ANÁLISIS QUINCENAL: Transparency and Extractives Update from Latin America

By Carlos Monge, RWI Latin America Regional Coordinator
With Claudia Viale and León Portocarrero

November 9th - 24th, 2008

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Proposed law would change ground rules for Ecuador's mining sector

Some countries now face energy shortages due to smuggling, high demand and policies that favor natural gas exports.

Volatility in international mineral and oil price volatility is affecting extractive companies

Proposed law would change ground rules for Ecuador's mining sector.

The Ministry of Mining and Petroleum of Ecuador has drafted a proposal for a new mining law, which would significantly impact bidding processes for mining concessions, concession contracts, royalty payments and the distribution of profits among workers. Indigenous organizations and other civil society groups have expressed their disagreement with the proposals and have held demonstrations to protest the proposal.

If approved, the new law would allow the state to obtain more income from mining activities through royalty payments. To date, existing mining concessions have only paid income taxes and patent fees. The final royalty figure will be subject to negotiation, but reportedly would be equivalent to at least 5% of sales. The patent payment would be increased from US$1-16 to US$5-20 per hectare.

The proposal also consolidates the State's intervention in the sector both in planning and oversight, and even in the development of some mining projects. It proposes that the Ministry of Mines develops a National Mining Policy related to the National Development Plan, defining the areas where mining activities can be carried out and regulating activities according to sustainable development and social involvement objectives. An Agency for Regulation and Control of Mining would also be created, with technical, administrative and financial autonomy. For the State's mining activities, the law would establish a National Mining Company, which would begin its operations with six non-metals projects and would also have financial and administrative autonomy.

Paradoxically, in spite of the intense contract renegotiation process recently carried out to move the oil sector from a concession system to service type contracts – and resulted in the departure of Repsol YPF from the country – the new law would allow mining contracts to take either form. Furthermore, mining concessions in areas over which the government has rights would be granted through public auctions.

Another controversial item is the proposed redistribution of profits to mining workers. The law would give workers only 3% of what they previously received, which has been 15% of the profits, as established by the current labor code. The argument behind this cut is that it generates too much inequality with workers from other sectors.

Finally, the new law would establishes additional incentives to revoke concessions, which before have expired only due to lack of patent payment. This law proposes that concessions be returned to the State in cases of false information, environmental damage, lack of patent or royalty payments, and if annual reports on exploration and production are not turned in.

This project is perceived by some as a key step towards setting clear ground rules and giving foreign investment a fresh start in Ecuador, after its paralysis since April due to the contract renegotiation process. However, the proposal has also generated resistance from indigenous peoples and environmentalists. Jorge Guamán, Coordinator of the organization Pachakutik, the political arm of the Confederation of Indigenous Nationalities of Ecuador (CONAIE), described the bill as "exclusive and contradictory" and said the subject requires more debate.  On November 18th, 1,500 people marched to the Caroldelet Palace in opposition of the proposal, but they were not received by President Correa.

From the government side, in a climate of falling oil production and declining exports due to the plunge in international oil prices, President Correa seems ready to promote large scale investment in mining, despite criticism from longtime supporters in the indigenous and environmental movements.

The final decision about this law will be taken on January the 3rd and if there is no dialogue with all actors involved, its approval will likely generate violent reactions which could affect the country’s stability.

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Some countries now face energy shortages due to smuggling, high demand and policies that favor natural gas exports.

Bolivia has labored under a fuel shortage for several months due to conflicts in the hydrocarbon producing regions which disrupted production and blocked fuel distribution. Though regional strikes have since stopped, natural gas and diesel shortages persist. Bolivia’s Vice president, Álvaro García Linera, argued that "there are several elements which come together; smuggling, corruption at junior levels (of YPF) and sabotage carried out by businessmen involved in distribution".

In response, the central Government has implemented measures to curb fuel smuggling. It issued a Supreme Decree to apply Law Number 1008 for controlled substances to fuel smuggling, punishing illegal transport of diesel, gasoline and LGP with 5 to 25 years in prison. It also established border surveillance by the Armed Forces, the Police Force and Customs Control.

Some have disagreed with the State about the reasons for the shortage, including those who have was argued that shortages were the result of the real lack of fuels due to low investment in the sector. Some analysts and former authorities such as Carlos Miranda pointed out that Bolivia was producing less oil because there were few well perforations.

Trinidad and Tobago recently faced a potential cooking gas shortage. The Oil Workers Trade Union launched a strike and warned about a shortage in liquefied petroleum cooking oil. By the end of November, this fuel had become more scarce in establishments in small towns. However, the National Petroleum Marketing Company (NP) argued that this was due to a distribution problem, not to a shortage. Nevertheless, workers continued to strike until the first days of December.

