Americas

3 Ways in Which the Fall in Oil Prices Affects Latin America

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This January, the price of crude oil fell to a 10-year low of $26.55 per barrel after a drop in prices lasting over 18 months. Oil-producing countries across the world have felt the pinch, and the Latin American nations are no exception. Here are three effects the oil crisis has on Latin America.

Economic deterioration

Many Latin American governments depend largely on oil and other natural resources for their revenues. The fall in oil price, therefore, has led to economic woes throughout Latin America. Nowhere have the effects of ill-advised dependence on energy been felt more painfully than in Venezuela, the country with the world’s second-largest oil reserves. Oil accounts for 95 per cent of Venezuela’s exports, 45 per cent of government income and 25 per cent of GDP. Traditionally, oil exports have also given the country the foreign currency needed for its imports. Following the drop in oil prices, the IMF has predicted that Venezuela, which has already been in recession for the last two years, will see a drop of 8 per cent in GDP this year.

Brazil is also in its deepest recession for a century, with a fiscal deficit of ten per cent. Matters will only worsen in the country if Brazil has to bail out its largest company, the crisis-ridden state oil producer Petrobras. Low oil prices, as well as a corruption scandal that allegedly involves both Petrobras and the incumbent president, Dilma Rousseff, led to a contraction in GDP of 3.8 per cent in 2015, the largest decline since 1990.

The change in oil price has also hit Mexico, Latin America’s second-biggest economy. The country’s government has been forced to cut more than one per cent of GDP from spending, and the peso has tumbled to an 11-year low. Meanwhile, Mexico’s current account deficit has risen to a 20-year high.

Major changes in oil companies

Latin American petrol companies have had to adjust to the difficult situation presented to them by low sales prices. The companies have had to rethink their internal workings as well as renegotiate their partnerships with governments as well as other players.

Petrobras, Brazil’s state oil producer, has now become the world’s most indebted oil company. Petrobras’s recent history is tragic. In 2011, the company raised $70 billion in the largest equity offering ever made. Just a few years ago its debts were only four per cent; after the fall in oil prices, they have soared to thirteen per cent. To make matters worse, the company is currently the subject of a multi-billion dollar corruption investigation, alienating outside investors and partners. According to current estimates, $2 billion has gone missing from the firm.

To compensate for its debt, the company has undertaken some major changes under its new CEO Pedro Perente, who is on a mission to cut leverage and prevent the need for a government bailout. Petrobras has already sold off $2.1 billion in assets. It has also focused its waning resources on its large-scale projects in the deep waters off Brazil’s coast.

To help with this project, Parente is urging the Brazilian Congress to change legislation that forces Petrobras to control all oil fields with a stake of a minimum of 30 per cent, a relic of nationalist politics in Brazil. Parente believes that partnerships with external operators will allow a more thorough exploration of the deep-water reserves.

Similar measures are being taken at Pemex, Mexico’s state oil company. The new Director General, José Antonio González Anaya, has announced plans to cut out $5.5 billion from Pemex’s costs. Part of these costs will be achieved by a departmental restructuring, for instance integrating Pemex’s HR into its administration department and research and development into exploration and production.

Ecopetrol, Colombia’s biggest oil producer, has undergone a catastrophe during the drop in oil prices. Its market capitalisation, which was $130 billion three years ago, has fallen to $15 billion. Ecopetrol has also announced an overhaul in its operations. The company’s workforce, currently 48.000, is set to be cut by a third. The company is also selling its equity in Empresa de Energia de Bogota, a Colombian electricity and gas company.

Possible increases in M&A

The changes caused by the drop in oil prices may spur a surge in mergers and acquisitions in Latin America for a number of reasons. Firstly, capital is increasingly hard to come by for Latin American companies struggling with low revenue, a hostile economic environment and decreasing investor confidence. Secondly, reforms in legislation, such as those that are being carried out in Brazil to attract external investment, may make it easier for companies to acquire significant portions of operations previously dominated by the state. Petrobras CEO Pedro Parente has stated his hope that these changes would attract investors used to sitting in the driver’s seat in projects, in other words, those who would acquire the lion’s share of equity in oil exploration projects. Thirdly, the drop in oil prices has also made the price of mergers and acquisitions in Latin America attractive to investors. The increase in M&A already seems to be starting, with Brazilian M&A at a 20-year peak in December 2015.

Related topics:Implications Latin America
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