BMI View: We continue to take a relatively positive view of Latin America's oil production, anticipating solid growth, although we note that above-ground factors, rather than below-ground potential, remain the key determinants of the rate of expansion. Indeed, while a poor regulatory environment will hinder the realisation of significant potential in Venezuela and to a certain extent in Brazil, with major oil producer Mexico having recently passed game-changing energy reform, we have turned more optimistic towards the region's broader oil output potential. Similarly, although above-ground risks continue to threaten the gas production potential of countries like Bolivia and Peru, a spate of recent investment deals, as well as an interim agreement between YPF and Spanish-firm Repsol, has begun to noticeably de-risk the Argentine gas sector.
We expect Latin America's oil production to increase steadily over the next 10 years, with average growth of 2.9% year-on-year (y-o-y) between 2014 and 2023. Moreover, while this is still below Latin America's potential, with a poor regulatory environment stymieing even greater potential in major producers Venezuela and Brazil, recent reform in Mexico suggests some upside risk to our long-term forecast. At the time of writing, a landmark energy reform bill had been recently pushed through Mexico's legislature - and this could open the hydrocarbons sector up to significant private investment.
Similarly, we believe the regulatory environment will also be the ultimate driver of growth (or a major hindrance) for Latin American natural gas output. Increasing signs that shale gas powerhouse, Argentina, may be willing to make a credible commitment to developing its resources suggests upside potential in the Southern Cone country, and this could act as a major driver of growth throughout Latin America. That said, the rest of the region still presents a somewhat mixed picture. Indeed, while we expect production to continue to grow over the long-term in Bolivia, Peru, and Trinidad & Tobago, we also see significant risks. Meanwhile, although Mexico has the resource potential to be a major gas play, access to plentiful and cheap natural gas from the US gives less of an impetus for the country to bring its gas resources online. As such, we continue to anticipate that demand will outpace production growth, leading to a rise in the volumes of natural gas being imported into the region.
| Increased Oil Export Capacity, Gas Import Dependency |
|Latin America - Oil & Gas Production & Consumption|
Key Themes In Latin America's Gas Sector:
In recent quarters, upside risks to our long-term gas production growth forecast for Latin America have increased, largely as a reflection of recent events in Argentina. While the US Energy Information Administration (EIA) has long highlighted the country's vast natural gas potential, with a recent report suggesting that Argentina has the world's second-largest technically recoverable shale gas resources, at 22.7 trillion cubic meters (tcm), a poor operating environment has necessitated caution. However, we have recently seen signs that the Argentine government is more willing to put the necessary policies in place to bring online the country's shale gas resources, and furthermore, that this has started to attract some interest from large independent oil companies (IOCs). On July 16, an agreement between US super-major Chevron and Argentina's YPF was signed - not only allowing the US supermajor to begin exploration in the highly-promising Vaca Muerta shale formation, but also beginning the process of de-risking the country for other companies. Indeed, since then we have seen several other firms, including the local unit of Dow Chemical, as well as Wintershall, sign deals. Moreover, the compensation agreement with Repsol over the Latin American country's 2012 expropriation of YPF could further bolster foreign inflows, removing a significant deterrent to investment in the upstream sector.
| Abundance Of Potential |
|Technically Recoverable Shale Gas Resources, tcm|
However, despite this more positive outlook on Argentina, we still believe Latin American natural gas production growth will underperform a number of other regions, with several of the major and minor regional producers failing to live up to their potential.
Mexico is currently the largest gas producer in the region at an estimated 53.4bcm in 2013. However, while there is potential for significant further expansion, even with the recently passed energy sector reform we see limited impetus for such growth. Namely, Mexico's natural gas prices are tied to the US futures pricing point, Henry Hub. With the US shale boom in full swing, we believe that Henry Hub prices will remain relatively cheap by historical standards, favouring imports into Mexico over domestic production. Indeed, significant pipeline infrastructure investment is being made to carry US natural gas south into Mexico. As such, even with significant energy sector reform, we believe that the potential for a massive expansion in its gas output is relatively limited in the medium term.
