Latin Two-step
There is nothing straightforward about Latin American gas and oil.
Among problems experienced in the region are dollar-denominated debt coupled with revenues denominated in local currencies, particularly in Brazil. The recent up-tick in oil prices also has had an impact. Factors adding to volatility in the region include consolidation of participants in the sector, particularly in Argentina, and the push to extract value out of underdeveloped natural gas reserves. And recent consolidations in the region appear to have been driven as much by reasons having to do with access to capital as by any operating synergies to be realised by merging.
US-based Reliant Energy is leaving the region. The company announced in mid-December that it was relying on Wall Street expertise to find a buyer for its Latin American investments, which included natural gas systems in Colombia as well as electric utility systems in Brazil, Colombia, El Salvador and Argentina; plus a power generation project in Argentina. Credit Suisse First Boston (CSFB) is the investment advisor on the sale of the Latin American assets. ?The initial thinking at the time of the announcement was that we would sell the subsidiary involved in Latin America as a unit. We are now contemplating selling assets individually because we believe we will realise a higher value for them,? according to company spokesperson Sandra Fruhman.
In addition to geographic diversity, Reliant's forays into the Latin market include ventures with a wide range of partners. ?In Brazil we are partnered with AES, Electricite de France and CSN, a Brazilian firm. In Colombia and El Salvador we are partnered with Electricidad de Caracas. In Argentina, we have sole ownership of a small electric distribution system and a cogeneration plant. Our partners in the Colombian natural gas assets are Colombian. Our business activities in Latin America are quite similar from country to country. The vast majority of our investments are in electric distribution systems. Some of these companies also have power generation and some do not.
?We have relatively small investments in natural gas distribution and one cogeneration plant.? Reliant will focus its efforts on opportunities emanating from electric restructuring in Europe and the US, states Fruhman.
According to a New York-based project finance banker, it was that diversity of location and partners that has prevented Reliant from making a package deal. However, the company announced on April 25 that it had sold its indirect interests in five natural gas companies in central and southwestern Colombia to an unnamed investment trust incorporated in Colombia, working on behalf of an unnamed Colombian company. The companies ? four natural gas distribution companies located in the states of Valle del Cauca, Quindio, Risaralda, and Caldas and one pipeline/transportation company located in the state of Tolima ? were developed largely as greenfield projects from concessions granted by the Colombian government in 1997. Reliant is being secretive about the eventual owner of the properties as well as the purchase price.
In early April, Dallas-based TXU announced that it was leaving Mexico City's gas market, highlighting the limitations facing investors in Mexico's energy sector. Mexico has not been overly successful in attracting investors to that market, mainly because opportunities are few. TXU sold its stake in the capital's gas distribution system last week to Spain's Gas Natural SDG SA and Hidroelectrica del Cantabrico for $68 million. The agreement is expected to close later this year, subject to regulatory approval. Gas Natural will become operator when the transaction is closed. In announcing the sale, TXU officials maintained that the Mexico market is vibrant, but that continuing the operation would not be consistent with the company's overall corporate strategy. A TXU subsidiary, Hidrocantabrico and two local partners acquired the natural gas distribution company operating in Mexico's capital city in August 1998.
Although the Mexican government continues to struggle over where it will get the cash to pay for the country's massive social programmes, there appears to be little movement to break the traditional monopoly held by the government in the gas and oil sectors. Investment opportunities for foreign energy companies are limited to distribution and transportation ? although most of that business is controlled by companies already in the market. Even so, investors fortunate enough to be in place are obligated to deal solely with government agency Pemex.
Last year, merger activity was strong among Latin American oil and gas producers. However, 1999 merger activity only continued a trend started earlier in the decade. For example, Repsol acquired a controlling interest in Astra in mid-1996. Amoco and Bridas combined their regional activities, forming Pan American Energy in late 1997.
Key consolidations last year included Repsol SA of Spain's acquisition of YPF. Spain's Repsol last year paid $19 billion for 98% of YPF, Argentina's largest company, and formed the Repsol-YPF group.
Repsol already controlled Astra. Repsol-YPF has vowed to divest itself from 800 service stations and 4% of its refining capacity in Argentina to avoid an unwanted dominant position in the Argentine energy market. YPF still exists as an Argentine registered company.
