(*) This ARI was written before the Bolivian government announcement of energy resources nationalisation on May 2006. It has been updated to 12 May 2006.
Theme: The issue of energy –especially gas– has recently become more complicated in Latin America, undermining both the region’s energy security and Spain’s interests in the region (**).
Summary: Following the energy crises in Brazil and Argentina earlier in the decade, and currently in the midst of a world-wide energy crisis, the major energy consumers in the southern extreme of the hemisphere have been exploring different options to ensure their future gas supplies, along with possible regional energy integration plans. All the formulae for adapting regional supply to demand raise political and economic problems difficult to resolve. In any event, such difficulties, although they may at first seem to threaten the energy security of the region –along with Spanish interests– could be transformed into the very axes of partnership and cooperation which could lead to possible solutions.
Analysis
Introduction
In recent years, the energy issue has heated up. There is nowhere in the world that has remained immune to changes in the sector or to their economic and geopolitical implications. In Latin America –where the United States has much at stake in terms of energy security and where Spain focuses much of its economic interests abroad– the energy scenario has recently become more complicated. This analysis broadly examines the principal changes and foremost challenges on the region’s energy scene, particularly where gas is concerned.
Supply and Demand
Theoretically, Latin America is relatively well endowed with energy resources. Central America (excluding Mexico) and South America, account for 8.5% of world-wide conventional proved oil reserves, not much less than Africa (9.4%) and the former USSR (10.1%), and considerably more than Asia (3.5%) and Europe (2%). However, most is located in Venezuela (6.5% of the global total). Nevertheless, the region is quite poorly positioned in terms of gas. Central and South America hold just 4% of the world’s proved gas reserves, ahead of only Europe (with 3.2%). But Latin America still consumes relatively modest amounts of both these hydrocarbons, and the region is still a net energy exporter, with production totalling 6.78 million barrels per day (bpd) in 2004 (8.8% of world-wide production) versus consumption of 4.74 million bpd (5.9%). In gas, Latin America produces some 130 billion cubic metres –more than 12% of world-wide gas production– but it consumes somewhat less (almost 120 billion cubic metres, more than 11.5% of the global total).
Although the energy balance in the region is still positive, it could easily be tipped. First, demand for energy will continue to increase –in all its forms (oil, gas and electricity)– especially if Latin America is to keep up a fast and stable pace of economic growth. Secondly, in order to enable economic growth and higher energy consumption, the region will have to further increase investment in the energy sector, not only to continue to boost production but also to attain better integration with both world energy systems and those of the region itself. The International Energy Agency estimates that Latin America will need to invest US$1.3 trillion in the energy sector by 2030 to meet increased demand. This investment will have to encompass not only exploration and development but also construction, on the one hand, of gas pipelines and liquid natural gas (LNG) terminals and, on the other, of electric power stations and transmission networks.
For better or for worse, the region is divided into net exporters and net importers. This distinction will continue to be noticeable in the future, and extensive and efficient regional energy integration will increasingly be necessary. In gas, the country to be most highly dependent upon imports in the region is Chile. It imports two-thirds of its energy consumption, and has been very dependent upon Argentine gas (20 million cubic metres a day), which until recently supplied energy for 25% of its electricity generation (more than half in the northern part of the country). Chile has only 28 billion cubic metres of gas reserves, whereas its projected demand to 2025 will be 196 billion cubic metres. Argentina has traditionally been a strong gas exporter –and it is still the top producer in Latin America (45 billion cubic metres in 2004, 50% more than Venezuela)– but it is finding it increasingly difficult to boost production (and, what is even more significant, to secure the level of investment necessary for this), and it could soon become a net gas importer. Brazil, with the third-largest gas reserves in the region, has quite considerable potential in the medium and long term (with almost one trillion cubic metres in reserves and a good chance of discovering more), but in the short term it is still clearly a net importer.
Furthermore, the major gas reserves in the continent are concentrated in the Andean region, particularly in Venezuela, Bolivia and Peru. Overall the situation is such that the Andean countries have more potential to export gas in the short and medium term, while the Southern Cone countries (Argentina, Brazil and Chile) will increasingly need to find ways to integrate with the Andean countries and the world as a whole in order to import larger amounts of gas.
Energy Crises and Integration Plans
Following the electricity crisis in Brazil in 2001-02 and the gas crisis in Argentina in 2003-04, the energy scenario in Latin America has become increasingly complex. Argentina has been a case in point. When the peso was devalued, the government converted gas tariffs to the devalued local currency and froze them. Gas prices (used for half of Argentina’s energy mix) slumped by 67%. When the economy bounced back from the 2002 crash, energy demand increased substantially, but supply remained flat because of the lack of new investment given lingering legal uncertainties. In 2004, proved gas reserves in Argentina were 35% below their levels of 2000. To ensure internal supply, the Argentine government cut exports to Chile, the traditional destination of Argentine surpluses. This cutback of between 20% and 50% in the supply to Chile almost sparked an energy crisis. It was only avoided by torrential rains in Chile, which temporarily boosted hydroelectric power production. Although Argentina has allowed tariff increases for major industrial consumers, residential prices are still reined in (although some increases have been recently allowed), thus maintaining the uncertainty in respect of investments and supply in Argentina and jeopardising future energy security in Chile.
