CHAPTER 9 AN OVERVIEW OF THE PRIVATIZATION OF THE LATIN AMERICAN OIL AND GAS SECTOR

• Jurisdiction: Derecho Internacional

Oil and Gas Development in Latin America
(Mar 1999)
CHAPTER 9
AN OVERVIEW OF THE PRIVATIZATION OF THE LATIN AMERICAN OIL AND GAS SECTOR
Jay G. Martin
Andrews & Kurth L.L.P.
Washington, D.C.

I. Preface

This paper reviews some of the more important recent efforts to privatize energy resources in Latin America.¹ It attempts to analyze the means by which various Latin American countries have adopted different schemes for privatizing their oil and gas assets. Privatization will play a major role in determining future energy supplies and prices — a concern to both energy producers and consumers. Foreign investment in energy sectors such as petroleum refining and marketing, electricity generation and transmission, and natural gas transmission have been permitted to a significantly greater extent than in the hydrocarbon production sector.

This paper is organized in two main parts. The first part of the paper addresses the economics of privatization — what motivates countries to privatize. It also discusses some of the common policy and legal issues associated with privatization. The second part of the paper reviews specific privatization efforts in those Latin American countries having significant oil and gas resources and electric power needs.²

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II. Introduction

Since the late 1980s, when numerous debt crises arose, all countries in Latin America have faced the pressures of strong demand growth, limited increases in oil and gas production and tight exploration budgets. The decline of socialism and the end of the ideological confrontation between democracy and communism, more than a decade of low oil prices, and fresh opening of new acreage such as those in the Commonwealth of Independent States has resulted in intense worldwide competition for oil and gas investment. All of these considerations in terms of ideology, finance and pragmatism have combined to force Latin American Governments to think about change and consider concepts like deregulation, decontrol, demonopolisation, debureaucratisation, decentralization, commercialisation, restructuring, downsizing, and privatization.

Energy privatization has been part and parcel of a worldwide trend which has placed greater reliance on market forces and less dependence on government in the allocation of energy resources. Since the means by which different countries have privatized state-owned oil, gas and electric power industries in Latin America have varied considerably, "privatization" in this paper is treated as any movement toward a market — driven economy — or any movement that diminishes public ownership and control and increases private ownership and control.

Virtually all of the countries in Latin America, have begun significant privatization programs in spite of the often fierce opposition of affected groups — labor unions, users of the subsidized products and services, and providers who overcharge them. Nevertheless, because of their potential

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to increase efficiency and reduce corruption and waste, privatization programs have become popular in Chile, Argentina, Peru, Mexico, Colombia, Venezuela, Brazil, and Bolivia.³

Privatization began in the western hemisphere in the late 1970's, as nationalized industries began to lose favor. Disenchantment with state enterprises grew as government enterprises began to be perceived as bloated, inefficient and not up-to-date with modern technology.

Among the developing countries, privatization has been wide-spread. With the exception of Cuba, virtually all of the Latin American countries have adopted some form of privatization. While Chile was Latin America's pioneer at privatization, Argentina, Peru and Colombia have undertaken the most ambitious overall privatization efforts with respect to their petroleum sectors.

Privatization has been driven, among other things, by the increasing globalization of the world economy. Several decades of rapid growth in international trade and investment have made competitiveness in international trade an essential factor in a nation's ability to create jobs, raise real wages and generate wealth. For many nations, privatization has been the only effective way of raising investment capital on favorable terms.

Although privatization efforts differ substantially from country to country, there is a strong common economic rationale underlying the various decisions to privatize state oil, gas and power resources. In general, Latin American countries have privatized state-owned oil and gas industries to achieve one or more of several objectives: (1) raising revenue for the State; (2) raising investment

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capital for the industry or company being privatized; (3) reducing government's role in the economy; (4) promoting wider share ownership; (5) increasing efficiency; (6) introducing greater competition; and (7) exposing firms to market discipline.

It should be kept in kind, however, that privatization is not an end in itself and is not a panacea for the various difficulties faced by the public sector in many economies of Latin America. Mere change of ownership or the introduction of private management will not by itself pave the road to financial and economic efficiency.

Ideally, privatization should be an element of broader economic policy comprising deregulation and liberalization with as much emphasis on improving the efficiency of retained State-owned enterprises ("SOEs") as on efforts to divest. Even when governments decide to continue State ownership of certain strategic assets, various measures can still be implemented to improve efficiency and reduce costs. In other words, privatization is a complement to and not a replacement for the other aspects of the development of the private sector such as the emergence of greater numbers of new private businesses.

III. Overview of the Privatization Process in the Latin American Energy Industry

A. General Trends in Privatization in Latin America

In the early 1980s, external debt spiraled out of control in many of the Latin American countries leading to years of macroeconomic instability, painful economic adjustment and low or negative economic growth. These countries reached a point where they could no longer absorb the burden of SOEs. The pace of technological change and the research and development commitment that is required to succeed in today's global market place have made it counterproductive for many

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firms to remain under control of the state. Further, many SOEs in Latin America (including state-owned petroleum companies) have historically been overstaffed, have had poor financial and export performance, depended on subsidies and unilateral budget transfers, maintained highly centralized and politicized organizations, and relied on their protected monopoly status.

In Latin America, Chile was perhaps the first and most successful privatizer. Chile's privatization efforts began in 1974 with the overthrow of Salvador Allende's regime but were largely unsuccessful. Following its economic crisis in 1982-83, Chile's privatization efforts began to blossom through the use of a number of privatization methods which resulted in the divestment of nearly all of its State enterprises. The privatization of Chile's pension funds represented a particularly key event because it created a sizeable and stable base of institutional investors for Chile's equity market, allowing a number of large privatizations to be absorbed domestically. Chile's highly successful move towards privatization of pension funds has been emulated by other Latin American countries including Argentina, Bolivia, Mexico and Peru. Throughout the Latin American region, although the pace of regulatory reform may vary, the direction of change is consistently towards liberalization of conditions that favor enhanced investment incentives.

In the mid-1980s, Mexico also tried to restructure some of its large SOEs but it quickly became apparent that restructuring would be long and difficult, requiring extensive resources and substantial labor reductions, and offering few short term benefits. In Mexico the bureaucracies that were incapable of effectively managing these firms proved not capable of turning them around.

B. Purposes of Privatization

Some of the most commonly identified objectives for privatization programs including those that have been implemented in the Latin American energy sector are (1) reducing the fiscal deficit;

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(2) raising revenue through asset sales; (3) generating additional tax revenues; (4) encouraging the return of flight capital; (5) promoting foreign direct investment; (6) deepening and broadening domestic equity markets; (7) boosting investor confidence; (8) increasing efficiency; (9) fostering competition; (10) improving the quality of goods and services; and (11) reducing the state's role in the economy. Some objectives such as reducing the deficit can be the direct outcome of privatization. Others, such as increasing efficiency and productivity are longer term objectives that depend largely on what new private owners bring to companies.

In essence, privatization is merely the first step (albeit an important one) in restructuring important SOEs and accomplishing three broad objectives; (1) getting government out of business by strengthening market forces to promote competition, thereby increasing productivity and efficiency, lowering the cost, and raising the quality of goods and services; (2) generating new sources of cash flow and financing for new enterprises by eliminating government crowding out of equity markets, encouraging return of flight capital, promoting foreign direct investment, facilitating domestic savings, and broadening and deepening domestic equity markets; and (3) reducing the government's fiscal deficit by using privatization revenues to retire external and domestic debt, reducing fiscal transfers to state enterprises, and increasing tax...