Petroleum Industry

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Petroleum Industry

The oil industry is perhaps the only one in Latin America where the most capital-, technology-, and management-intensive industry in the world meets the mercantilist and statist philosophies of sixteenth-century Iberia. During the colonial period the colonies provided raw materials to the mother country, and the commercial exploitation of the natural resources of the colonies could be carried out only with a franchise from the crown. Natural resources such as subsoil wealth were defined as the property of the state.

As with many areas of public policy, an understanding of Latin American issues begins with Mexico, where, in the last quarter of the nineteenth century President Porfirio Díaz opened many areas of the economy to foreign investment. One of these was the recently inaugurated petroleum industry (including crude oil, natural gas, and natural gas liquids). Under Díaz the entrepreneur who took the risk to develop oil-producing properties was entitled to merchandise the production according to his own criteria—paying, of course, the appropriate taxes to the government.

In the first two decades of the twentieth century, British, Dutch, and U.S. entrepreneurs had discovered major oil-producing reservoirs, and by 1919—despite the chaos produced by the Mexican Revolution and World War I—Mexico was second only to the United States as the leading oil exporter in the world. What soured Mexico in the eyes of foreign investors was Article 27 in the Revolutionary Constitution of 1917, which not only reimposed the policy of the colonial period in matters affecting subsoil resources but also prohibited the Mexican state from leasing franchises for the commercial exploitation of those resources.

About ten years of open- and closed-door negotiations considered the question of the extent to which, if at all, the new policy would apply retroactively to properties that had been lawfully acquired by oil companies during the period which the Díaz Mining Codes (as they were called) were valid. The oil companies insisted that Article 27 could not abrogate legally acquired rights to the properties (estimated at 90 percent of their total portfolio) that had been acquired for future exploration and development. Mexican negotiators responded that Article 27 would not apply to properties on which some "positive act" of development had taken place prior to February 5, 1917, the date on which the constitution went into effect.

Mexican negotiators finally proposed that all titles to properties be exchanged for fifty-year leases. Despite the fact that a fifty-year lease was, in effect, title to the property (few wells provide commercial production beyond twenty years), the oil companies objected. They did not want the leaders of other countries to follow Mexico's example of what they regarded as unfair and stultifying regulation. With the policy framework surrounding Mexican investments in doubt, oil companies started looking elsewhere for safe investments. Indirectly, Mexico provided the impetus for the development of the oil industries of Venezuela and Saudi Arabia. With investment and oil production falling in Mexico, relations between the oil companies and the government began a process of polarization that, on March 18, 1938, resulted in the total expropriation of foreign oil companies in Mexico.

For the next fifty years, in varying ways and on varying time schedules (Venezuela nationalized its oil industry only in 1976), Latin America followed at least the rough outline of the Mexican model. In setting up its monopoly state oil company, however, Venezuela tried to avoid creating a clone of the Mexican company, Petréleos Mexicanos (Pemex), that would function as a state within a state; for this reason, three operating companies with a quasi-competitive relationship among them were established.

With the rise in the early 1970s of the Organization of the Petroleum Exporting Countries (OPEC—the idea for which had been that of a Venezuelan diplomat, Juan Pablo Pérez Alfonso, and the original membership of which had included Venezuela and Ecuador), relations between the international oil companies and Latin American states became more difficult. By the late 1970s, with the world price of oil exceeding $30 per barrel, oil producers such as Mexico and Venezuela borrowed heavily from eager international lenders who wanted to shore up non-Middle East oil reserves. The high price of oil, in turn, stimulated exploration everywhere, and by 1981, substantial new non-OPEC oil production had been achieved in Mexico's Bay of Campeche, the Alaskan North Slope, and the North Sea.

The late 1970s and early 1980s were also years in which increasingly intense efforts were being taken in the First World as well as in the Third World to reduce dependence on imported oil supplies. In Western Europe, Japan, the United States, and Canada, economic growth was registered without a simultaneous increase in hydrocarbon consumption—a relationship that economists previously had thought highly improbable. In Brazil, the state created a new industry dedicated to the production of "gasahol"—an industrial and transportation fuel based on sugar cane alcohol. Meanwhile, oil-producing countries such as Mexico and Venezuela continued, at great cost to the environment, to subsidize motor fuels, believing that economic growth could be induced by offering the public cheap—and low-quality—gasoline and diesel fuel.