This Argentine pattern, of a sudden change –negative for the interests of private investors– in the legal framework of the hydrocarbons sector, followed by a decline in investments, scant and sometimes interrupted supply (now or in the future) to neighbouring countries –thus undermining the potential for more stable and deep-rooted energy integration– has become a leitmotif throughout the entire continent. This dynamic has become even more complicated by the resurgence of national rivalries between Bolivia, Chile and Peru, and by the political ambitions of the Venezuelan government to promote its own version of continental energy integration.
Bolivia: the Promise and the Problem
With the Argentine gas crisis, Bolivia emerged as potentially the main gas supplier to the Southern Cone. Between 1997 and 2004, the major energy corporations (including Petrobras, Repsol YPF, Total and British Gas) ploughed almost US$5 billion into the hydrocarbons sector (mainly gas) in Bolivia. The country’s exports actually totalled 30 million cubic metres per day, most notably to Brazil and Argentina, and there were plans for major investment to expand the gas pipeline network to Brazil and Argentina (which might help Chile, at least indirectly) and also to take gas directly from Bolivia to Chile, where an LNG terminal under construction (promoted by Repsol YPF) would re-export liquefied gas to Mexico and the US (and possibly to other regions in Chile in the near future).
However, in 2004, the domestic movement against the liberalisation of the Bolivian economy made gas its main bone of contention with respect to foreign interests. The idea of liquefying gas in Chile was abandoned and in May 2005, following the fall of the Sánchez de Lozada government, the country’s Legislature approved a new Hydrocarbons Law increasing taxation on production from 18% to 50%. At the end of last year, the new government-elect under Evo Morales announced its intention to ‘nationalise’ the country’s resources –although it insisted that the project did not include plans to expropriate assets owned by foreign companies– generating more legal uncertainty in the region and undermining the projects to supply Chile, Brazil and Argentina with more Bolivian gas. Only weeks ago, the Morales government decreed that contractual terms with foreign energy companies will have to be renegotiated, prompting many to interpret the latest Bolivian decree as an effective confiscation of foreign assets. Repsol YPF may be forced to write off another 8% of its reserves (after having written off 25% earlier this year).
Furthermore, at the recent EU-Latin America Summit in Vienna, Morales announced that foreign firms’ petition to be compensated for the ‘nationalization’ would not be met, and he proceeded to launch into a particularly aggressive attack on Petrobras, the Brazilian state energy firm and the largest hydrocarbons investor in Bolivia. The potential implications that this brewing crisis in Bolivian-Brazilian relations will have for Chavez’s plans to include Bolivia in the “Great Gas Pipeline of the South” – considering that most of the pipeline’s trajectory will have to pass through Brazil – remain unclear.
Peru and the ‘Great Gas Ring’ Project
Political upheaval in Bolivia initially had the effect of relocating the interest of Southern Cone countries to Peru and the ‘great gas ring’ project of South America. This alternative project was unveiled in June 2005 –shortly after implementation of the new law in Bolivia–. It includes a new gas pipeline to take gas from the huge Peruvian fields at Camisea across the Andes to Chile, where it would link up with the gas pipeline network of Brazil and Argentina, supplying gas to all countries in the south of the continent. This ‘great ring’ would imply an investment of at least US$2 billion and, if it goes ahead, would be a major step towards energy integration in the Southern Cone and towards solving the region’s gas crisis.
However, the ‘great gas ring’ has been shrouded by a veil of uncertainty nearly since the project’s launch. First, although Camisea’s reserves are sizeable (some 187 billion cubic metres of gas), new demand for liquid gas in Mexico and the US is competing directly with the countries on the continent for Peruvian gas and is casting doubts over the capacity of Camisea to supply both the northern and southern markets. Without gas from Bolivia –which is involved in a major diplomatic row with Chile over its potential access to the sea– many observers believe that Camisea’s gas, on its own, will not be enough to make the ‘ring’ project viable. Secondly, a long-standing conflict between Chile and Peru regarding the exact demarcation of the sea border reared its ugly head last year, casting further doubts over the future of the ‘gas ring’ project. Finally, the nationalist and populist candidate, Ollanta Humala –who has already declared his willingness to consider a change in the legal framework of the hydrocarbons sector, one of the most open and liberal in the region, at least so far– has just won the first round of the presidential election in Peru. If Humala wins the second round in early June –which cannot be ruled out– the likelihood of him following the model of Chávez and Morales is quite high.
