With oil nationalism taking hold in several countries in Latin America, Paul McGrath from Exclusive Analysis, the Londonbased strategic intelligence company, casts his expert eye on what we can expect in 2007.

The marked surge of oil prices, the strengthening of leftwing governments in Latin America and the backlash against the free market reforms implemented through the 1990s has resulted in an environment increasingly hostile to energy multi-nationals.

Venezuela

President Chavez has tightened the state's grip on the oil industry, but outright nationalisation of assets is unlikely. The intensification of his 'Bolivarian Revolution' saw the government deepening its oil nationalist policies in 2006. The overhaul of oil contracts introduced in March 2006, in which foreign operating companies were forced to enter into joint ventures with state energy company PDVSA, has been followed by announced changes to contractual agreements for exploration in the Orinoco belt, Venezuela's new oil frontier. Given the extra-heavy nature of the Orinoco belt's crude, companies were expecting to be granted improved contractual conditions.

However, the government has let it be known that exploration in the Orinoco belt will be treated as a standard project, namely that no foreign oil company in Venezuela is allowed to operate independently from PDVSA, the state-run company, with foreign partners becoming minority shareholders.

Once changes to contractual conditions in the Orinoco belt are implemented, Venezuela would have completed the overhaul of the legal framework governing foreign investment in the oil industry. Therefore, what will follow for oil multinationals operating in Venezuela is the practical implementation of the new contractual arrangements. Venezuela views all oil contracts signed with foreign companies before the arrival of President Chavez as illegal. This means that all projects must be led by PDVSA, leave little room for manoeuvre. Most foreign companies are likely to stay despite the new contractual regime. Venezuela has considerable untapped resources and a string of profitable projects to offer. This, and the death of attractive investment opportunities elsewhere, gives Venezuela the upper hand.

Once the migration of contracts is complete, it is in the interest of Venezuela to offer some degree of legal stability, mostly because despite the current oil boom the country still needs foreign capital to fulfil its ambitious plan of increasing production to five million barrels a day by 2012. PDVSA officials have acknowledged that the company lacks the technological expertise that a challenging project such as the Orinoco belt will demand, and therefore are interested in securing the participation of key foreign players.

President Chavez indicated that he will pursue a more radical agenda under his second administration, after being re-elected in December 2006. However, the deepening of the Bolivian revolution will be targeted at economic sectors other than oil. SENIAT, the national tax agency, has launched a major offensive against tax evasion, in which foreign oil companies have been slapped with large bills for tax arrears. Most companies have obliged and reached settlements with SENIAT. However, in 2006 Italy's Eni and France's Total violated some of the new regulations, resulting in their having to abandon oil projects after the government claimed that their tax arrears bills amounted to more than $100 million. Generally, it appears that tax issues can be used by the government at its own leisure to make conditions untenable for investors. The scope for legal redress is limited as the judiciary is under total control of President Chavez, while international litigation is unlikely to be a credible option. The likelihood that Venezuela will abide by international rulings such as those made by the ICSID, the World Bank's international settlement court, is slim.

Bolivia

President Morales had pushed through the nationalisation of gas, but the need to secure markets for gas and technical knowhow are likely to force him to accommodate foreign companies' interests.

Foreign companies are attracted to Bolivia for its untapped gas resources, estimated to be the second largest in South America after Venezuela, and a liberal foreign investment regime. The election of Evo Morales into a state run by, and accountable to, the indigenous majority, has serious implications for foreign energy companies operating in Bolivia.

Upon taking office the new government out recovering ownership of the gas and oil industry for the state at the centre of its agenda, but its implementation has proved difficult. Bolivia's ability to impose new contractual conditions has been constrained by a lack of resources to compensate the foreign companies relinquishing control of assets. YPFB, the state-run hydrocarbon company, does not have the technical expertise to take over and run the industry efficiently. Brazil will play a central role in the final outcome of the negotiations as it is Bolivia's main gas buyer and Petrobras, the Brazilian oil company, is Bolivia's largest foreign investor. Without the participation of Brazil, Bolivia will find it very difficult to extract and export its gas. However, Brazil and in particular Petrobras, has investment in Bolivia in excess of $1 billion and would lose a lot if forced to withdrawal. This set of factors will most likely push both sides to find common ground. Indeed, on 26 October 2006, most foreign operators agreed to abide by Bolivia's new contractual conditions, including Petrobras, although in its case, negotiations over ownership of refineries are ongoing.

Ecuador

The polarisation of politics in Ecuador suggests unrest targeting the energy sector and pressures political leaders to revise contractual conditions in the oil industry in the form of higher royalties and taxes.

The fractured politics of Ecuador, its poor economic management and the neglect and poverty endured by its indigenous population, are the main factors behind the persistent regime insecurity that has undermined the country since 1997. The lack of stable government has opened the way for the mergence of radical left-wing politicians who are seeking to emulate policies being implemented elsewhere in South America, particularly Venezuela and Bolivia. Whether Noboa or Correa come to power, calls to act against foreign investors in the energy sector will come from Correa's supporters.

Ecuador's treatment of foreign investors in the oil industry has been erratic due to lack of tax and contractual certainty. This ahs resulted in international arbitration over tax rebates and confiscation of assets of US-based Occidental, until recently the largest foreign investor in Ecuador. The situation has been compounded by a surge of unrest in the oil-producing provinces in the north, where local communities have targeted the oil companies to secure investment in public works. More recently, Congress approved an increase in windfall oil taxes, which oil companies condemned as a breach of contract. The new tax reflects the enormous pressure being put on government officials by various social and political groups to follow Bolivia's example on the grounds that the benefits of the recent oil boom are accruing mainly to foreign companies.

Previously published in Foresight 2007 - Political Risk Forecasting. Foresight 2007 - Political Risk Forecasting is available from Exclusive Analysis. Log on to www.exclusive-analysis.com for more information.

This Special item appeared in issue 112 of JTW News - February 2007

Author: Paul McGrath - Exclusive Analysis