The acquisition has performed well for Repsol as demonstrated by ratings agency actions in early April. Standard & Poor's raised its ratings on YPF SA's 8.95% structured export notes due 2002 and YPF SA's 7.5% structured export notes due 2002 to triple-B-plus from triple-B. The ratings upgrades are based on: a sufficient level of oil reserves in the Neuquen Basin to cover the delivery obligation under the oil purchase agreement; credit enhancement in the form of overcollateralisation, a price hedge agreement, and a three-month debt service reserve account; and a strong structure to mitigate the risk of sovereign interference. The oil reserves in the Neuquen Basin have continued to increase rising to 600 million barrels in 1999, up from 571 million barrels in 1998. Production levels have also continued to increase since the rating was first assigned in 1995. Production levels rose to 245,000 barrels per day (bpd) in 1999 from 201,000 bpd in 1994, indicating a strong likelihood that YPF will continue to honour its obligations under the oil purchase agreement.
YPF is obligated to sell, and Empresa Nacional del Petroleo-Chile (ENAP) is obligated to purchase, an average of 40,000 bpd of crude oil delivered through the Transandean Pipeline. The three-month debt service reserve account is available to cover price risk not otherwise covered by the hedge agreement and delivery shortfalls. The product is delivered directly to ENAP through a Transandean Pipeline, and ENAP has agreed to make all US dollar payments into an off-shore collection account maintained by the trustee for the benefit of the noteholders. The rating action follows the assignment of a triple-B-plus local currency corporate credit rating to YPF on March 29. According to Standard & Poor's (S&P), the notes are a direct obligation of YPF and are secured by an assignment to the trustee of YPF's right to receive a percentage of all amounts due under the crude oil purchase agreement entered into with ENAP. Another major deal was Chevron's 100% acquisition of Petrolera Argentina San Jorge. Recent production increases have moved the company toward being one of the top producers in Argentina with gross operated daily production of approximately 78,000 barrels of oil and 40 million cubic feet of gas, accounting for about 8% of the total oil production in Argentina. San Jorge has potential reserves of over 400 million barrels oil equivalent. San Jorge owns a 14% equity interest in Oldeval, the major export pipeline to the Atlantic coast. Additional export access is through the Transandino pipeline to the Pacific coast, making San Jorge Argentina's second largest petroleum exporter. The company has a strong acreage position in Argentina's prolific Neuquen Basin and controls significant acreage in the Austral Basin in southern Argentina. In addition, it has five million acres of exploration acreage in key petroleum basins in Colombia, Ecuador, Peru, Bolivia, Chile and Brazil.
Alberta Energy Co's acquisition of Pacalta Resources, announced in March 1999 when oil prices were substantially lower, added 208 million barrels of proven and probable reserves. Subsequent drilling added 72 million barrels of proven and probable reserves at a finding and development cost of $0.89 per barrel.
During 2000, the company expects to invest $150 million to further expand its reserve base and production facilities. Current light and medium oil sales are approximately 42,000 barrels per day and are forecast to average approximately 48,000 barrels per day in 2000. Ecuador production capability currently exceeds export pipeline capacity. AEC's pipeline group is part of a consortium actively pursuing a major expansion of the export system. AEC has been leading a group of producers seeking to build a new export pipeline in Ecuador that will unlock the potential of its Ecuador holdings. The proposed 290,000 barrel per day OCP pipeline is targeted to be on-stream in late 2001. AEC expects to own approximately one-third of the new pipeline.
A recent Standard & Poor's report describing challenges inherent in the volatile Latin American energy sector notes that these transactions represent only a small percentage of merger and acquisition activity in the region, as many properties changed hands among foreign investors. Among those transactions were the sale of Arco's Venezuelan, Ecuadorian and Peruvian properties to Burlington Resources and Agip, as well as the sale of the Bolivian assets of Tesoro Petroleum Corp to SG International.
A number of factors precipitated the disappearance of local companies in the Latin American oil sector. The drop in oil prices last year forced some local companies to consolidate with international companies because of lack of access to domestic sources of finance in the wake of a series of economic shockwaves. The S&P report notes that, at the same time, the wave of deregulation sweeping through the gas and oil sectors throughout most of the region during the 1990s allowed investments to be made to serve the broader Latin American market rather than specific markets defined by national boundaries. This process spurred gas and oil companies to develop projects on a larger scale, with greater impact on the earnings of larger international companies.