What is more, with Bolivian-Brazilian relations today teetering on the brink of crisis, it remains unclear under precisely what terms Bolivia would sell gas to Brazil in any case – regardless of the ultimate export route (ie, (1) through the currently existing Bolivia-Brazil transport network; (2) through a potential link into a resuscitated “Great Gas Ring” project; or (3) by way of an eventual Bolivian incorporation into the “Great Gas Pipeline of the South”.
Venezuela and the ‘Great Gas Pipeline of the South’
With gas production in Argentina about to enter a downward spiral, with Bolivia submerged in political and legal uncertainty, with Peru facing the uncertain outcome of its presidential election and with a rejection of economic liberalism spreading throughout the continent –along with a new nationalist and populist sentiment–, all hopes of increasing gas production and pursuing regional energy integration seem to have effectively dissipated. In just two years, Argentina, Bolivia and Peru have basically been eliminated as viable options for supplying gas to the growing economies of the Southern Cone. This development has paved the way for the ambitious initiatives of the Chávez government to take centre stage. Taking advantage of its still not fully consummated entry into MERCOSUR, and seeking a way to lead an alternative version of regional integration with which to oppose the FTAA, Venezuela has put forward a new continental gas pipeline project. This ‘great gas pipeline of the South’ would, in principle, carry 150 million cubic metres per day to Southern Cone countries and could potentially become a pragmatic first step in the much-vaunted economic and political integration of South America.
Although the route of this projected gas pipeline is not yet clear, it would likely pass through north-eastern Brazil to end up in Buenos Aires, where it would connect to the existing Argentine network. It would be approximately 8,000 km long and would cost around US$20 billion. In any event, it would have to overcome a lengthy succession of hurdles. First, the amount of investment necessary is formidable. In fact, of all the gas pipeline projects in the region, the only one that is actually already under construction –the Gasene pipeline to transport gas from southern to north-eastern Brazil– is significantly over its budget and a number of companies involved have repeatedly halted work. It seems the Gasene project can only be saved by a deeper commitment from Sinopec, the Chinese national company, than originally proposed. If the experience of this project is anything to go by, the ‘great gas pipeline of the South’ may end up costing even more than the initially estimated amount, particularly considering that it is more than likely to face protests by environmentalists and indigenous groups due to its possible entry into vulnerable areas of the Amazon.
The same doubts regarding the sufficiency of Peruvian reserves to supply the ‘great gas ring’ could possibly even apply to Venezuelan reserves. To keep transport tariffs at the same level that Brazil currently pays for Bolivian gas (although, admittedly, the current tariffs seem obsolete in the wake of Morales most recent statements), Venezuela would have to generate initial flows of at least 30 million cubic metres per day. Before building the pipeline, Venezuela would have to increase its own gas reserves. Although the country claims that its reserves total 4.5 trillion cubic metres, only 10% is unassociated (ie, not linked to oil reserves). In any event, the Venezuelan government also says that the country is set to increase its internal consumption by some 60 million cubic metres per day before 2012 (to supply new electric power and petrochemical plants). Furthermore, the state-owned company PdVSA is building another gas pipeline to connect its eastern network with the country’s western region, where there is little gas, and it has plans to take another 35 million cubic metres per day to the area within ten years.
But Chávez has established the same control over the gas sector that the Venezuelan government has asserted over the oil sector. In September 2005, the government announced that PDVSA would control all new construction of gas pipelines and export plants (including LNG plants). Furthermore, the government has recently changed the rules for calculating taxes on gas production, effectively increasing them. These changes have generated further doubts as to legal security, jeopardising the only two projects which are currently committed (the Chevron projects in the offshore Deltana blocks, and the Yucal-Placer onshore project of Repsol YPF and Total).
Another paradox is the fact that in both Venezuela and Brazil, as well as in Chile, a number of projects to build liquefied natural gas plants have been placed on the back burner in favour of new regional gas pipeline plans. However, estimates in the sector suggest that for distances over 3,000 km it is more profitable to liquefy the gas and export it by sea. Given the possibility that the costs of the ‘great gas pipeline of the South’ will continue to increase, both Brazil and Chile may end up returning to their previous plans of opting for a liquefied gas strategy. The mere possibility of this generates even further uncertainty. In any event, in light of Morales recent statements both before and during the Vienna summit, the LNG strategy –both for consumers like Chile, Brazil and Argentina, as well as for potential future exporters like Brazil—is looking increasingly attractive, if not yet essential.