While we expect Bolivia's production to increase over the medium term, we note that the country's above-ground situation could pose a threat, especially if it stymies future exploration and keeps new reserves from coming to light. In 2010, the country was rocked by a disastrous reserves scandal, with consultant Ryder Scott estimating reserves were actually a third of the level previously cited in official estimates. The longer-term prospects for Bolivia as a major regional gas supplier are therefore contingent upon new and successful gas exploration. State oil company YPFB announced in June 2013 that bidding was to be opened to seek firms to quantify and certify new reserves, and estimates a noticeable uptick in reserves by 2014. However, we believe that there is risk that increased nationalism across the country's strategic sectors, including electricity generation and mining, could act as a deterrent to much-needed investment inflows.
| EIA Reserves Judgement As YPFB Makes Case For Gas |
|Bolivia Natural Gas Reserves (bcm)|
Meanwhile, we had turned somewhat less positive on Peru's natural gas outlook in previous quarters, and maintain that stance. While we expect production to expand considerably from an estimated 12.3bcm in 2013 to 15.0bcm by 2018, highlighting the country's still largely underexplored acreage and relatively strong business environment, this still represents a downward revision from our previous forecasts given increased above-ground risks. The continued presence of the insurgent group, the Shining Path, which has previously targeted the country's energy infrastructure, as well as elevated social tensions between the government and native communities, could both potentially slow Peru's ability to offer onshore acreage - suggesting downside risks to growth.
In terms of supply and demand dynamics, the Latin American gas market will remain sharply divided: surging demand in Mexico and the Southern Cone countries will exacerbate their import requirement. At the same time, major liquefied natural gas (LNG) exporter Trinidad & Tobago (as well as Peru) will continue to realise its export potential. That said, while we see this dynamic remaining in place for now, we note that there are some long-term risks. As highlighted above, there is considerable potential for upside risks to materialise with regards to Argentine gas production. If Argentina is able to bring its shale resources online, it would be more than able to fully meet domestic demand. Similarly, the government of T&T has taken laudable steps to bolster hydrocarbons production, offering improved fiscal and contractual incentives. The country is still facing an uphill battle given the mounting technical difficulties with regards to the discovery and production of its oil and gas. That said, with a number of fields set to come online in the coming years and recent upticks in interest by foreign players, this suggests some upside risk.
Key Themes In Latin America's Oil Sector:
We hold a relatively positive view of Latin American oil production, although we note that a weak regulatory environment in many of the biggest producers limits the realisation of even greater gains. In this regard, the three biggest players in the market - Brazil, Mexico and Venezuela - seem to be following differing paths.
After years of underperforming its potential, Mexico has begun to look more promising. Indeed, at the time of writing, a landmark energy sector reform bill had been pushed through the Mexican Congress and signed into law by President Enrique Peña Nieto, and we are awaiting the passage of secondary legislation. The reform creates a multi-tiered system in which the State is given power to grant a number of different contract terms ranging from profit sharing for less technically difficult plays, up to licenses for the most risky plays. This bill is a product compromise, in order to make the politically charged reform more palatable, with the government having refused to challenge the dominant narrative that hydrocarbons belong to the state. That said, overall we see reform as a major step forward and highlight that it represents a significant opening that could draw private sector involvement into the energy sector. Indeed, while still dependent on the details of the secondary legislation, it will likely be sufficient to draw significant investment into the Mexican hydrocarbons sector and suggests potential for a considerable upward revision to our still cautious medium- and long-term production forecasts in the coming quarters.
| Historic Vote |
|Mexico - Chamber of Deputies, Vote on Energy Reform, %|
In contrast, while Brazil remains at the forefront of the expansion in Latin American oil production, it could face some serious short-term obstacles given administrative and regulatory hurdles. First, we see scope for continued delays to Petrobras' targeted production plan, as the development of its numerous production units, support fleets and infrastructure lag. In this regard we highlight that state-owned Petrobras, responsible for the lion's share of liquids output, ended 2013 with production of 1.93mn b/d - below the 1.98mn b/d recorded in 2012. In part, this can be traced back to delays in bringing online production platforms, and we cannot rule out further setbacks. Secondly, local content requirements, strict labour laws and a complex and hefty tax burden raise production costs and pose a growing deterrent to doing business in Brazil. Indeed, only one consortium put forward a bid in the country's first pre-salt licensing round, and we believe the lack of competition for such a highly prospective field - estimated to hold between 8bn and 12bn bbl - is telling. Third, Petrobras is required to take the lead in the development of its subsalt resources, with the company selected as the exclusive operator of the new blocks, and holder of a minimum 30% stake in each. In practice, this means that in order to bring online the country's substantial subsalt potential, the company will have to undertake considerable expenditure - a significant financial burden.
