Fruits of Peruvian Economic Development

Intangible Fruits of Peruvian Economic Development

by COHA Research Associate Andrea Cornejo

“Between 2004 and 2009, approximately $1.13 billion in revenue generated by the Camisea natural gas project was transferred to local governments in Camisea’s sphere of influence. However, more than five years after the start of operations, critical gaps in meeting the basic needs of local citizens remain.” -Oxfam

The natural gas industry in Peru has boomed since mid-2004, when natural gas from the Camisea Project, located in the Urubamba Basin in the southeastern Peruvian Amazon, began to flow. At approximately 1.7 billion USD, Peru’s Camisea Project represents the largest investment in the country’s history. Since the project’s 2004 launch, according to an Oxfam report published in July of 2010, Camisea has been satisfying part of the external market demand for natural gas, albeit at alarmingly low prices dictated by the existing contract. These low prices, along with the sub-par royalties awarded to Peru in comparison to other gas-exporting Latin American countries, have become a liability for the Peruvian economy. Indeed, in terms of natural gas exports, Peru is currently not getting a fair deal.

While high domestic natural gas prices act as a deterrent to domestic industries and individual consumers, low royalties charged by the government to foreign exporters mean a paucity of compensation for what some see as the usurpation of Peru’s natural resources. Consequently, President Alan García’s administration now must contend with a good deal of political and social pressure to increase export gas prices in order to reverse this trend of inadequate compensation. At the same time, there is counter-pressure from both foreign and domestic investment firms that insist upon the fixed low prices ordained by the prior contract. Negotiations for an increase in the price of exported natural gas will therefore prove to be tricky, if not entirely out of the question.
Government leaders and political elites justify the low natural gas export prices as necessary to promote economic growth, pointing to the unyielding benefits of overall trade and foreign investments as an illustration of the positive impact that such low prices have on the economy. Nevertheless, the dilatory and seemingly unconcerned attitude on the part of Peruvian government officials demonstrates their unwillingness to take a more comprehensive view of the nation’s prospective economic growth, and its potentially critical social, economic, and environmental impact on the state.

A Recapitulation of Events
In May of 2010, President García assured the people of Peru that contract alterations regarding Camisea were not necessary, as there was enough natural gas to fulfill domestic as well as export demand under the current arrangements. However, according to The Economist, there is less gas to go around than García is willing to acknowledge. The government and corresponding companies (Hunt Oil, Tecpetrol, Pluspetrol, and Repsol among others) claim that Camisea has enough gas not only to meet 4.2 trillion cubic feet of export obligations, but also to supply the local market with at least 5 trillion cubic feet of natural gas for half a century. This would suggest that Camisea contains reserves of approximately 10 trillion cubic feet. That figure, however, stands in contrast to the 8.8 trillion cubic feet estimate certified by hired consultant firms. Though a subsequent study commissioned by the government raised the consultants’ initial figure by almost 30%, the population remains unconvinced, as evidenced by the continuous protests in the most-affected southern region of Peru. In any case, over 100 Peruvian enterprises, including a new power station, must anxiously wait for the Camisea consortium to finish expanding its domestic pipelines before they will have access to the natural gas.

In response to popular unease over high domestic natural gas prices and the corresponding inaccessibility of the natural gas market for local consumption, the Peruvian government, in July 2010, passed decree 039-2010-EM. This edict establishes a minimum value for the royalties placed on exported natural gas extracted from Block 88—Camisea’s original land concession—and utilizes the Henry Hub benchmark, a standardized method of setting natural gas prices that is used in the United States. According to Epifanio Baca, Director of Grupo Propuesta, a consortium of NGOs focused on the consolidation of democracy in Peru, the current Henry Hub gas prices for exports hovers at 4 dollars per million BTUs (British Thermal Units), not including transport prices. This means that the well head price (the price at the location of extraction) for domestic demand oscillates between 1.00 USD and 2.50 USD. For Peru’s exported oil, in contrast, the well head price is approximately 0.54 USD, with royalties estimated at around 0.14 USD per million BTUs. This is significantly lower than royalties charged by other natural gas-exporting countries such as Bolivia, which passed legislation in 2005 to establish the minimum royalty rate at 18%.

However, the July 2010 decree itself does not ensure an increase in export prices for Peru’s natural gas. In order to make higher export prices a reality, 039-2010-EM must now be followed by contract renegotiations with the Camisea consortium’s export firms. After a July 4th meeting with the Council of Ministries, the Prime Minister, Javier Velázquez Quesquén, affiliate of the American Revolutionary Popular Alliance Party (APRA), announced the initiation of price and royalty renegotiations designed to ensure that domestic natural gas prices do not exceed export prices. Two days later, however, the Ministry of Energy and Mining (MEM) altered the proposal, establishing the domestic royalty rates as the price floor for gas exports. This move by the Ministry is somewhat troubling, as it all but eliminates the possibility of equalizing domestic and export gas prices.

Despite this sometimes confusing sequence of events, the Peruvian government has pledged to continue the renegotiation process with the Camisea consortium. As the talks regarding Camisea’s Block 56 advance, there seems to be little political will to ensure that in-house gas prices will be equalized any time soon. This is despite assurances that Camisea and PeruPetro S.A., a private enterprise created to represent the state in the promotion, negotiation, and oversight of contracts related to the exploitation and continued exploration of hydrocarbons in Peru, will continue to be able to meet every two weeks to advance negotiations. However, PeruPetro S.A. recently stated that it will only negotiate in accordance with the 039-2010-EM decree passed by the MEM, a development that further calls into doubt Peru’s ability to equalize domestic and export gas prices.