Despite the significant Camisea gas reserves in Peru, the available supply may still not meet the growing domestic demand. The problem began in 2007 when Alan García's government signed a contract with gas transport company TGP and the firm Peru LNG to export 620 million cubic feet per day to Mexico. This represents more than half the capacity of the pipeline that carries hydrocarbon from the jungle to the coast. The remaining available pipeline capacity is below the domestic demand forecast for the year 2011. This alarming situation has been aggravated by recent droughts which imply a reduction of energy generated by hydroelectric power plants.

The construction of the pipeline for the Camisea Project was made possible by numerous tax benefits granted by the Peruvian State, including fragmented tariff payments for seven years, the anticipated recovery of VAT, as well as a guaranteed initial demand. But even faced with the possibility that current installed capacity will not cover domestic demand, the government has not prioritized Peru itself. The Minister of Energy Pedro Sánchez stated on November 18th that: "The supply for the south Andean pipeline must be met with new natural gas findings." However, the new findings in Block 57 which will be exploited by Repsol, have probable reserves of 2 TCF, compared to 11.2 TCF in Camisea I (Blocks 88 and 56). Furthermore, the price of the natural gas extracted from Block 57 will be significantly higher than the gas sold to Mexico because Repsol will have to assume exploration risks, while the risks for the Camisea Project were assumed by Shell during the exploratory phase. Shell later abandoned the project and gave the Block back to the State, saving these costs for Pluspetrol. As a result, Natural Gas from Block 88 is sold to the industry at US$ 2.10 per thousand cubic feet, while gas from Block 56 will be sold at the international price, which is currently around US$ 6.7 per thousand cubic feet.

In this context, projects such as those from the American firm BPZ to build a pipeline from Piura, in northern Peru, to Chimbote, and the approval of a credit line by the Andean Development Corporation (CAF) for TGP to expand the pipe system to transport Camisea gas, become highly relevant.

The situations described above are just some of the factors currently affecting energy supply in Latin American countries. Even though not all countries are facing a full-blown energy crisis, it is essential that all develop clear energy plans and policies that consider the country's real demand, the world price context, and current climate conditions.

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Volatility in international mineral and oil price volatility is affecting extractive companies

When oil prices hit historic levels above US$ 147 per barrel, companies like Colombia's state owned Ecopetrol and Brazil's Petrobras registered record profits, which persisted until the third quarter of 2008. However, beginning in July, prices have fallen dramatically, to levels around US$ 48 per barrel in November.

This drop had not yet affected the aforementioned companies' net profits by the third quarter, which were US$ 3.93 billion for Ecopetrol and US$ 5.66 for Petrobras, but it is expected that figures for the last quarter of 2008 and 2009 will show a reversal and a decline in profits.

In the case of mining, the price drop has already started to affect the profitability of large companies in both Peru and Chile. According to Peru's National Mining, Petroleum and Energy Society (SNMP), companies from this sector have faced a 35% fall in profitability due to the sharp drop in international prices. Companies were reportedly working to reduce their costs and improve profitability, and the president of the SNMP stated: "Though this year the production of minerals has increased in Peru, the conditions for obtaining good results have become difficult in every sense of the word."

José de Echave, a Peruvian expert in the mining sector, warned that one serious consequence of the new situation would be lower income tax revenues, 50% of which are distributed as canon resources to regional and local governments of producing regions. Resources could therefore fall up to 30% in 2010, even the effect will not be felt yet though in 2009 because the canon to be distributed will correspond to the income tax collected in 2008.

In Chile, tax revenue projections from the Central Bank had to be corrected in light of the international price drop. New estimates also consider that lower copper prices will significantly affect the income of state-owned company Codelco, which will in turn cause such a great decline in fiscal income that there will be a 1% fiscal deficit for the first time in 6 years. Codelco is estimated to have transferred US$ 7.9 billion to the State in 2007, while the 2008 this figure is estimated at US$ 5 billion. The company’s administration attribute the lower profitability to the drop in prices.

In Peru, the new reality situation has also led to the delay of some mining projects – including Minas Conga from Newport Mining Corp.'s Yanacocha Mine – and the suspension of others – such as Doe Run in La Oroya and possibly the second phase of Cerro Verde in Arequipa. Also, many firms have announced the reduction and even suspension of the so-called "voluntary contribution," in light of the the expected decline.

Faced with this situation, former Minister of Energy and Mines Juan Inchaustegui sought to calm fears by noting mining investments will probably not face the same sharp decline as mining profits. He also said that the mining sector is one of the best prepared to face the international crisis and that, although some projects were delayed, it is likely that they will be developed in the future, when there is greater liquidity.

Though the deceleration in the mining sector is a challenge for State revenues, the State itself must promote that the companies in the sector face this crisis with windfall profits earned during the high price period. As José de Echave has suggested, it would be a mistake for governments to further relax regulations and grant additional benefits in order to promote new investment projects, because that is likely to means that the country will once again be unlikely to benefit during the next cycle of high demand and prices.

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Sources: La Primera, Correo, El Comercio Peru, Elcomercio.com, ElDeber.com.bo, El Universal, The Trinidad Guardian, La Razón, La Republica.com.co, La Republica.pe, Folha Online

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