Two other factors that have spurred consolidation in the Latin American oil and gas sectors have been deregulation throughout the industry and economies of scale. The deregulated energy sector has allowed for foreign competition. While deregulation has opened the door for global companies to invest in the region, the same process favours those companies with the deepest pockets and the best technology.
In recent years, governments in the region have recognised the need to implement economic development plans to attract foreign capital. S&P analysts maintain that investors will follow the highest risk-adjusted returns. Examples of this phenomenon include the Bolivia to Brazil natural gas pipeline built by Petroleo Brasileiro (Petrobras), Royal Dutch/Shell Group of Companies, El Paso Energy Corp, and Enron; the Petrozuata heavy oil project being developed by Conoco and PDVSA in Venezuela; and, the MEGA project being carried out by YPF, Petrobras, and Dow Chemical in Argentina.
However, investors have not made indiscriminate bets in the region. In 1998, Shell and Mobil opted out of developing the huge Camisea natural gas deposit in Peru, despite two years of exploration work, after they became concerned that certain actions by the Peruvian government would make the project uneconomical. In early 2000, a consortium which included Texas-based Hunt Oil was chosen to develop the upstream portion of that project, one of Latin America's largest natural gas fields, with about 13 trillion cfe proved reserves. Long-term gross capital requirements could total $1.6 billion for the consortium.
Governments also have turned their attention to the natural gas sector, spurred by significant new discoveries, development of more efficient technologies, and environmental concerns. S&P analysts point out that the linking of Latin America's Southern Cone through construction of natural gas pipelines has been under way since the mid-1990s and is expected to continue through much of the next decade. Specifically, the GasAndes pipeline was completed in 1997, connecting Argentina's Neuquina Basin with Santiago, Chile and the surrounding region. In 1999, the Gas Atacama and NorAndino pipelines were completed, linking Argentina's Northwest Basin to the mining regions in the north of Chile. The Gas Pacifico pipeline also was completed, connecting the Neuquina Basin to southern Chile, as was the Bolivia-to-Brazil (BTB) pipeline, currently not operating at full capacity.
S&P notes that other regional natural gas pipelines are in various stages of completion, including the Cruz del Sur project, which connects Argentina to Uruguay, and then to southern Brazil. Potential projects include a pipeline connecting Venezuela to northern Brazil; a pipeline linking Colombia and Venezuela to Central America; another from Mexico to Guatamala; and another line running from Bolivia, through Paraguay and into Brazil. There is also talk about eventually connecting the Camisea gas deposit in Peru to a line in order to connect it to the BTB pipeline. However, according to S&P, that project may not be completed due to the recent discovery of large natural gas deposits in Bolivia.
Bruce Schwartz, S&P oil and gas analyst, says: ?There are not a lot of new oil projects being financed in the region. While there is increasing demand for oil, there already is too much refining capacity. And demand for gas is growing in the region. However, major issues continue to involve capital flows and political risk.? Schwartz notes in addition, that the move to substitute cleaner gas for oil has been slowed by regional economic malaise, particularly in Argentina and Brazil.
S&P stressed in its report that disruptions in capital flows in the wake of recent economic volatility in Latin America highlights the importance of financial flexibility and the cost of capital for developing projects. That volatility caused financing alternatives to disappear or to become prohibitively expensive. As spreads on debt widened, companies increasingly became unable to earn their cost of capital. Superior access to capital was perhaps the most important factor leading to the acquisitions of Pacalta Resources and Petrolera Argentina, according to S&P.
The ratings agency maintains that companies operating in the sector are susceptible to sovereign risk. Perception of country risk may translate into sharply reduced capital flows into the region ? although the outright risk of nationalisation or expropriation is minimal. However, governments may change tax codes to realise higher revenues if the market so warrants, or default on contracts ? either of which would produce disincentives for further investment. Because coercive changes to contracts rarely result in the loss of assets, the risk is seldom insurable, according to the ratings ageny. S&P predicts that funds will continue to flow into the gas and oil sectors as deregulation advances, making the region an increasingly attractive target for foreign direct investment.
