ECUADOR: ECONOMIC IMPACT OF PETROLEUM DEVELOPMENT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700030096-2
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 12
• Document Creation Date: December 22, 2016
• Document Release Date: January 18, 2011
• Sequence Number: 96
• Publication Date: June 1, 1972
• Content Type: IM

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Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Ecuador: Economic Impact of Petroleum Development
CIA
DOCUMENT
FILE COP'S
DO NOT ncranv
Confidential
ER IM 72-96
June 1972
Copy No. 77
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WARNING
This document contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
GROUP 1
Ex;ludad from oulomaliC
downgrading and
dn,Io fea lion
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CONFIDENTIAL.,
CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
June 1972
ECUADOR:
ECONOMIC IMPACT OF PETROLEUM DEVELOPMENT
1. This chronically unstable and politically volatile country will soon
become the second largest crude oil exporter in Latin America, although
at lever far below Venezuela, the leading producer. Petroleum exports are
scheduled to begin in July, after a Texaco-Gulf consortium completes a
trans-Anlean pipeline from the eastern jungle oilfields to the Pacific coast.
The resulting spurt in foreign exchange earnings and budget revenues should
substantially ease some of Ecuador's chronic economic problems. Important
financial questions remain. to be settled, however, between the consortium
and the military government that took power in February 1972. This
memorandum briefly examines Ecuador's economic problems and assesses
the potential impact of petroleum development on them. It also discusses
the unresolved issues that could impede further petroleum development and
limit financial returns from the nev industry.
Background - Rodriguez's Economic Inheritance
2. When the military junta headed by Army General Guillermo
Rodriguez Lara assumed power on 15 February 1972, it inherited the
tenacious economic problems that were partly responsible for the Velasco
government's overthrow. Budget deficits had increased steadily between
1969 and 1971 and, in the latter year, amounted to mc;*e than US $35
million - 18% of expenditures (see Figure 1). Tha Velasco gov?rnment had
attempted to dissipate the inflationary potential of its 1971 deficit by easing
import restrictions. This move succeeded in holding the inflation rate to
about 6%, but it also allowed imports to grow considerably more rapidly
than exports (see Figure 2). Capital flight triggered by the turbulent
Note: This memorandum was prepared by the Office of Economic
Research and coordinated within the Directorate of Intelligence.
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1964 1965 1966 1967 1968 1969 1970 1971
'Excludes imports related to petroleum development, which generate additional trade deficits
that are automatically financed by the foreign ^ompanies making the direct investment.
Figure 2
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DEFICIT AS A PERCENT
OF EXPENDITURES
26.2
r,
20.7
n 1 18.4 18.1
M- r-t
1957 1968 1969 1970 1971
Est.
ECUADOR: Trade Trends
Million US $
ECUADOR: Government Revenues and Expenditures
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pre-coup political situation further aggravated the foreign exchange drain.
As a result, net foreign reserves fell during the year by more than one-half,
to only $25 million - equal to about one month's imports and the lowest
year-end reserve position since 1949.
3. The new government was able to stave off a financial crisis by
negotiating a $40 million loan package with a US bank. The basic problems
nevertheless remain and might be exacerbated by new social and economic
programs if a major new revenue source were not on the horizon. While
these programs are now little more than vague promises, some armed forces
factions are pressing hard for a Peruvian-type "revolution." Other elements,
including new Finance Minister Nestor Vega Moreno, are pushi-g for fiscal
responsibility - at least during the first year. The sketchy 1972 budget
approved by the previous administration projected a $40 million to $50
million deficit, but Vega claims that the deficit could reach $90 million
unless substantial changes are made. Consequently, he is preparing a new
1972 budget that will focus on limiting expenditure growth and improving
tax collection. Nevertheless, given the regime's need to establish a popular
base, an eventual large expenditure increase will probably be politically
necessary. The government increasingly is looking toward petroleum to save
the day.
The New Oil Discoveries
4. After almost three decades of unsuccessful exploration,
commercial quantities of petroleum were discovered in March 1967. Since
then, the Texaco-Gulf consortium that made the original discovery has had
spectacular success. By the end of 1971, it had drilled 74 successful wells
and only four dry holes in the northeastern jungles near the Colombian
border (see photographs and map). The oil is of good quality, having a
sulp;iur content of less than 1%. Proved reserves, already an estimated 5
billion to 6 billion barrels, could increase substantially as drilling by other
consortia proceeds. Although Ecuador's proved reserves already exceed
Colombia's 1.7 billion barrels and Bolivia's 200 million barrels, they still
stand a distant second to Venezuela's 14 billion barrels.
