Baker Institute expert: Latin American countries should use oil revenues to diversify economies

The mix of good short-term prospects for oil revenues and long-term market uncertainties has a clear policy implication for oil-dependent Latin American economies: use short-term revenues to diversify, according to an issue brief from Rice University’s Baker Institute for Public Policy.

Credit: 123RF.com/Rice University

“Implications of the Oil Prospects for Latin America” was authored by José Antonio Ocampo, a nonresident fellow with the institute’s Latin America Initiative, member of the board of Banco de la República de Colombia and professor on leave from Columbia University.

“The strong rise of oil prices since the second half of 2017 raises myriad questions about the future of oil,” Ocampo wrote. “In the short term, the question is what are the supply and demand prospects and whether prices will continue to be strong or will weaken. In the long term, there are contrasting scenarios. The first involves market trends, as analyzed by major institutions such as OPEC, the International Energy Agency and the U.S. Energy Information Administration. The second relates to climate change debates, particularly with the agreed-to targets of the 2015 Paris agreement on climate change.”

The five major Latin American oil-producing countries have played very different roles in the world oil economy, Ocampo said. “In terms of additional oil supplies, the major contributions have been those of Brazil and, to a much lesser extent, Colombia in 2008-13,” he wrote. “However, this has not compensated for the sharp reduction in Mexico’s production since 2006-07 and the veritable collapse of Venezuelan production in recent years. That collapse took place in two steps: the first, in early 2016, was associated with the difficulties of maintaining production in the high-cost oil Orinoco Basin oil fields; the second, since September 2017, was related to effects of U.S. financial sanctions and the loss of human capital in the oil industry. Ecuadorian production has remained stagnant and that of Colombia fell in recent years, though it has stabilized in 2018. Together, the production of these five countries in 2018 is expected to be 11.7 percent below 2003 levels, and 15.6 percent below those of 2013.”

The sharp reduction in prices since 2014 has had different effects on these countries, given the differences in their dependence on oil exports, fiscal oil revenues and the evolution of their production, Ocampo said. “The economies most dependent on oil for exports and fiscal revenues are Venezuela and Ecuador,” he wrote. “This is followed by Colombia (which depends on oil more for trade than fiscally) and Mexico (more fiscally). In all these countries, the price collapse has had pronounced effects. Brazil has also been affected, but less so; it is less dependent on oil and the effects of falling prices have been partly compensated by rising oil production and exports. Given the central role of state oil companies in all these countries, the different effects are closely interconnected.”

Ocampo said that beyond the uncertainties surrounding future production, the contrast between different long-term global scenarios — the market-based scenarios, the requirements associated with mitigating climate change and the effects of technological revolutions — must be on the agenda of Latin American oil producers.

“The major simple recommendation for Latin America’s oil-dependent economies is to diversify, and to use higher short-term oil revenues to do so,” Ocampo wrote. “This means developing a strong nonoil export sector, new sources of public revenues and developing new renewable energies on a large scale. The first change is particularly important for Colombia, Ecuador and Venezuela, and the second is particularly important for Mexico. Developing new sources of renewable energy is also a major recommendation for the state oil companies of all these countries. This will also help these countries contribute to climate change mitigation — although in the case of Latin America, energy issues are somewhat less important in this regard than land use and deforestation.”