Potential for Integration
Although all of these regional gas pipeline projects are plagued with economic and political uncertainties, they do have an appealing advantage, especially for the left-wing and centre-left leaders of MERCOSUR. Both the ‘great gas ring’ and the ‘great gas pipeline of the South’ could potentially serve as effective tools for achieving further strides toward regional partnership and integration, lending more substance and coherence to the long-sought dream of a South American union. Given the increasing convergence among politically like-minded governments across the continent –despite the clear distinction between neo-populists (ie, Chavez, Morales, Kirchner and possibly an eventual President Humala) and more moderate social democrats (Like Vazquez, Lula, Bachelet and –at least one would hope— a possible future President Garcia in Peru)– this possibility is becoming more and more viable, even if it still remains less than likely. The moment is actually more propitious than ever: energy prices remain at a record high, governments in the region are increasingly in tune with each other and the United States appears to have lost interest in the area, while the Washington Consensus faces widespread rejection. These are the key factors which explain the new aggressive and independent stance taken by the governments of the region, in producer and consumer countries alike.
On the other hand, many observers had previously speculated that one objective of these ambitious regional gas pipeline projects was to bring pressure to bear on Bolivia so that it might moderate its hydrocarbons policies. None of these projects had explicitly included Bolivian gas –at least not until the recent Iguazu Summit– raising the possibility that Bolivia might be ultimately excluded from its natural markets in the Southern Cone. This possibility might conceivably tone down the actions of the Morales government which, in turn, would likely improve the business climate and underpin adequate investment levels in Bolivia. Nevertheless, one of the surprises of the meeting in Iguazu was the announcement made by Chavez that Bolivia would be incorporated into the ‘great gas pipeline of the South’ project. How this development would square with the more recent aggressive statements of Morales with respect to Petrobras, however, remains a mystery.
Implications for Repsol YPF
This potential Bolivian oscillation between moderation and rigidity in relations with Brazil and Argentina is highly significant for Repsol YPF, which has spent years replacing its declining Argentine reserves with new reserves in Bolivia. Although the Spanish-Argentine company recently announced a major downgrade in its reserves in Bolivia, Argentina and Venezuela (accounting for 25% of its total reserves) –and may be forced to write off still more as a result of the most recent May Day decree by the Morales government– Repsol YPF still has major interests in these countries. Whatever happens, the company will have to live with the existing uncertainty and perform a delicate balancing act in its relationship with these increasingly neo-populist governments, particularly over the next 6 months, during which Bolivia plans to renegotiate all of its gas contracts.
For better or for worse, Repsol YPF finds itself in an almost unique situation among the world’s major hydrocarbon giants. The vast majority of its reserves are concentrated in Latin America, where indeed it enjoys a relatively privileged relationship with certain governments, particularly in Venezuela (even despite all the recent drama), while its sector peers –with the exception of the Chinese national companies and the state-owned Russian operator Gazprom– are losing interest in Latin America for geological reasons and issues of investment insecurity, and slowly but surely they are abandoning the region. Although Repsol YPF has plans to diversify its reserves and other assets in geographical terms, this will not be easy without an increase in its cash flow from Latin America.
Conclusion: Yet it is quite possible that in the medium term the crude reality which gas producers in the region will have to face might work in favour of the Spanish energy company. The fundamental need to generate sizeable new investment in production and infrastructure will likely temper the attitudes of the governments of Bolivia and Venezuela (and that of Peru should Humala win the presidency) with respect to private investment, and particularly that of Repsol YPF, in view of Spain’s privileged relationship with these countries. One should be careful to take Morales’ most recent rhetoric with a grain of salt, at least for awhile. In any event, Repsol YPF has not been verbally singled out, something that might be interpreted as an encouraging sign.
In the end, only Venezuela is potential capable of financing its investment needs on its own, and there are even doubts as to PdVSA’s ability to implement all of its future key projects without outside help. Although the region may see greater involvement from Chinese and Russian companies in the future, this is unlikely to be enough to enable governments of producer countries to dispense entirely with Repsol YPF’s potential contribution.
Accordingly, the Spanish government’s foreign policy and Repsol YPF’s business diplomacy will be pivotal for Spanish national interests in Latin America over the short and medium term. It is true that the region is still in the midst of a flurry of electoral activity, but the main pieces of the political puzzle now seem to be in place. Chávez, Lula, Kirchner and Uribe will likely renew their mandates. The only novelty might be the election of Humala in Peru and ongoing uncertainty in Ecuador. But from now on, it is certain, a new and vital period opens up for Spain’s foreign policy and corporate diplomacy in the region.
Are Spanish policy-makers, diplomats and executives up to this subtle challenge? An astute gambler, taking a calculated risk, would say yes.
Paul Isbell
Senior Analyst, International Economy & Trade, Elcano Royal Institute
(**) Original version of this ARI was published in Cuadernos de Energía, Nº 12, March 2006.