In addition, further diversification is expected in Latin America, with the Mexican government talking with key players in the oil business about investing up to $300 million in the Mexican petroleum industry. The government is attempting to modify a law requiring that 51% of a project must remain in state hands. Investors have been wary of sinking cash into projects controlled by the government. By law, Mexico cannot sell more than 49% of a petrochemical plant to the private sector. The industry is run by state oil and gas monopoly Pemex. However, this move should not be construed as an overall first step towards opening up the Mexican petroleum industry to private investment, sources insist.
?In Mexico and Venezuela, for example, oil revenues represent about 33% and 50% of all government revenues respectively. However, the Mexican government runs Pemex, with about 60% of revenues paid to the federal treasury as royalties. While a price hike translates into higher revenues, it doesn't necessarily equate with more money going into capital programmes,? according to Hugh Welton, Fitch IBCA analyst. With less government interference, ?Petroven is more autonomous; with the oil sector specifically ? and not the government in general ? benefiting from higher prices.?
Private sector companies also have been shut out of deals with national oil companies, although those public companies have accessed substantial amounts from the capital markets during 1999, backed by export receivables. Deals backed by export receivables allow these public oil companies a cost of capital cheaper than can be accessed by independent private sector companies. As a result, private companies are forced either to abandon the market or to structure secured transactions ? although few companies have sufficient exports to warrant such transactions.
John Diaz, managing director in Moody's energy group, says: ?A lot of companies are pulling back from investments in the emerging markets ? and Latin America is no exception ? because of political risk and the way the stock market values their investments. With uncertainty in these markets, companies are inclined to cut back and redirect these investments to their less volatile domestic markets.? Investment in the oil sector has been constrained ? in spite of recent hikes in oil prices ? by uncertainty about future prices as well OPEC compliance rates. This uncertainty caused local companies to put off investing in projects until capital became too expensive. This same uncertainty has deterred international companies which have access to capital from sinking it in the region, according to Diaz.
In spite of problems, there is a huge need for natural gas throughout Latin America as the fuel of choice, because it is more environmentally friendly. As Diaz says: ?I think there are a lot of companies interested in the region who have laid groundwork for projects. But the question is how long it will take the market to develop. Governments run into problems with devaluation and things slow down. In an economic sense, countries often take two steps forward and one step back.?
Among problems experienced in the region are dollar-denominated debt coupled with revenues denominated in local currencies, particularly in Brazil. The recent up-tick in oil prices also has had an impact. Factors adding to volatility in the region include consolidation of participants in the sector, particularly in Argentina, and the push to extract value out of underdeveloped natural gas reserves. And recent consolidations in the region appear to have been driven as much by reasons having to do with access to capital as by any operating synergies to be realised by merging.
US-based Reliant Energy is leaving the region. The company announced in mid-December that it was relying on Wall Street expertise to find a buyer for its Latin American investments, which included natural gas systems in Colombia as well as electric utility systems in Brazil, Colombia, El Salvador and Argentina; plus a power generation project in Argentina. Credit Suisse First Boston (CSFB) is the investment advisor on the sale of the Latin American assets. ?The initial thinking at the time of the announcement was that we would sell the subsidiary involved in Latin America as a unit. We are now contemplating selling assets individually because we believe we will realise a higher value for them,? according to company spokesperson Sandra Fruhman.
In addition to geographic diversity, Reliant's forays into the Latin market include ventures with a wide range of partners. ?In Brazil we are partnered with AES, Electricite de France and CSN, a Brazilian firm. In Colombia and El Salvador we are partnered with Electricidad de Caracas. In Argentina, we have sole ownership of a small electric distribution system and a cogeneration plant. Our partners in the Colombian natural gas assets are Colombian. Our business activities in Latin America are quite similar from country to country. The vast majority of our investments are in electric distribution systems. Some of these companies also have power generation and some do not.
?We have relatively small investments in natural gas distribution and one cogeneration plant.? Reliant will focus its efforts on opportunities emanating from electric restructuring in Europe and the US, states Fruhman.
According to a New York-based project finance banker, it was that diversity of location and partners that has prevented Reliant from making a package deal. However, the company announced on April 25 that it had sold its indirect interests in five natural gas companies in central and southwestern Colombia to an unnamed investment trust incorporated in Colombia, working on behalf of an unnamed Colombian company. The companies ? four natural gas distribution companies located in the states of Valle del Cauca, Quindio, Risaralda, and Caldas and one pipeline/transportation company located in the state of Tolima ? were developed largely as greenfield projects from concessions granted by the Colombian government in 1997. Reliant is being secretive about the eventual owner of the properties as well as the purchase price.
