Economics of the Latin American Oil Trade
Updated: May 18, 2020
“The oil industry globally has so far announced some $40 billion in cuts to investment for 2020, with an average cut by company of 35%, according to Welligence calculations(oil and analytics firm for the upstream Latin American sector). In Latin America, that figure is higher, at 43%.”- Reuters
The OilField Services (OFS) have reported that oil corporations in the Latin American region have reduced their expenditure due to their ailing economy in Q1 in 2020. This situation couldn’t come at a worse time, pairing with the COVID-19 pandemic is causing the oil economy to bear double digit declines.
The largest oil companies in Latin America responsible for a significant portion of the oil production have been severely impacted (when indexed to US’s oil trade benchmarks which is the West Texas Intermediate, WTI. Further information on WTI can be found in the article ‘The Basics of Oil Trade’).
The National Oil Companies as well as several Juniors have taken the decisions to cut their costs to prevent an impact from the crashing global oil price .
Colombia’s 88.5% state-owned oil company Ecopetrol SA will reduce capital by $1.2 billion in 2020 and Brazilian state firm Petróleo Brasileiro SA, or Petrobras, will slash capital expenditure by $3.5 billion to $8.5 billion and will also temporarily reduce their production by 200,000 barrels per day.
The under-lying problem with incentivizing the oil chains is that there is so much volatility in the region due to inequalities, political insecurities and factional democracies along with economic disadvantages that companies are leveraged into looking at short term solutions instead of the long term.
The decline in the global oil price heavily impacts the currency causing further depreciation in the currencies of the countries in the economically violent region.
LAC (Latin American and the Carribean) countries are facing simultaneous setbacks, due to the blow it suffered in early 2020 and the delayed interference of the governments in response to the Covid -19 pandemic.
The restoration of the oil economy will not come at a small cost, causing multiple fluctuations and outliers in the oil price index which would require such sensitive economies to introduce massive overhauls for the long term to prevent such a phenomenon commonly known as ‘oil shocks’. The devastating impact of the oil imbalance can’t be predicted by the models established by the private sectors and cited by the World Bank, they require a sophisticated team of researchers to immediately monitor the situation to prevent the derailing of the weakening economy.
The corollary effect of such a phenomenon on the contrary also leads to higher oil prices in the long run causing stakeholders and benefactors to look at alternatives. This results in a trade-imbalance in the crude oil market.
A solution to curb such fluctuations is a method called the international financial integration mechanism which is adopted specifically for such situations where the asset distribution occurs across the oil network which offsets debts and long standing financial burden. In such an occurrence crude oil is traded region wise through a specially devised common network and not through private channels and chains at a commonly established index price. This collaborative technique was established during the 1978 Iraq Revolution in a similar fashion, only unregulated.
ECLAC and other organizations are yet to monitor the situation at hand by introducing new fiscal and monetary policies that would be of immediate advantage to the National Oil Companies that operate in the Latin American region.
However, the impact on the middle eastern region won’t be as devastating as that on the Latin American region due to the relatively more stable economies and the immediate response of OPEC to a crisis. We know the variable costs of the oil companies in South America will cause a heavy burden to their hopefully long standing economies, the problem lies in understanding the magnitude and gravity of that situation, something that will get less blurry only when we see the light at the end of the tunnel.
Author : Shrey Gupta