As production from non-OPEC sources rose, there was an increasing competition between oil exporters for market share. In 1980 Mexico announced a new energy plan that called for 1.5 million barrels per day (b/d) of crude oil exports, a target that was not price- or profit-sensitive. Within OPEC there was so much cheating by member countries on their oil-export quotas that Saudi Arabia finally decided to punish the others by increasing its oil production, to nearly 10 million b/d, up from a previous level of about 7 million.

By mid-1981 the trend lines of new Saudi and non-OPEC oil production and energy savings symbolically crossed. The result was that for the first time in nearly a decade, the world trading price of crude oil dropped. In many of the producing countries, notably Mexico, news of the price drop was received skeptically—"just a market fluctuation." Perhaps no one could have foreseen that cargoes of Mexican heavy oil that sold for $32/b in early 1980 would sell for $5/b in mid-1986. Although spokesmen for oil-producing countries such as Mexico and Venezuela denied that their general economic development programs were keyed to oil, the ensuing ten years of economic decline and stagnation—from which, by 1992, Latin America had far from recovered—showed the extent to which leaders of the 1970s had gambled on a single commodity as an economic panacea to underinvestment and widespread rural and urban poverty.

In 1990, the sacrosanct status of the state-as-oil-monopolist began to fade in many parts of Latin America. Privatization as a policy concept was incorporated in government programs in Argentina, Brazil, Peru, Ecuador, and other countries. By late 1992 such countries were reviewing new offers from private industry to participate as direct investors in their oil industry in both upstream and downstream activities. Driving this policy was the realization that property rights by themselves did not translate into efficient oil production, much less into reliable streams of foreign currency from export sales. A second realization was that real fiscal efficiency from the state's point of view lay in its power to tax oil companies' profits from their operations. Contracts were negotiated in which the oil itself remained the property of the host state; the oil company was paid a percentage (typically 20-30 percent) of the market value of total production. Finally, the leaders of some Latin countries realized that a hidden problem with the state-as-oil-producer model was the inherent managerial and technological isolation that it fostered. In some countries the international oil companies were seen in a new light: as a source not so much of risk capital as of managerial and technological expertise that could be bought for an affordable price.

By 1992 Mexico remained the exception to privatization in the industry. Although since 1989 privatization as a policy theme had been touted in Mexico City as much as in other Latin American capitals, the state oil sector was not included in the government's agenda. Despite intense pressure from U.S. and Canadian negotiators in the summer of 1992 during negotiations for the North American Free Trade Agreement (NAFTA), Mexico refused to change any of the basic planks of its nationalistic and monopolistic policies that dated from the 1930s, 1940s, and 1950s. Mexico's view was that Pemex was self-sufficient in technological and managerial skills, and that where it might be deficient, such skills could be acquired through contracts with oilfield services companies. Representatives from integrated oil companies remained skeptical of such a course, and voiced concerns about the future of Mexico's oil production capability. They recalled that in November 1989, Pemex had alerted the administration of President Carlos Salinas de Gortari that unless domestic oil production increased and domestic demand for refined products decreased, Mexico easily could become a net oil importer.

In some countries—again Mexico and Venezuela are good examples—the hidden cost of several decades of subsidized, low-quality motor fuel could be seen by 1992 in the alarming deterioration of air quality in major metropolitan areas. Several policy remedies were being taken in the region: one is the tardy conversion to unleaded gasoline; a second is the reduction of the sulfur content of diesel and residual fuel (in Mexico in the range of 3-4 percent) to acceptable levels (under 0.5 percent); a third is the increased use of natural gas, which has much lower emissions levels than other industrial or transportation fuels. Within Latin America, Mexico, Venezuela, Bolivia, and Argentina have major reserves of natural gas.