| A Steady Climb |
|Brazil's Proven Oil Reserves & Production, 2002-2022 (bn bbl & '000b/d)|
While we still have a relatively optimistic long-term outlook for the country, in the short term, the government has taken a 'two steps forward, one step back' approach to addressing its challenges - necessitating caution. On the one hand, in recent years there have been several fuel price hikes and we have seen some indications that the government recognises the huge financial burden implicit in the 2010 law stipulating that Petrobras must be largely responsible for bringing its presalt resources online. That said, domestic prices are still a long way from reaching parity with international prices, and while the government allowed the company to increase gasoline and diesel prices by 4.0% and 8.0% respectively in late November 2013, clarity on a new fuel pricing mechanism was not provided - a significant and disappointing failure. This has ensured the company is forced to carry a substantial level of leverage, with net debt/adjusted EBITDA at 3.5x - well above the company's 2.5x goal. As of March 24 th, Standard & Poor's cut Petrobras' rating from BBB to BBB-, in line with its decision to downgrade Brazilian sovereign debt, but also likely as a reflection of the company's weakening financial position.
Finally, despite its substantial resource potential, Venezuela's above-ground environment remains a major deterrent. On the one hand, we continue to expect some oil production growth in the country over the long term, bolstered by its Orinoco heavy oil belt. On the other, we believe the country's output will fall far short of its potential given the poor operating environment. Namely, the country's unparalleled below-ground potential has disappointed in recent years due to economic mismanagement, underinvestment and the unsustainable social policies that have drained state-owned Petróleos de Venezuela, S.A. (PdVSA ) of critical resources. Moreover, despite some signals by the government, including hints that the government is considering raising fuel prices or allowing its joint venture partners greater autonomy, we have seen little concrete action.
| Not Even Close |
|PdVSA - Liquids Production & PdVSA's 2018 Target|
Regional refining capacity is forecast to rise, though will be unable to keep up with consumption growth due to delays in bringing online crucial downstream infrastructure and insufficient investment to maintain aging infrastructure. Moreover, the risks lie to the downside given continued project delays .
| Widening Gap |
|Latin America - Crude Oil Refining Capacity & Product Consumption|
Brazil had been anticipated to undergo the largest refinery capacity expansion over the forecast period, with investment to be primarily channelled towards the construction of four large new refineries: Abreu e Lima (Pernambuco state), Complejo Petroquimica Rio de Janeiro (Rio de Janeiro state), the Premium I refinery (Ceará state) and Premium II (Maranhão state). The investment also includes conversion and improvements at Petrobras' existing refineries, which will improve the company's capacity to produce diesel fuel and gasoline with lower sulphur content. Altogether, this suggests refining capacity could hit 3.3mn b/d by 2021. That said, we note that we have already seen 'start dates' for projects such as the Abreu e Lima plant pushed back considerably, and given the considerable financial pressure on Petrobras' margins, we cannot rule out further delays.
The Venezuelan downstream sector is in even more dire straits such that despite the government launching Plan Siembra Petrolera in 2005, which among other things was meant to bolster refining processing capacity by 500,000 b/d by the end of the decade, for now we take a cautious stance. Indeed, our forecasts imply only moderate refining capacity growth, climbing from 1.3mn b/d in 2012 to 1.5mn b/d in 2017, as neglect of current facilities (which has caused a high rate of impairments), as well as continued delays in bringing new refineries online has tempered our optimism.
Finally, Mexico's Pemex has plans to significantly enhance refining capacity, but even with the recent energy sector reforms, which could begin to bolster inflows over the medium term, we believe that the country faces an uphill battle. Namely, in an effort to bolster the efficiency and profitability of the ailing downstream sector, Pemex has indicated an US$11bn plan to install deep conversion coking units at the company's three biggest refineries. That said, not only do we see significant scope for setbacks (with potential for the project to be delayed through 2020), but it is also worth noting that final outputs could disappoint. For example, Pemex completed a coking upgrade at its Minatitlan refinery last year, but the US$2.5bn upgrade fell short of delivering the 310,000b/d by more than 20%, according to local news sources.