Ecuador Threatens Expropriation of Private Oil Operations

Ecuador is a relatively unknown member of OPEC, due mostly to its up and down relationship with the cartel. Ecuador first joined OPEC in 1973, then in 1992 suspended its membership for 15 years before rejoining in 2005. The country’s proved reserves of crude amount to about 6 billion barrels, and it produces less than 500,000 b/d of crude.

Of that amount, 42% is produced by private oil companies. The largest companies working in the country are Petroleo Brasileiro SA, or Petrobras, (NYSE: PBR), Spain’s Repsol YPF S.A. (NYSE: REP), and Italy’s Eni SpA (NYSE: E). Chevron Corp. (NYSE: CVX), as a result of its purchase of Texaco, is currently involved in litigation claiming as much as $27 billion in damages for environmental violations.

In a move reminiscent of the takeover of Occidental Petroleum’s (NYSE: OXY) Ecuadorian operations in 2006, the government is threatening to expropriate all foreign-owned oil field operations unless the companies agree to re-negotiate existing contracts to increase Ecuador’s share of production revenues.

The government wants to move eliminate contracts what are now essentially production sharing agreements to contracts where the producer would be paid a production fee and re-imbursed for investment costs. Needless to say, the producers like the current system better because they make a lot more money off production that they would off a production fee. Recent contracts awarded in Iraq have set a production fee of $1.90/b. The Ecuadorian government has not specified a fee yet, but it is unlikely to be significantly higher.

The Ecuadorians are following the example of both Venezuela and Bolivia in trying to force production contract changes to maximize revenue from the country’s hydrocarbon deposits. The government expects to sign new contracts within 60 days.

The Wall Street Journal reports that the oil companies have drastically reduced investment in Ecuador, spending just enough to maintain existing output. President Rafael Correa promises to submit a bill to the Ecuadorian Congress to allow him to expropriate the oil assets if the companies do not sign the new agreements.

Repsol YPF, Petrobras, and Eni are likely to cave in rather than lose the revenue, even though the number of barrels is fairly small. The new agreements essentially turn the companies into oil field services companies. That’s not necessarily a bad thing, and if these companies don’t want to bother with it, companies like Schlumberger Ltd. (NYSE: SLB), Halliburton (NYSE: HAL), and other services companies would not turn down the opportunity to operate the Ecuadorian fields for a straight fee. That’s their business model after all.

As in all these cases, the government has the upper hand. The choice for the oil companies is one between two evils.

Paul Ausick