Ecuador | Oil windfall

Siobhan Morden | March 4, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The market has drawn a line between commodity exporters—oil, in particular—and exporters. Ecuador is perhaps the most obvious beneficiary in Latin America, especially if the oil shock persists through what may be a lengthy isolation of Russia. The positive trade shock should clearly provide a buffer for Ecuador this year but hopefully not deter an obstructionist legislature from needed structural economic reforms.

The rise in oil prices has been almost exponential with insufficient spare global oil production capacity to mitigate what could be a lengthy disruption from Russia, the second largest oil producer. Ecuador is only a small oil producer at near 500,000 bpd. However, the impact would be substantial on Ecuador’s fiscal and external accounts.  This doesn’t substitute for an economic program backed by the International Monetary Fund and structural economic reforms including labor, judiciary, and investment reforms.  However, it would provide a near-term windfall to buffer against negative shocks and reduce some of the political and social pressures in the pandemic aftermath.

Ecuador’s oil dependence has declined over the past few years of stagnant oil production, and it is now only a 6% share of GDP. However, oil revenues are still relevant at 14% of the budget. The average oil price of $62 a barrel in 2021 has now jumped to $110a barrel (Oriente crude as proxy). The latest formula from Minister Cueva was that for every additional $1a barrel there would be $80 million in gross revenues or $50 million in net revenues after mandated spending on oil imports, subsidies, and other ear-marked spending. If the revised budget assumes a conservative $60a barrel, then the extra $50 a barrel windfall would translate into $2.5 billion in extra revenues or basically shift the central government fiscal deficit into a small surplus after prior revisions to $2.3 billion for this year.

This is not to say that oil prices would remain at these levels throughout the year or that the Lasso administration wouldn’t pass on some of that into spending stimulus. However, it would certainly provide budgetary and policy flexibility that would eliminate any needs to re-enter the Eurobond markets. The oil price shock provides a buffer on lower gross financing needs and a lower dependence on external capital markets. There is also less global financial integration of a completely dollarized economy and underdeveloped local markets that immunizes against financial contagion. This oil windfall immunizes against the latest external shock but is not a substitute for structural reform and explains why the IMF includes non-oil fiscal data as indicative targets.

The IMF will begin the fourth review of the current program this week with extensive logistical delays for the end September review and the December loan disbursement.  There are no obvious obstacles on compliance of these reviews now through the end of the program in December under the impressive fiscal performance, current oil price shock and approval of tax reform last year. The investment reform is not a structural benchmark within the IMF program.  The IMF anchor and high oil prices should reinforce carry returns; however more important for total returns are the backloaded payments on restructured Eurobonds and follow-through on medium-term economic reform and fiscal consolidation.

The Lasso administration now faces another governability test with the investment reform currently under review on the 30-day fast track status for a March 24 approval-or-rejection deadline.  The investment reform was approved at the CAL (administrative council) and then submitted to the (friendly) Economic Development committee for a maximum 10 days to review (3/12). There has been significant socialization and discussion on the importance of higher investment for economic growth and job creation.  However, it’s difficult to expect rational legislative support after the recent obstructionist shift of the opposition (UNES, PSC, PK radical breakaways) to undermine Assembly President Llori and prioritize political control over economic stability.  If the opposition reaches a 70 simple majority, then there would be sufficient to archive/reject the reform. It looks like an extremely fragile breakdown (70 deputies were absent from the last session called by President Llori) and polarization between the legislature that could compromise support for the economic reform agenda. There is also the obvious risk of revisions with some headlines suggesting that opposition deputies will seek a backdoor repeal of the tax reform from within the investment reform legislation.

There hasn’t yet been a plenary session with President Llori avoiding challenges to her authority; however political headlines could shift increasingly noisy next week. The potential setbacks on the reform agenda will require an alternative political strategy such as a popular referendum next year.  The high oil prices should sustain solid support for the Lasso administration that could be leveraged for a successful reform agenda via a referendum. Meanwhile, the surge in oil prices should continue to provide a near-term buffer on resilient bond prices and lower the market beta with Ecuador still one of the emerging markets outperformers this year.