In early April, Dallas-based TXU announced that it was leaving Mexico City's gas market, highlighting the limitations facing investors in Mexico's energy sector. Mexico has not been overly successful in attracting investors to that market, mainly because opportunities are few. TXU sold its stake in the capital's gas distribution system last week to Spain's Gas Natural SDG SA and Hidroelectrica del Cantabrico for $68 million. The agreement is expected to close later this year, subject to regulatory approval. Gas Natural will become operator when the transaction is closed. In announcing the sale, TXU officials maintained that the Mexico market is vibrant, but that continuing the operation would not be consistent with the company's overall corporate strategy. A TXU subsidiary, Hidrocantabrico and two local partners acquired the natural gas distribution company operating in Mexico's capital city in August 1998.
Although the Mexican government continues to struggle over where it will get the cash to pay for the country's massive social programmes, there appears to be little movement to break the traditional monopoly held by the government in the gas and oil sectors. Investment opportunities for foreign energy companies are limited to distribution and transportation ? although most of that business is controlled by companies already in the market. Even so, investors fortunate enough to be in place are obligated to deal solely with government agency Pemex.
Last year, merger activity was strong among Latin American oil and gas producers. However, 1999 merger activity only continued a trend started earlier in the decade. For example, Repsol acquired a controlling interest in Astra in mid-1996. Amoco and Bridas combined their regional activities, forming Pan American Energy in late 1997.
Key consolidations last year included Repsol SA of Spain's acquisition of YPF. Spain's Repsol last year paid $19 billion for 98% of YPF, Argentina's largest company, and formed the Repsol-YPF group.
Repsol already controlled Astra. Repsol-YPF has vowed to divest itself from 800 service stations and 4% of its refining capacity in Argentina to avoid an unwanted dominant position in the Argentine energy market. YPF still exists as an Argentine registered company.
The acquisition has performed well for Repsol as demonstrated by ratings agency actions in early April. Standard & Poor's raised its ratings on YPF SA's 8.95% structured export notes due 2002 and YPF SA's 7.5% structured export notes due 2002 to triple-B-plus from triple-B. The ratings upgrades are based on: a sufficient level of oil reserves in the Neuquen Basin to cover the delivery obligation under the oil purchase agreement; credit enhancement in the form of overcollateralisation, a price hedge agreement, and a three-month debt service reserve account; and a strong structure to mitigate the risk of sovereign interference. The oil reserves in the Neuquen Basin have continued to increase rising to 600 million barrels in 1999, up from 571 million barrels in 1998. Production levels have also continued to increase since the rating was first assigned in 1995. Production levels rose to 245,000 barrels per day (bpd) in 1999 from 201,000 bpd in 1994, indicating a strong likelihood that YPF will continue to honour its obligations under the oil purchase agreement.
YPF is obligated to sell, and Empresa Nacional del Petroleo-Chile (ENAP) is obligated to purchase, an average of 40,000 bpd of crude oil delivered through the Transandean Pipeline. The three-month debt service reserve account is available to cover price risk not otherwise covered by the hedge agreement and delivery shortfalls. The product is delivered directly to ENAP through a Transandean Pipeline, and ENAP has agreed to make all US dollar payments into an off-shore collection account maintained by the trustee for the benefit of the noteholders. The rating action follows the assignment of a triple-B-plus local currency corporate credit rating to YPF on March 29. According to Standard & Poor's (S&P), the notes are a direct obligation of YPF and are secured by an assignment to the trustee of YPF's right to receive a percentage of all amounts due under the crude oil purchase agreement entered into with ENAP. Another major deal was Chevron's 100% acquisition of Petrolera Argentina San Jorge. Recent production increases have moved the company toward being one of the top producers in Argentina with gross operated daily production of approximately 78,000 barrels of oil and 40 million cubic feet of gas, accounting for about 8% of the total oil production in Argentina. San Jorge has potential reserves of over 400 million barrels oil equivalent. San Jorge owns a 14% equity interest in Oldeval, the major export pipeline to the Atlantic coast. Additional export access is through the Transandino pipeline to the Pacific coast, making San Jorge Argentina's second largest petroleum exporter. The company has a strong acreage position in Argentina's prolific Neuquen Basin and controls significant acreage in the Austral Basin in southern Argentina. In addition, it has five million acres of exploration acreage in key petroleum basins in Colombia, Ecuador, Peru, Bolivia, Chile and Brazil.