The early twenty-first century has been a heyday for much of the petroleum industry in Latin America. The torrid pace of economic growth in emerging markets, especially China and India, has ensured a boom in petroleum exports from the region. Furthermore, as noted by President George W. Bush in his 2006 State of the Union address, the United States remains "addicted to oil." From 2000 to 2006, the price of light crude more than tripled, producing a windfall for many of Latin America's exporters, especially Venezuela. In 2007, Brazil's state-owned oil company, Petrobrás, announced the discovery of enormous oil reserves in the ultra-deep Tupi field. The finding could net as much as 8 billion barrels of light crude, increasing Brazil's oil reserves by 40 percent, and making the nation one of the largest oil exporters in the world. However, these developments are not unqualified successes for many Latin American economies. Many nations remain hamstrung by their insufficient refining capacity. For example, even Mexico, with its vast reserves of oil, is not necessarily benefiting from soaring oil prices. Recent IMF studies point toward an inverse correlation of oil prices and Mexican economic growth when the price per barrel exceeds a range of $80-$90, a feature attributable to Mexico's reliance on imported refined petroleum products.

Beyond infrastructure shortcomings, Latin American governments have increasingly sought to diversify the nature of their energy exports away from petroleum. Brazil's ethanol industry is generally seen as the most dynamic in the world. This has yet to make a substantial impact on international markets, primarily because the U.S., which would seem to be the ideal importer of Brazil's ethanol, has imposed a more than 40-cent per gallon tariff on it in order to prop up its own corn producers.

The oil industry in Latin America faces a mixed horizon in the twenty-first century. Real technological advances in crucial areas such as deep-water drilling have been made by Brazil; in Argentina, natural gas pipelines and metropolitan distribution systems have been partially privatized. Development of oil and gas production in Peru and Colombia, on the other hand, has been constrained by political unrest, drug-related violence, and the absence of sufficiently attractive regulatory and fiscal frameworks. For most countries, most notably Mexico and Cuba, a sharp limitation under present regulatory frameworks is financing. With the elimination of Soviet oil supplies in 1991, Cuba's energy supplies and hard-currency reserves were severely curtailed. As for Mexico, in 1992 Pemex claimed that it needed funding support for capital investments for the period 1992–1997 of some $22 billion. Pemex's plight has been underscored by the fact that crude production reached it peak in 2004. Most analysts now believe that regardless of technological advancements, Mexico's oil production is undergoing a one-way slide. Furthermore, greater external investment to the oil industry in Latin America is problematic given political instabilities. High-profile nationalization drives undertaken in Ecuador and Venezuela have sent cautionary messages to Western investors. This has been coupled with antagonistic rhetoric from many leaders, chiefly Venezuela president Hugo Chávez, but also Bolivian president Evo Morales and Ecuadoran president Rafael Correa. Chávez has repeatedly sought to tie Venezuela's oil exports to political relations, threatening on several occasions to divert his country's exports to the U.S. to other parts of the world. The combination of infrastructure and financing woes portend continued uncertainty for the oil industry in Latin America as a whole, even before calculations are made considering energy diversification away from petroleum.

BIBLIOGRAPHY

Brown, Jonathan C. Oil and Revolution in Mexico. Berkeley: University of California Press, 1992.

Koppes, Clayton R. "The Good Neighbor Policy and the Nationalization of Mexican Oil: A Reinterpretation." Journal of American History 69:1 (June 1982), 62-81.

Meyer, Lorenzo. Mexico and the United States in the Oil Controversy, 1917–1942. Translated by Muriel Vasconcellos. Austin: University of Texas Press, 1977.

Philip, George D. E. Oil and Politics in Latin America: Nationalist Movements and State Companies. Cambridge, U.K. and New York: Cambridge University Press, 1982.

Smith, Peter Seaborn. Oil and Politics in Modern Brazil. Toronto: Macmillan of Canada, 1976.

Williams, Bob. "Latin American Petroleum Sector at Crossroads." Oil & Gas Journal 90:27 (July 6, 1992).

George Baker

Sean H. Goforth

Encyclopedia of Latin American History and Culture