Peru looks to grow its hydrocarbons investment portfolio

Several industry reports have illustrated the growing optimism in the short-term development of the international hydrocarbons sector. Although there is an overall optimism globally, the outlook in Peru is mixed with the advancement of certain projects and the stalling of others. In early 2018 the Peruvian government awarded new exploration investments to global energy majors, such as the US’ Anadarko and Tullow Oil of the UK. However, due to corruption cases and a change in government, President Martín Vizcarra Cornejo announced the repeal of the contract with the latter company in May 2018, which proved to be a setback for sector optimism elsewhere.

Government Reform

In November 2017 Congress approved the creation of both the Vice-Ministry of Hydrocarbons and the Vice-Ministry of Electricity, which will now work independently from the Vice-Ministry of Energy and Mines, to encourage more transparency and effective implementation of projects in the energy sector. For industry specialists, the move is seen as central to the promotion of investment in the exploration and production (E&P) of hydrocarbons in the country. Investment in E&P fell considerably between 2010 and 2017, resulting in a 40% drop in oil production and a 25% decrease in proven reserves, Francisco Ísmodes, the minister of energy and mines, told local media in April 2018.

In addition to promoting private investment, current government policies are focused on the development of infrastructure, the exploitation of regional energy resources through updates to existing regulations and the development of market mechanisms, the vice-minister of energy and mines, Raul García Carpio, told local press in February 2018. Moves to enact these aims were already under way at the end of 2017, when the Ministry of Energy and Mines (Ministerio de Energía y Minas, MINEM) proposed a bill to amend several articles of the 1993 Organic Hydrocarbons Law (Ley Orgánica de Hidrocarburos, LOH) which includes the creation of a single hydrocarbons window to facilitate management for businesses, the collection of environmental and social data for preparation of future project baselines, and the expansion of 30- to 40-year oil contracts. Other measures to modify regulations relate to increasing the transparency and predictability of the signing of sector contracts, and the supervision of the approval of other contractual modalities in the industry, such as shared production, risk services and mixed contracts involving public and private capital.

Exploration

A 10% rise in oil production would increase Peru’s GDP by 0.15%, its trade balance by 0.27% and the fiscal fund by 7%, the LOH amendment bill estimates. Furthermore, the bill forecasts that such a rise in exploration would increase production by 14bn barrels of oil and 4.2trn standard cu feet of natural gas from contingent resources, as well as spur related infrastructure projects, and improve revenues in the regions where it takes place.

However, the bill had yet to approved as of mid-2018, and a number of indigenous groups such as the Quechua Indigenous Federation of Pastaza, the Federation of the Corrientes River Basin, the Cocama Association for the Development and Conservation of San Pablo de Tipishca, and the Organisation of Indigenous Peoples of Kichwas and Amazonians of the Peru-Ecuador border have spoken before Congress’ Energy and Mining Commission and Peruvian ombudsman to raise issues related to prior consultation, transparency and participation as part of the amendment. The current government was, however, able to promote supreme decree 011-2018-EM in early 2018, which approves, among other things, the rights of citizens’ to access information and participate in matters relating to environmental management.

According to the National Society of Mining, Petroleum and Energy (Sociedad Nacional de Minería, Petróleo y Energía, SNMPE), as of 2018 there were 44 E&P contracts in force in the country; however, 20 of these were partially or permanently suspended activities. One of the most prominent project suspensions was the contract signed with UK-based Tullow Oil. In 2017, days before the resignation of President Pedro Pablo Kuczynski, the government awarded five oil lots in the north coast to Tullow Oil, for an initial investment of $250m. These would have permitted the exploration of hydrocarbons in lots Z-64, off the coast of Tumbes; Z-65, close to Piura; Z-66, near to Lambayeque and Piura; and lots Z-67 and Z-68 off the coast of Áncash. In May 2018, however, President Vizcarra’s government repealed the award, stating that the company had not complied with the regulatory framework. For the SNMPE the state’s decision to stop contracts with Tullow Oil is notable, given Peru currently consumes six times more oil than it produces. In addition, according to figures from PeruPetro, in 2017 the hydrocarbons trade balance posted a deficit of $2bn, up from $1.7bn the previous year.

Government Royalties

In 2017 the hydrocarbons sector generated $792m in government royalties, up 26.3% on the previous year, when they reached $627.3m. In terms of the distribution of revenue by resource, in 2017 the production of natural gas contributed $260.6m, followed by oil ($140m), and liquefied natural gas ($391.4m). In response to the announcement of the figures, in late 2017, Carlos del Solar, then-director of the SNMPE, expressed his disagreement with the sector’s current royalties’ scheme, arguing that 30% to 40% of royalties cannot continue being paid with low oil prices. He therefore suggested that a new scheme be implemented as part of the new hydrocarbons law.

Despite the lower production of hydrocarbons, the observed increase in oil and natural gas prices has contributed to improving the amounts transferred by royalties to hydrocarbons-producing regions, according to the SNMPE. In 2017 royalty transfers for oil reached PEN505m ($155.5m), up 5.6% on the previous year, while those for gas totalled PEN1.3bn ($400.3m), a 0.6% increase on 2016 levels.

Investment Projects

Investment in the hydrocarbons sector could amount to an estimated $47.1bn in 2018, according to MINEM data published in February of that year. Investment in the upstream segment, which includes partially explored and unexplored areas, is expected to reach around $45bn, led by discoveries of oil resources, at $29.43bn; natural gas exploration, with $14.07bn; and the contract for the Lot 192 oil field in Loreto, worth $615m.

In the downstream segment meanwhile, investments in 2018 are expected to reach almost $3bn. This will be distributed between the modernisation of facilities and equipment of the Northern Peru Pipeline ($2bn); the Seven Regions Project ($350m), part of government efforts to “massify” natural gas provision; and an infrastructure storage project for liquefied petroleum gas and diesel B5 for the purposes of energy security ($637m).

As part of government efforts to achieve the “massification” of natural gas, a number of projects are under way for the design, financing, construction, operation and maintenance of the natural gas distribution system. In late 2017 MINEM awarded two contracts for natural gas massification projects, both of which are currently expected to conclude in 2036.

The first contract was awarded to Quavii, a local subsidiary of Colombia’s Promigas, to carry out a project in the northern Peruvian regions of Lambayeque, Cajamarca, Áncash and La Libertad, expected to attract $200m of total investment and reach 150,000 beneficiaries. The second will be executed in the south-eastern regions of Arequipa, Moquegua and Tacna, and is forecast to attract $60m in investment and benefit 64,000 people.

The Seven Regions Project, meanwhile, will be carried out in Junín, Apurímac, Ayacucho, Cusco, Puno, Huancavelica and Ucayali. The project has a July 2018 award date, with an estimated investment of more than $350m for a term of 32 years. It is expected that by the end of the project’s eighth year, 100,000 households will be connected.

Challenges

The main challenge for the subsector is to encourage investment that can maximise its potential and restore confidence among investors in the coming years. Compared to the rest of the region, Peru faces the highest cost to produce a barrel of crude oil. According to 2018 statistics from Spanish energy company Cepsa, the cost of producing a barrel of oil in Talara, in the interior of the country, is $20, while in Ucayali it is $35. In Ecuador, meanwhile, this cost falls to $17, while in Colombia it reaches $16.30, figures well below that of Peru.

Creating an environment attractive to investment is especially important as Peru confronts the fact that the World Bank will no longer finance oil and gas projects after 2019, instead focusing its efforts on helping countries transition towards renewables in relation to the objectives of the Paris Agreement.