Ecuador throws down oil gauntlet

From BBC News

By Jane Monahan
Washington

When Ecuador's left-wing President Rafael Correa drastically increased the state's share of oil revenues in October, and oil minister Galo Chiriboga also announced that contracts with foreign oil companies had to change, industry analysts said the country had gone too far.

After all, foreign firms currently account for about half of Ecuador's total crude production of more than 500,000 barrels a day (bpd).

And while Petroecuador, the state oil corporation, accounts for the rest, it continues to be plagued by mismanagement and debt, analysts say.

The proposed increase in the government's share of windfall oil profits - those obtained whenever world oil prices exceed those established in existing contracts - was also huge.

The tax went up from 50% of windfall oil profits to 99%.

That would net the government $830m a year more in revenues, assuming world oil prices stay at current levels.

The principal oil companies affected - Spain's Repsol, China's Andes Petroleum, Brazil's state company Petrobras, French-owned Perenco and US-owned City Oriente - were already unhappy.

They objected strongly when the state's share of windfall oil profits was increased for the first time, to 50%, in a law passed in 2006.

But President Correa, who has been in office since January, is coming from a position of strength.

He decreed the oil tax hike within hours of winning a landslide victory in a vote and more than 60% of the seats in a new national assembly, which has started rewriting the country's constitution and forging ahead with his radical agenda.

Poverty reduction

Mr Correa, a former finance minister who has a PhD in economics, also explained the move in his decree.

He said the government would spend the extra oil money on services, roads and electricity for the poor, which was wildly popular.

Ecuador is Latin America's fifth-biggest oil producer. But World Bank estimates show that some 56% of the country's 13.4 million people live in poverty.

That figure rises to more than 80% for indigenous Ecuadoreans, who are mainly small farmers in mountainous highlands.

But confronting the foreign oil companies is risky. Take the controversy over changing the oil contracts.

In announcing the change at a recent press conference, Mr Chiriboga said the companies could comply by reducing their levels of participation in existing production-sharing contracts with Petroecuador.

Otherwise, they could switch to new service contracts, where they earn a fixed fee for specific services such as prospecting and production, but the state owns all the oil once it is extracted from the ground.

Mr Chiriboga, whose ministry is now in talks with the oil companies over the latest oil tax increase and the new contracts, said his objective was to find a solution that offered both sides "a reasonable profit".

But Simon Pachano, a professor at the Latin American University of Social Sciences in Quito, Ecuador's capital, says that in either case, "there will be much less incentive for the companies to increase exploratory work and production, or to invest in machinery."

As a result, because Ecuador's oil industry accounts for 40% of the country's exports and more than a third of government revenues, there is a risk that the nation's economy may suffer, if investment and production in the oil sector declines.

Legal wrangles

There is also a risk of litigation, as shown by the US's City Oriente, the smallest of the principal oil firms in Ecuador with only a 3,000 bpd output.

It won a favourable ruling in November from the World Bank's International Centre for the Settlement of Investment Disputes over the first oil tax increase approved last year.

And Antonio Brufau, chief executive of Repsol, the biggest oil multinational now in Ecuador, with a 65,000 bpd output, referred to Mr Correa's new oil tax hike at a meeting in Chile in November, saying: "This [measure] to us is one that does not allow us to operate within a reasonable corporate environment."

Complicating matters further, Mr Correa's repudiation of the current oil contracts is not just about foreign oil companies, but also the previous Ecuadorean governments, run by conservative political elites, that agreed to them.

"The contracts have not benefited Ecuador. The problem is also the previous governments. This is widely recognised, " Mr Pachano says.

Mr Correa is an ally of Venezuela's President Hugo Chavez - and, like him, is not shy about using colourful rhetoric on occasions.

He maintains justice is on his side. Most of the existing oil contracts were agreed when international oil prices averaged $24 a barrel, before they started rising in 2003.

But, said Mr Correa at a press conference during a state visit to China in November, Ecuador was still receiving just $3 to $4 in taxes from oil sales, even though the price of crude has risen to about $90 a barrel.

"These are the extraordinary benefits that the investors haven't done anything specific to receive. The benefits should go to the owner of the resources," Mr Correa declared - in other words, the citizens of Ecuador.