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Venezuela will be hit hardest as it was already beset by falling production and U.S. sanctions that restrict its potential buyers, experts say. Here workers at Venezuelan state oil company PDVSA.(Photo: PDVSA)
Wednesday, March 18, 2020
Perspectives

Oil Price Plunge: The Impact on Latin America


Oil-producing Latin America is also feeling the shock of low crude prices.

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

An oil price war erupted [last week]  between Saudi Arabia and Russia, causing prices for the commodity to plunge 25 percent [March 9] -- their steepest drop since the Gulf War in 1991. The start of the oil price war coincided with the first global fall in demand since 2009, according to the International Energy Agency. Which oil-producing nations in Latin America and the Caribbean are most at risk from the situation, and what will be the consequences of such low oil prices on their economic and fiscal stability? How should governments in the region respond? What’s behind the price war, and how will the geopolitical dynamics play out this year as they relate to Latin America?

Lisa Viscidi, director, and Sarah Phillips, assistant, in the Energy, Climate Change & Extractive Industries Program at the Inter-American Dialogue: … Russia chose not to back OPEC’s proposed production cuts, and Saudi Arabia responded by significantly reducing its crude prices and deciding to ramp up output in an effort to maintain market share. While it appears that U.S. shale producers (who have benefited from higher prices resulting from OPEC production cuts in recent years) were the real targets of Russia’s decision, Latin America, a major oil-producing region, is also feeling the shock of low crude prices in an oversupplied market. Venezuela will be hit hardest. Already beset by falling production and U.S. sanctions that restrict its potential buyers, state-owned PDVSA has been forced to sell its crude at steep discounts. PDVSA has been selling its flagship Merey heavy crude blend at discounts of as much as $23 below the Brent international benchmark, which closed at just $36 per barrel on Wednesday. With Venezuelan production costs averaging $10-$12 per barrel, plus royalties, PDVSA is scarcely making a profit on oil sales. Conversely, Mexico will not feel the effects of low oil prices as acutely thanks to its hedging strategy. For 2020, Mexico spent $1.4 billion on oil hedging—a kind of financial insurance that gives it the option to sell oil at a certain strike price. On [March 10], Mexico’s finance minister said it had secured the price of $49 per barrel set in its annual budget. Other oil export-dependent economies around the region, such as Colombia and Ecuador, will also suffer from lower prices.

Cleveland Jones, professor and researcher at the National Institute of Oil and Gas at the State University of Rio de Janeiro: The plunge in oil prices after the price war between Saudi Arabia and Russia exposed some uncomfortable realities regarding world oil supply. When prices were at levels that allowed profitable production from most major producers, few dared to discuss how production could be rendered at risk by low oil prices. Now, it is clear that prices could fall below the national budget breakeven levels of many countries, and also below the economic costs of production in some regions. Production from some countries is at risk, while that of others will stand out as most resilient to low prices. Production from Russia and U.S. shale plays will also be hurt, but in Latin America, lost revenues will be severely felt in Venezuela, although production will continue regardless, given the need for foreign exchange. Mexico, Colombia and other Latin American countries risk uneconomical production, despite official claims. They are paying the price for not implementing reasonable energy legislation and reforms. However, underlying geological and technical favorability of production in Brazil’s deepwater and pre-salt plays, and recent reforms that improved the country’s attractiveness, place Brazil in the forefront of world oil plays, both in production potential and resiliency to oil prices. Prolific wells and production costs as low as $5.60 per barrel in the pre-salt ($12.50 per barrel in deepwater plays) ensure that in any price scenario, these regions will remain economically viable and may even assume much greater relevance in the world scenario. Brazil stands to gain while others lose.

Chris Cote, energy analyst at ESAI Energy: We are optimistic that the effects of Covid-19 on public health and the economy, although now dire, will lessen by the second half of the year, which should lead to a modest recovery in economic activity and demand growth. And now that Saudi Arabia has gotten the world’s attention, it is in its interest to resolve this price war with Russia with another production restraint agreement by the end of the second quarter. Of course, they may find it difficult to reverse the events they have set in motion. For Latin America’s major oil producers—Brazil, Mexico, Colombia, Venezuela, Ecuador, Argentina, Guyana—low oil prices will have severe effects on the economy, even if the timeline is relatively short. Exporters will have to fight for market share amid Saudi Arabia’s production surge while dealing with the consequences of lower revenues. Brazil and Guyana, producing high-quality crude oils that China and the United States will continue to buy, should fare better than the rest. Venezuela is another story: PDVSA will find it close to impossible to sell its crude, given the increased availability of similar grades and tightening U.S. sanctions. Nicolás Maduro will try to sustain what is left of Venezuela’s economy without its most important source of income, and with his most important ally, Russia, facing its own shortfall in revenue.

Joel Acosta, director for energy and natural resources at FTI Consulting: The recent oil price plunge will have an impact on Latin America’s largest oil-producing economies, including Mexico, Ecuador, Venezuela, Colombia and Brazil, by affecting their public coffers and their capacity to continue producing oil and gas. However, most of these countries have learned how to protect themselves from scenarios such as this by gradually diversifying their economies and adopting multiple financial/credit mechanisms to stabilize their revenues. Oil rents constitute a significant percentage of the GDPs of Suriname, Ecuador, Mexico, Trinidad and Tobago, and Venezuela. Although oil dependency has decreased significantly in the region over the last decade, these countries are the most vulnerable when political unrest and weak public finances compound single commodity economies, such as Venezuela and Mexico. Sovereign wealth funds, oil hedge programs, contingent credit lines with the IMF and other credit mechanisms will play a key role in maintaining public finances. For instance, Mexico has made its oil hedge program a habit for almost two decades now. Despite the current administration’s receding economy, the Mexican government renewed its 2020 hedging program at $49 a barrel—the world’s largest sovereign oil hedge. Low prices will also dampen investments in E&P projects in the region. Although state oil companies will continue producing even if it may not be profitable, international oil companies will certainly think twice where they allocate their resources. Such is the case of Brazil and Guyana, two of the biggest frontier areas in the region. Thus, increasing public expenditures and cutting taxes, without buying debt, will be key to stimulate economies at this moment.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

 

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