5. Texaco-Gulf moved quickly to exploit its new discoveries.
Following difficult negotiations in 1969, the consortium received
government permission to construct a 318-mile, 20-26 inch diameter pipeline
to the Pacific port of Esmeraldas. Construction has been rapid despite
difficult mountain and jungle terrain, and the $154-million project if
expected to be completed in June 1972, about six months ahead of
schedule. By then the consortium's total investment in developing its 2.6
million acre concession will have reached an estimated $300 million, or
about 60% to 70% of the book value of total US direct investment in
Ecuador. The pipeline's capacity will be 250,000 barrels per day (b/d),
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ECUADOR: Petroleum Development
Crude.Oil Storage Tanks at Esmeraldas
Coating and Laying Pipe near Santo Domingo
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which can be increased to 400,000 b/d by adding additional pumping
stations. When operations begin, the pipeline's initial flow will be 150,000
to 200,000 b/d; full capacity ehould be reached in 1973. Ecuador's crude
oil exports would then rank secon3 in Latin America, after Veneauela's
(which amounted to 2.2 million b/d in 1971).
6. Texaco-Gulf's success has attracted other foreign oil companies,
and six other consortia embracing some 20 companies now are actively
exploring or drilling in neighboring areas. Thus far, three consortia have
announced oil finds, but their commercial potential has not yet been
determined. Another US consortium has found gas in the Gulf of Guayaquil.
If further drilling reveals that deposits are large enough for commercial
production, liquefied gas exports seem likely.
Petroleum and the Budget
7. Despite the government's new financial resources, budget strains
will continue in 1972. If petroleum exports start at mid-year as anticipated,
government oil revenues will reach an estimated $30 million this year -
equal to 18% of its total revenues in 1971. Even so, if deficits are held
to a reasonably noninflationary level, unpopular restraints on expenditures
will still be necessary'.
8. The government's revenue position should improve markedly in
1973. Expected oil revenues of about $100 million - some 60% of total
1971 revenues - would permit a balanced bud, .et even with substantially
increased public investments in social and economic infrastructure. The lack
of such investment in recent years has been a major cause of unemployment
and sluggish economic g4?owth. Total gross domestic investment (excluding
petroleum) was only about 11% of gross domestic product (GDP) in 1970,
one of the lowest shares in South America, and public investment was a
very small 4% of GDP and declining. Petroleum investment, financed almost
entirely by foreign companies, reached some 3% of GDP in 1970.
9. The ousted Velasco government had laid the groundwork for
channeling some petroleum revenues into public investment.17or 1973,
about $10 million were earmarked for electric power development, and $4.5
million were to be used to expand educational facilities. Velasco yielded
to military pressure, however, and planned to use $10 million of oil revenues
to purchase military equipment. The new government is not expected to
make any immediate changes in these measures, but if it limits the rise
in current expenditures, oil revenues will be available to finance other major
investments. Priority areas for public investment include agricultural
irrigation systems, road construction, and health facilities, in addition to
education and electric power development.
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Petroleum and Exports
10. Without oil, Ecuador's export prospects would not be promising.
Three commodities - bananas, coffee, and cocoa - now account for 75%
to 85% of total earnings (see the tablc). Banana exports, by far the most
important, stagnated during the 1960s and then spurted in 1970-71 as
Ecuador took advantage of storm damage in other producing countries.
Because world production now is outrunning demand, however, Ecuador's
banana sales probably will do no better than level off during the next few
years. Moreover, growing world supplies are expected to restrict coffee and
cocoa sales as well. Despite probably rapid expansion in minor exports,
chiefly fish products, sugar, and lumber, the expected poor performance
of Ecuador's chief foreign exchange earners could limit the growth of
non-petroleum exports as a whole to 3% or 4% annually during the next
few years.
Ecuador: Commodity Composition of Exports
Million US $
Commodity
1960
1965
1969
1970
1971
E
ti
s
mated
Bananas
90
96
96
111
118
Coffee
22
38
27
50
36
Cocoa
21
19
25
22
25
Fish products
2
6
9
7
15
Sugar
1
7
11
9
14
Other
13
14
20
19
27
Total
149
180
188
218
235
a. Exports are f.o.b.
11. Petroleum exports should substantially improve this picture in
1973, when crude oil exports of 250,000 b/d should yield some $180
million in foreign exchange, equal to more than three-fourths of total export
earnings in 1971. At this level, oil exports would represent 40% to 45%
of total exports. If import growth can be held to a reasonabl3 8% annually,
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Ecuador could achieve a trade surplus approaching $100 million in 1973
and add substantially to its foreign reserves.
