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Petroecuador’s Problems

Why is the situation at the notoriously inefficient Petroecuador not improving? Three experts share their insights.

Inter-American Dialogue 

Fernando Zurita resigned last month as president of Ecuadorean national oil company, Petroecuador, after just six months in the post, and a day after the company slashed its output target for this year from 180,000 barrels per day (bpd) to 172,000 bpd. Why is the situation at the notoriously inefficient Petroecuador not improving? How will the company benefit from government plans for an increased state role in the country's oil sector?

Jose Valera, Partner at King & Spalding LLP: The situation at Petroecuador is not improving due to legacy and new problems. The main legacy problem is a historical lack of available economic resources to invest in exploration, infrastructure, and enhanced recovery. This is due to the fact that Petroecuador's revenues are treated as general purpose funds by the government and the company's budget is approved by politicians. The government just recently decided to remedy this situation and appropriated a sum of around $2 billion for Petroecuador to spend in 2008 on a series of much-needed projects. It remains to be seen how this money will be spent and what the results will be. The new problem is that the president of the country decided that the Ecuadorean navy should run Petroecuador. The reason seems to be that only the navy can provide efficient and honest administration. Fernando Zurita was a rear admiral who has been replaced with another rear admiral. It is said that hundreds of navy personnel are now in control of all the company's businesses. The career personnel at Petroecuador are disgruntled and skeptical, to say the least. The revision in the target production numbers is being attributed to steeper production declines from existing fields than originally anticipated, delays in the arrival of contracted drilling rigs, and almost no production from a few horizontal wells that had been drilled recently. All in all, a mix of faulty assumptions, bad administration, and excessive optimism ...

Roger Tissot, independent energy consultant: Changing presidents will only reinforce the perception of chaos and inefficiency at Ecuador's most important corporation. Petroecuador's problems are much deeper, but the solutions are limited. Governments have few options when it comes to oil production: either they ask private companies (often foreign) to do it or they do it themselves through a national oil company. In between there are a number of combinations, such as production-sharing agreements, NOC-NOC deals, or having the NOC compete with international oil companies (IOCs). If the government opts to produce oil directly, it must ensure that the NOC has the technical, financial, and management capabilities to do it. The risk, of course, is for the government to become dependent on a technical bureaucracy or a demanding union limiting government influence over company activities. The NOC 'political risk' is to see its strategic, financial, and operational independence taken away as financial pressures force the government to over-tax the company and/or over-scrutinize its investments, while never being too eager to put the national budget at risk because of exploration schemes. In this case, the end result is operational paralysis and the creation of an entrenched culture within the company set to avoid government 'meddling' but without the strength to make any relevant strategic decisions. The government could invite private companies to invest, but that requires a minimum level of contractual stability, in addition to attractive fiscal terms. Ecuador has been notorious for the lack of legal and fiscal stability, and its terms have been deteriorating lately. President Correa finds himself in an unenviable position of depending on an increasingly dysfunctional NOC for the country's output, while IOCs are reluctant to invest. He should perhaps revise the entire petroleum strategy, redefine the country's relationship with IOCs, and while securing output and royalty revenues from private investments work toward a deep re-engineering of the NOC and not simpler changes at the top.

Patrick Esteruelas, Latin America Analyst at the Eurasia Group: Petroecuador, a heavily politicized, slow, and cash-strapped firm, has had a very poor track record with few signs of improvement. The company has seen its production fall by close to 30 percent since 1999—before artificially boosting output through the state's takeover of Occidental's assets in 2006—due to the company's heavy dependence on the state for funding, a lack of technically qualified personnel, and overly burdensome and non-transparent procurement practices. Petroecuador's heavy operating costs, refining shortages, and fuel import costs have traditionally prevented the company from allocating more than 20 percent of its budget toward investment and maintenance, resulting in serious investment shortfalls. To make matters worse, Petroecuador also suffers from a very low execution rate, typically spending no more than 40 percent of its budget every year. President Rafael Correa's government has taken some positive steps to strengthen Petroecuador, endowing the company with substantial additional funds and transferring the burden of financing fuel imports to the finance ministry. However, by insisting on handing control of the company to the navy, Petroecuador will continue to be weighed down by overpoliticization and inexperience.

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


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