Alberta Energy Co's acquisition of Pacalta Resources, announced in March 1999 when oil prices were substantially lower, added 208 million barrels of proven and probable reserves. Subsequent drilling added 72 million barrels of proven and probable reserves at a finding and development cost of $0.89 per barrel.
During 2000, the company expects to invest $150 million to further expand its reserve base and production facilities. Current light and medium oil sales are approximately 42,000 barrels per day and are forecast to average approximately 48,000 barrels per day in 2000. Ecuador production capability currently exceeds export pipeline capacity. AEC's pipeline group is part of a consortium actively pursuing a major expansion of the export system. AEC has been leading a group of producers seeking to build a new export pipeline in Ecuador that will unlock the potential of its Ecuador holdings. The proposed 290,000 barrel per day OCP pipeline is targeted to be on-stream in late 2001. AEC expects to own approximately one-third of the new pipeline.
A recent Standard & Poor's report describing challenges inherent in the volatile Latin American energy sector notes that these transactions represent only a small percentage of merger and acquisition activity in the region, as many properties changed hands among foreign investors. Among those transactions were the sale of Arco's Venezuelan, Ecuadorian and Peruvian properties to Burlington Resources and Agip, as well as the sale of the Bolivian assets of Tesoro Petroleum Corp to SG International.
A number of factors precipitated the disappearance of local companies in the Latin American oil sector. The drop in oil prices last year forced some local companies to consolidate with international companies because of lack of access to domestic sources of finance in the wake of a series of economic shockwaves. The S&P report notes that, at the same time, the wave of deregulation sweeping through the gas and oil sectors throughout most of the region during the 1990s allowed investments to be made to serve the broader Latin American market rather than specific markets defined by national boundaries. This process spurred gas and oil companies to develop projects on a larger scale, with greater impact on the earnings of larger international companies.
Two other factors that have spurred consolidation in the Latin American oil and gas sectors have been deregulation throughout the industry and economies of scale. The deregulated energy sector has allowed for foreign competition. While deregulation has opened the door for global companies to invest in the region, the same process favours those companies with the deepest pockets and the best technology.
In recent years, governments in the region have recognised the need to implement economic development plans to attract foreign capital. S&P analysts maintain that investors will follow the highest risk-adjusted returns. Examples of this phenomenon include the Bolivia to Brazil natural gas pipeline built by Petroleo Brasileiro (Petrobras), Royal Dutch/Shell Group of Companies, El Paso Energy Corp, and Enron; the Petrozuata heavy oil project being developed by Conoco and PDVSA in Venezuela; and, the MEGA project being carried out by YPF, Petrobras, and Dow Chemical in Argentina.
However, investors have not made indiscriminate bets in the region. In 1998, Shell and Mobil opted out of developing the huge Camisea natural gas deposit in Peru, despite two years of exploration work, after they became concerned that certain actions by the Peruvian government would make the project uneconomical. In early 2000, a consortium which included Texas-based Hunt Oil was chosen to develop the upstream portion of that project, one of Latin America's largest natural gas fields, with about 13 trillion cfe proved reserves. Long-term gross capital requirements could total $1.6 billion for the consortium.
Governments also have turned their attention to the natural gas sector, spurred by significant new discoveries, development of more efficient technologies, and environmental concerns. S&P analysts point out that the linking of Latin America's Southern Cone through construction of natural gas pipelines has been under way since the mid-1990s and is expected to continue through much of the next decade. Specifically, the GasAndes pipeline was completed in 1997, connecting Argentina's Neuquina Basin with Santiago, Chile and the surrounding region. In 1999, the Gas Atacama and NorAndino pipelines were completed, linking Argentina's Northwest Basin to the mining regions in the north of Chile. The Gas Pacifico pipeline also was completed, connecting the Neuquina Basin to southern Chile, as was the Bolivia-to-Brazil (BTB) pipeline, currently not operating at full capacity.