Export Contracts: Perhaps Unfair, Most Likely Unwise
Low export prices and royalties are not the only issues in question. The physical exportation of more than half of Peruvian natural gas reserves is also a matter of concern, as it takes place amid uncertainty as to the total amount of natural gas reserves available in the region. In the event that there is insufficient natural gas to satisfy both domestic and export demand, the Camisea export contracts, as they now stand, would most certainly be harmful to domestic Peruvian demand. Additionally, Peru LNG (Natural Gas Liquefaction) will, for the most part, be routed to a plant in Mexico that, according to The Economist, is not yet complete, and may not be ready for more than a year. Most likely, it would be more advantageous for Peru to export its commodity to another country. If Repsol, the Spanish firm handling the exports, were, for example, to ship the gas to Asia or Argentina, export prices and profits would increase above the levels currently provided for in the existing export contracts. The appallingly high opportunity cost of the Camisea export contracts would then seem to run counter to economic incentives, and may instead be indicative of powerful political interests lurking behind the issue.

The unfortunate lost opportunity to maximize revenue that this current arrangement represents is no secret to analysts. According to Epifanio Baca, at the current under-negotiated price, gas royalties are so low that the Peruvian government is patently foregoing considerable revenue. Camisea’s associated companies claim that the low Henry Hub gas prices are only temporary, and that, in the medium run, they will be increased from their current price of 4 USD per gallon up to at least 8 to 10 USD.

Consequences of the State’s Negligence to Lower Gas Export Prices

When export prices remain lower than domestic prices, two main problems arise. First, Peruvian national industries will continue to pay 2.50 USD per million BTUs as a well head price, five times the well head export price of 0.53 USD per million BTUs. When the Camisea contract was signed in 2006, domestic demand for gas was much lower. But as of now, many Peruvian departments, including Arequipa, Cuzco, Moquegua, Puno, and Tacna are troubled by shortages in the local supply of gas. The common perspective is that while the government continues to assert that, in the future, there will be enough gas to go around, Peruvians feel cheated of the true value of natural resources under their land. These are, of course, resources that Peruvian’s will have to depend upon not only in the future, but in the present as well. “Southern Peru needs five trillion cubic feet of gas, an amount that is not guaranteed,” said Tacna governor Hugo Ordóñez, head of the National Association of Regional Governments.

A second problem is that reduced royalties for the Peruvian government mean that in the course of an 18-year contract export period, the state will have lost $US 3,750 billion dollars of income if the government fails to renegotiate rent and royalty accords for Block 56. Indeed, instead of selling its natural gas to Mexico, Camisea could have sold it to clients in neighboring Chile or Argentina for a much higher price. According to Swarthmore College Economics Professor Stephen O’Connell, if exporting Peru’s natural resources so cheaply is in fact unnecessary to attract investors, then “Peruvians are giving away a resource rent that could be used to support a variety of important public expenditures.” He also points out that, “as foregoing public revenue that could have gone toward public expenditures is something typically linked to corruption and bargaining between domestic political elites and foreign capital, renegotiations for Block 56 are important for transparency and fairness.”

It is interesting to note that the case of low export prices for Block 56 sales abroad contrasts sharply with the prices of Block 88 gas sales. For the latter, there is a specific clause in the renegotiation agreement that explicitly states that gas prices charged for the consumption of individual household users would, under no circumstances, be higher than prices for exported gas. According to Baca, Block 88 allowed for regulations of gas prices because, like Block 56, it was conceded to the Peruvian state at no cost after being discovered by Shell in the 1990s. For rent-related reasons, gas from Block 88 was designated for the internal market, while gas originating from Block 56 would be consigned exclusively to the external market.

The concrete impact of increasing royalties and/or reducing gas prices would be substantial, and needs to be taken seriously by the Peruvian government as negotiations with Camisea continue. Fiscally, reduced royalties mean less public spending, and directing fewer financial resources toward public services will no doubt adversely affect the breadth and quality of public infrastructure in areas that are already suffering the environmental consequences of Camisea’s activities.

For average Peruvians, higher domestic prices for natural gas also mean a reduction in real income. That real income squeeze, in conjunction with the prevailing high domestic gas prices, has the potential to shift the market for natural gas toward the informal sector. According to Professor O’Connell, the distributional effect of such high domestic prices on real income will be regressive if most of the consumption for natural gas comes from lower- to middle-income sectors. In contrast, if most of the consumption comes from middle- to higher-income sectors, the effect will be progressive. Furthermore, high domestic prices of natural gas have a negative environmental impact in Peru, as they discourage the consumption of natural gas, thereby providing an incentive for the use of other, more environmentally damaging, energy sources as alternatives.

Beyond socioeconomic and environmental impacts, this foregone revenue from unusually low export prices could, in the long run, affect Peru in terms of its dependence on international financing. Specifically, a weaker revenue base has the potential to damage Peru’s credit-worthiness in international markets, making borrowing more expensive.

Natural gas resources are undoubtedly an invaluable asset for Peru’s economic development. Accordingly, Peru must ensure that Camisea serves export market demand in a manner parallel, and certainly not contrary, to internal market demand. This will ensure higher socioeconomic returns, which remain crucial to maintaining the country’s economic growth. The Peruvian government must ensure that a renegotiation of prices is achieved, one that not only maximizes revenues that can subsequently be directed toward public expenditure, but also takes into consideration the potential environmental, social, and economic concerns previously discussed.

Sources and references for this article available here.

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This analysis was prepared by COHA Research Associate Andrea Cornejo
Posted 15 Sep 2010
Word Count: 2200

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