Unresolved Issues
12. How much or how little Ecuador eventually gains from its oil
bonanza largely depends on the policies established relative to the foreign
o11 companies. Too generous a policy could entail needless loss of budget
revenue and foreign exchange, while too strict a policy could discourage
further oil expansion and generally dampen the investment climate. S3veral
important financial issues carried over from the Velasco administration are
still to be resolved by the government and Texaco-Gulf. These issues have
been at least temporarily overshadowed by a totally unexpected decree of
6 June which would retroactively apply the very restrictive Hydrocarbons
Law of October 1971 to all existing oil company contracts. The terms
involved in the final resolution of all of these issues will be indicative cf
the degree of economic realism in the Rodriguez government's oil policy.
13. The most important issues still pending when the ; Velasco regime
was ousted center on activating a 15% tax on oil exports, handling foreign
exchange earnings from oil exports, establishing the price basis on which
company income taxes will be calculated, and determining the pipeline
amortization period. When the Velasco government imposed a 15% tax on
exports other than oil after the August 1970 devaluation, it gave private
assurances that the tax would not be extended to oil exports. This promise,
however, has not been enacted into law despite consortium pressures to
do so. The consortium also is pressing the government to modify its
requirement that all oil companies' foreign exchange earnings be turned
over to the Central Bank before exchange is made available for profit
remittances and capital depreciation. It also is seeking a ruling on whether
income taxes will be assessed on the basis of realized export prices or tax
reference prices. The government began negotiations with Texaco-Gulf in
April but, at the time of its surprise announcement in early June, had not
resolved a single one of these issues. The company attributed this delay
to the government's fear that its ignorance on petroleum matters would
result Li a faulty decision.
14. Although all of the oil companies operating in Ecuador have been
highly critical of the Hydrocarbons Law, they had been repeatedly assured
that the law would not be applied retroactively to their existing contracts.
The Velasco government had indicated, however, that it would try to
renegotiate several contracts, including Texaco-Gulf's, to make them
conform more closely to the new law's "association" principle, which allows
the government to share directly in profits. The oil companies are dismayed
by the new government's more sweeping action and claim that, if the decree
is s'i:rictly enforced, it would make petroleum operations in Ecuador
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unprofitable. Rodriguez's motives in issuing the decree are unclear. He could
be making an empty gesture to nationalist forces while intending in practice
to apply the decree only in the broadest and most lenient terms. It is also
possible, however, that because of inexperience in petroleum matters the
government misjudged the adverse impact of its precipitous action.
15. The tentative financial arrangements now in force between the
government and Texaco-Gulf would give Ecuador 60% to 65% of gross
profits, well below the average 80% that major oil-producing countries now
receive. The government is well aware of this discrepancy and, faced with
nationalist pressures, could be expected to try to exploit it. Texaco-Gulf,
with its extensive investments serving as hostage, probably will be f.'orced
to give in to government demands even if they severely reduce the
profitability of its operations. The other consortia, however, are not yet
heavily committed. In the event of an unrealistic stance by Ecuador, they
probably would deem it prudent to cut their losses by pulling out.
Nationalism, Petroleum, and the Future
16. Since taking power, the new government has not had to contend
with any organized political opposition, and for the moment Ecuador's
political scene is relatively quiet. Given the country's past history, however,
such a situation is unlikely to continue. Should the government's political
position weaken, Rodriguez would be even more tempted to strike a
nationalistic posture to consolidate public support. There is already an
element within the military around which this course of action could
coalesce. This element hopes that Rodriguez can be forced to emulate the
military regime in Peru and press ahead rapidly with far-reaching social and
economic reforms. Whether or not Rodriguez eventually follows such a
course - and there are few indications that he is personally inclined to
do so - will depend on internal political pressures.
17. The only obvious target of a nationalist course is the oil industry.
Relations between the foreign oil companies and the Velasco government
were always uneasy and threaten to continue unstable under Rodriguez.
There are also strong indications that ,he new government is interested in
participating in other aspects of the industry apart from cr;ide oil
production. It is moving ahead with plans initiated under Velasco to
construct a refinery, strengthen the administration of the state-owned
enterprise to monitor all phases of the petroleum industry, and establish
a joint government-private tanker fleet to transport the one-half of oil
exports reserved for Ecuadorean vessels.
18. If a modicum of reason prevails, however, there is little likelihood
that Ecuador would want to nationalize the petroleum industry in the next
few years. Unlike some other Latin American countries, Ecuador simply
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does not have the human resources to explcit its petroleum deposits. The
state-owned Ecuadorean Government retroleum Corporation was established
only in January 1971. It is still in the process of being organized and has
had no experience in the industry's day-to-day operations. Although the
government is sending some military officers abroad for petroleum industry
training, it will be years before they have much technical competence. Only
when the oil companies themselves, through years of operation in the
country, have trained a large corps of Ecuadorean workers, technicians, and
administrators, will the government be in a position to operate the industry
effectively. Whil'i an economically self-defeathig act cannot be ruled out,
it appears far more likely that E.,wadorean nationalism will take the form
of increased regulation and demands for higher profit shares.