S&P notes that other regional natural gas pipelines are in various stages of completion, including the Cruz del Sur project, which connects Argentina to Uruguay, and then to southern Brazil. Potential projects include a pipeline connecting Venezuela to northern Brazil; a pipeline linking Colombia and Venezuela to Central America; another from Mexico to Guatamala; and another line running from Bolivia, through Paraguay and into Brazil. There is also talk about eventually connecting the Camisea gas deposit in Peru to a line in order to connect it to the BTB pipeline. However, according to S&P, that project may not be completed due to the recent discovery of large natural gas deposits in Bolivia.
Bruce Schwartz, S&P oil and gas analyst, says: ?There are not a lot of new oil projects being financed in the region. While there is increasing demand for oil, there already is too much refining capacity. And demand for gas is growing in the region. However, major issues continue to involve capital flows and political risk.? Schwartz notes in addition, that the move to substitute cleaner gas for oil has been slowed by regional economic malaise, particularly in Argentina and Brazil.
S&P stressed in its report that disruptions in capital flows in the wake of recent economic volatility in Latin America highlights the importance of financial flexibility and the cost of capital for developing projects. That volatility caused financing alternatives to disappear or to become prohibitively expensive. As spreads on debt widened, companies increasingly became unable to earn their cost of capital. Superior access to capital was perhaps the most important factor leading to the acquisitions of Pacalta Resources and Petrolera Argentina, according to S&P.
The ratings agency maintains that companies operating in the sector are susceptible to sovereign risk. Perception of country risk may translate into sharply reduced capital flows into the region ? although the outright risk of nationalisation or expropriation is minimal. However, governments may change tax codes to realise higher revenues if the market so warrants, or default on contracts ? either of which would produce disincentives for further investment. Because coercive changes to contracts rarely result in the loss of assets, the risk is seldom insurable, according to the ratings ageny. S&P predicts that funds will continue to flow into the gas and oil sectors as deregulation advances, making the region an increasingly attractive target for foreign direct investment.
In addition, further diversification is expected in Latin America, with the Mexican government talking with key players in the oil business about investing up to $300 million in the Mexican petroleum industry. The government is attempting to modify a law requiring that 51% of a project must remain in state hands. Investors have been wary of sinking cash into projects controlled by the government. By law, Mexico cannot sell more than 49% of a petrochemical plant to the private sector. The industry is run by state oil and gas monopoly Pemex. However, this move should not be construed as an overall first step towards opening up the Mexican petroleum industry to private investment, sources insist.
?In Mexico and Venezuela, for example, oil revenues represent about 33% and 50% of all government revenues respectively. However, the Mexican government runs Pemex, with about 60% of revenues paid to the federal treasury as royalties. While a price hike translates into higher revenues, it doesn't necessarily equate with more money going into capital programmes,? according to Hugh Welton, Fitch IBCA analyst. With less government interference, ?Petroven is more autonomous; with the oil sector specifically ? and not the government in general ? benefiting from higher prices.?
Private sector companies also have been shut out of deals with national oil companies, although those public companies have accessed substantial amounts from the capital markets during 1999, backed by export receivables. Deals backed by export receivables allow these public oil companies a cost of capital cheaper than can be accessed by independent private sector companies. As a result, private companies are forced either to abandon the market or to structure secured transactions ? although few companies have sufficient exports to warrant such transactions.
John Diaz, managing director in Moody's energy group, says: ?A lot of companies are pulling back from investments in the emerging markets ? and Latin America is no exception ? because of political risk and the way the stock market values their investments. With uncertainty in these markets, companies are inclined to cut back and redirect these investments to their less volatile domestic markets.? Investment in the oil sector has been constrained ? in spite of recent hikes in oil prices ? by uncertainty about future prices as well OPEC compliance rates. This uncertainty caused local companies to put off investing in projects until capital became too expensive. This same uncertainty has deterred international companies which have access to capital from sinking it in the region, according to Diaz.
In spite of problems, there is a huge need for natural gas throughout Latin America as the fuel of choice, because it is more environmentally friendly. As Diaz says: ?I think there are a lot of companies interested in the region who have laid groundwork for projects. But the question is how long it will take the market to develop. Governments run into problems with devaluation and things slow down. In an economic sense, countries often take two steps forward and one step back.?
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