What's In The Pipeline for South America

By: Mark Turner | Thu, Dec 21, 2006
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PERU (KWR) December 20, 2006 -- The near landslide re-election of Hugo Chavez in Venezuela in what neutral international observers declared "free, fair and democratic elections" has apparently set the scene in Latin American politics for the next 6 years at least. There is a clear turn to the left throughout the continent, home of 370 million people, with socialist governments of various shapes and hues now in control in the major South American states. Brazil, Argentina, Chile, Bolivia, Venezuela, Ecuador, Uruguay are all under some sort of leftist leaning government that range from free market advocates like Chile to downright social revolutionaries such as Evo Morales's MAS (movement towards socialism) party. The change in direction for the continent is undeniable. The future is now tinged a pinkish red in Latam, and the savvy investor should take note.

Without doubt, the proposed oil and gas pipeline championed by Hugo Chavez is the most interesting probable development. The plan is to build a 5200km pipeline from Venezuela through Brazil that would connect as far south as Argentina and possibly also supply Bolivia. A similar 600km pipeline running westwards would connect both Colombia and Ecuador. The cost of such a project has been estimated at around U$20 Billion... a pretty penny indeed. But with Venezuela's PVDSA state oil company predicting revenues from oil for the state at some U$85bn in FY06 alone, they certainly have the funds to make it a reality. Chavez has no doubts as to the import of the pipeline, calling it "the most important project ever for Latin America". In his whirlwind post-election tour of South America, he was quick to push forward the project that had been put on the back-burner for the previous year. Recent speeches in Argentina, Uruguay and Brazil all highlighted the pipeline plan.

Chavez is well-known for his anti-US stance. His various tirades against the Bush administration and President Bush himself hardly need to be repeated here. But as his detractors are quick to point out, Venezuela's petrodollars largely come from sales to the United States. Whilst down from the virtual dependence on the US market in the past 30 years, 60% of Venezuelan oil sales still arrive in the US mainly via the Panama canal. Chavez has from time to time made noises about stopping all oil shipments to the US. Up to now these have been empty threats, but the prospect of diverting 100% of oil production to markets other than the States seems to be the long-term objective of this charismatic President now basking in a popular mandate. The oil pipeline would give him this opportunity, and the possible repercussions to the United States and therefore world oil prices would be obvious. Venezuela currently supplies 11.8% of all oil used in the US.

The pipeline plan would be twofold. Firstly, by supplying his southern neighbours, his grand vision of an economically independent South America would take a giant step toward reality. The price paid by other nation states in the region would be at a substantial discount to world market prices, and deals already struck with Argentina and Uruguay amongst others would point to swap deals. Presently, Argentina is supplying Venezuela with cereals, beef and dairy products in exchange for Hugo's black gold. Future swap deals with participating countries would not be a shock to any observer in the region.

Secondly, a pipeline running horizontally across the continent would open up Pacific trade routes for Venezuelan oil. This is backed up by Chavez's July 2006 state visit to China, when he signed trade agreements with the eastern giant and proposed upping oil shipments to China eightfold by the year 2012. With oil piping directly to Colombian or Ecuadorean deepwater ports, this could easily be achieved, and to say that China is becoming an important market may be the understatement of the 21st century. Interestingly, if Chavez does bump up shipments to China from the presently modest 150,000 barrels per day (bpd) to the proposed 12 million bpd, this would close in on Venezuela's current US shipments of 15.4m bpd.

The amount of crude in Venezuela makes any policy decision from Chavez a worldwide concern. Oil reserves there are big...very big. Although not usually publicized out of OPEC circles, Venezuela is supposed to hold five times the reserves of Saudi Arabia. The downside to these reserves is the type of oil found in and around the Orinoco basin. Rather than the light sweet crude favoured by the market, most of Venezuela's oil is of the heavy, bituminous type that is harder to extract and costlier to refine. Whilst a barrel of light sweet crude has an average worldwide production cost of approximately U$10bbl, PDVSA puts average production costs for their oil products at U$30bbl. Under other world circumstances this high production cost may clip revolutionary wings, but with the surge of oil prices to U$62 (at time of writing) and the prospect of oil returning to the sub-30 level virtually nil, Venezuela's present and future role in world oil supply is not to be discounted by anyone with an eye to energy investments.



Mark Turner

Author: Mark Turner

Mark Turner
KWR International

Mark Turner is a Peru-based Latin America Equities Analyst for Hallgarten and Company

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