Oil Price – Latin American Activity – Not So Volatile After All

Latin America is somewhat unique in having a long standing history of having a mix of economically and politically motivated activity. With Oil Prices having drifted down to the $60 / bbl Latin America will once again be subjected to a stress test of volatility. Which markets will see activity fall, and which will be able to weather the storm ?

One general factor that works in the region’s favour in down turns is that few projects are predicated on the economics of oil prices above $80 / bbl. The variety of risks that are inherent in most of the markets in the region generally cause operators to be more conservative, and take a longer term view on the oil price. The tax and pricing structure present in some markets also limit the tendency of operators to see the full benefit of high oil prices and work to mute the impact of lower prices.

Markets such as Chile, and to a lesser extent Argentine and Brazil are net importers of energy, and are currently doing so at prices which are above international averages and above local production costs. This has caused the governments to try and continue to maintain activity. The presence of state run oil companies in most major markets (Brazil, Mexico, Argentina, Venezuela, Ecuador and Chile) also allow governments to directly control a large portion of the market activity independently of the oil price, which often occurs to maintain employment, or meet economic or development goals. Certain state run oil companies, most notably Pemex, have contracting cycles that cause activity to reflect oil prices from 12-18 months before contracts come into effect also muting the effect of a short term change in the price. Political issues such as the constitutional energy reform in Mexico, Brazil’s goal for energy independence and the recent upswing in Argentina which is really a bet on long term oil and gas prices should keep activity higher than might be expected otherwise.

Regional supply dynamics now often dominate global energy prices. As an example the southern cone gas network, effectively linking the gas price in Bolivia, Argentina, Brazil, Paraguay and Chile into a regional block, links pricing to long term politically negotiated contracts – currently around $6 / Million BTU. With alternative supply being very costly LNG imports, the gas price is unlikely to be effected adversely by global energy price drops. The same is also true for oil and gas, with only Venezuela, Colombia, Mexico and Ecuador having significant enough export capacity to have their budgets be directly exposed to global commodity prices.

The net result is that activity in Latin America is much less volatile than in other markets. The typical rapid decline in drilling activity which is seen in North America has not been seen in past down turns and is not likely to be seen in this down turn. The reality facing Latin America is that geopolitical influence and political decisions will likely continue to be a stronger influence on activity than short term price drops. Should oil stay in the $60 range, or briefly drop to even lower price points, Latin America drilling activity is likely to drop, but at a significantly muted rate as compared to North America. In this down turn, buoyant pressures from Mexico and Argentina may overcome the downward economic pressure and we may very well find that Latin America is able to avoid experiencing a significant downturn.

Warren Levy

December 20, 2014