local sale prices of most derivatives (gasoline, diesel, cooking gas) are frozen Derivative import volumes grow at annual double-digit rates Highly regressive subsidies: 85% of the gasoline subsidy goes to the richest quintile In 2007 on average a family in the richest quintile received a US$1,053 subsidy vs. US$173 for a family in the poorest quintile Opposition to lifting subsidies: Thermal electric generation: highly inefficient utilities, controlled by regional groups Smuggling activities to and Transportation sector Vocal middle classes The timing is always wrong Year Domestic Derivatives Subsidy (in US$ millions) Direct Subsidy (Net direct import costs) % Nominal GDP Total Subsidy (import costs + opportunity costs) % Nominal GDP 2003 36.2 0.1% -47.0-0.2% 2004 316.0 1.0% 512.6 1.6% 2005 769.5 2.1% 1482.4 4.0% 2006 1090.1 2.6% 1959.9 4.7% 2007 1426.4 3.1% 2381.6 5.2% 2008 1890.9 3.6% 3651.1 6.9% Source: BCE, Petroecuador, authors' calculations
Oil Funds & Fiscal Rules In 2002-06, established: Diverse oil stabilization funds. Some were genuine fiscal stabilization mechanisms, others mainly earmarking mechanisms Fiscal responsibility clauses (growth of primary current spending, capital spending, non-oil fiscal deficit, public debt) In parallel, oil revenues were subject to legally mandated earmarking for diverse beneficiaries, bringing strong budget rigidities In April 2008, the Constitutional Assembly suppressed all oil funds, all fiscal rules, and several revenue earmarkings All fund savings transferred to the budget Fiscal spending increased by about 70% in 2008
Oil Funds & Fiscal Rules Memories of 1999 economic crisis & need to support dollarization induced increased awareness of fiscal responsibility => political will to establish funds. Large earmarking clauses reflected political economy. Budget execution with large discretionary powers pushed public entities to actively look after earmarking clauses to protect their revenues from large fluctuations. Implicit recognition of the absence of fiscal stabilization mechanisms to ensure a more stable flow of fiscal revenues despite oil price fluctuations. Political argument for suppressing oil funds: they channeled pubic money for debt payments instead of social investments. Liberal use of emergency declarations diverted money from oil funds to current spending and derivative subsidies, thus largely distorting the initial macroeconomic goal. Law suppressing oil funds approved with extraordinary high oil revenues and 5 months before a referendum.
Some conclusions: how many months is the long-term? Oil remains a critical sector for s economy Recent years: blessed by high oil prices but challenges to long-term development Existing & unused reserves: loosing net savings? Contractual agreements: how to incorporate long-term risks & minimize short-term volatility Large governance & inefficiency issues: need to find an adequate transparency mechanism Addressing very large and regressive subsidies is a growing political challenge Oil stabilization funds & fiscal prudential rules were a parenthesis in history Building coalitions to support long-term policies: the marketing may count more than the content