Latin America's oil producers sweat to cover costs as price war takes toll

MEXICO CITY (Reuters) – A price war between the world’s oil powerhouses is leaving many producers in Latin American struggling to cover production costs, boosting the chances of output cuts and investment delays in the coming months.

Global oil price benchmarks are suffering their steepest declines in decades in a perfect storm of falling demand in the face of the coronavirus epidemic, and surging supplies after Russia and Saudi Arabia failed to strike an agreement to cut output.

WTI crude Clc1 last week tumbled 29%, its biggest fall since the 1991 Gulf War. In the last two weeks, the U.S. benchmark lost around half its value, while Brent crude LCOc1 dropped about 40%.

Latin America’s heavy crudes, mostly indexed to these benchmarks and to Mexico’s Maya crude, accumulated a 42% fall in the same period, leaving some grades priced in the single digits, according to independent calculations.

Experts and analysts are expecting a global demand contraction of at least 10% this year.

“There will not be a fast recovery from these low prices,” said one trader of Latin American oil, who asked not to be identified. “We are now seeing demand destruction, and we all know what comes after that: layoffs, production cuts and investment postponed.”

Latin America’s average cost for lifting an oil barrel is close to $13 since 2019 excluding indirect costs and taxes, according to a Reuters calculation based on data provided by state-controlled Ecopetrol (ECO.CN) from Colombia, Petroecuador from Ecuador, Pemex from Mexico and Petrobras (PETR4.SA) from Brazil, as well as experts watching Venezuela’s PDVSA.

Until last month, those essential costs were covered by sale prices.

But the price war is drying up spot sales of Latin American heavy grades, knocking down regional benchmarks like Mexico’s Maya while dragging down Venezuela’s flagship crude Merey to as little as $8 per barrel last week.

With fuel demand in the United States – the main market for Latin American crude – declining as the nation enters shutdown, appetite for heavy oil from U.S. Gulf refiners has tumbled.

On March 18, Mexico’s Maya declined to its lowest level in 18 years, with sales to the U.S. Gulf Coast closing at below $13 per barrel according to S&P Global Platts, creating panic among neighbors.

Sending Latin America’s crudes to more distant markets such as Asia had provided some outlet for oil, but if freight tariffs increase amid a growing demand for floating storage, that avenue could also close in the coming months, traders said.

THE ONES AT RISK

With few options on the table, the most expensive production operations could be forced to cut back output or shut.

Those typically include offshore ventures like some deep and shallow water fields in Brazil, where production costs last year were between two and five times higher than the $5.6 per barrel registered for pre-salt, according to Petrobras’ data.

Also at risk are extra heavy crude that needs upgrading such as Venezuela’s output from its Orinoco Belt joint ventures and shale projects like many in Argentina.

The price slump could also have a heavy impact on countries struggling due to output inefficiencies and heavy government takes such as Mexico and Ecuador, as well as firms facing high transportation costs like those operating in Colombia.

“Petrobras should have a slower development in its investment case, while Ecopetrol and (Argentina’s state-run) YPF would struggle as they have a breakeven of $30 per barrel and $40 per barrel, respectively,” said investment firm UBS in a note to clients.

Ecuador’s Energy Minister Rene Ortiz told Reuters that Petroecuador’s production costs are between $15 and $19 per barrel. “Our production continues uninterruptedly. Exports of Oriente and Napo crudes are normal, according to schedule made before the sanitary crisis,” he said in an email.

PDVSA, Pemex and YPF did not immediately reply to requests for comment. Petrobras declined to comment.

While production cost typically refers to the cost of lifting an oil barrel to the surface, breakeven price is the sale price needed to cover all the operational and financial costs of that barrel, including lifting, workforce and taxes.

An Ecopetrol spokesman said output costs were not yet above sale prices, so no fields have been shut. The Colombian firm has a target of producing at least 745,000 barrels of oil equivalent a day in 2020.

Colombia-focused oil producer Frontera Energy (FEC.TO) on Monday announced a 60% reduction in capital expenditures for 2020 and said it would prioritize essential well workovers and critical maintenance until market conditions improve.

In Venezuela, oil sale prices and export volumes have been the most punished by the market due to the additional weight of U.S. sanctions.

Venezuelan President Nicolas Maduro this month confirmed that PDVSA, whose lifting costs are around $11 per barrel, is selling its oil below production costs. However, he did not outline any plans to curb production.

ON THE VERGE

Even though it is partially protected by a hedging program and has credit lines available, Mexico’s Pemex seems the most vulnerable among its peers in Latin America to low crude prices.

The company’s financial debt surpassed $100 billion in 2019, even after receiving capital injections from the government.

“At the current Mexican crude basket price of below $20 per barrel, Pemex upstream business (exploration and production) does not generate enough cash flow to cover operational and financial costs,” Fitch Ratings said last week.

Pemex revised its Maya price formulas down last Friday, which could bring even lower prices. So far this year, Pemex exploration and production costs – which do not include financial costs or taxes – average about $16 per barrel, according to company data.

But the firm, which is on the verge of losing its coveted investment grade rating, has full-cycle costs of more than $80 per barrel after taxes, according to Fitch.

Under pressure by legislators, Mexico’s Energy minister Rocio Nahle on Sunday said the country, which has offered to mediate between Russia and Saudi Arabia, is in talks with other producers while Pemex is applying a tax easing program.

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U.S. industries scramble for exemptions as state shutdown orders grow

WASHINGTON (Reuters) – As several more U.S. states moved to impose stay-at-home orders to limit the spread of the coronavirus, industries from steelmakers to auto dealerships were scrambling for exemptions that would allow them to remain open.

A patchwork of state and local authorities are imposing business closures. While many manufacturing firms were declared “essential” and were being allowed to stay open, some suppliers were not.

The stay-at-home orders are designed to stop the spread of the highly contagious virus, which has infected over 40,000 Americans in recent weeks and killed over 500.

The manufacturing-heavy states of Ohio, Indiana, Pennsylvania and Michigan imposed stay-at-home orders on Monday, joining states such as New York, California, Illinois, Delaware and Maryland.

“What we do now will slow this invader,” Ohio Governor Mike DeWine said Sunday. “It will slow this invader so our healthcare system … will have time to treat casualties.”

The National Association of Manufacturers has urged states to declare all manufacturing facilities and supply chains as part of the “essential infrastructure” and “essential businesses,” allowing them to stay open under guidance here provided by the federal Cybersecurity and Infrastructure Security Agency (CISA), part of the Department of Homeland Security.

As the virus halts physical commerce, keeping operations open provides companies a better chance of staying in business than waiting for a government handout, said Gary Hufbauer, a non-resident senior fellow at the Peterson Institute for International Economics.

“Cash flow and survival are the key words here,” said Hufbauer. “As the shutdown continues, more and more firms will seek to be designated ‘essential.’”

Several letters to state and local officials from industry groups did not address how worker safety would be maintained for firms granted exemptions.

According to the CISA guidance, working remotely is encouraged, but when that is not possible, the agency recommends following guidance from the U.S. Centers for Disease Control and Prevention for social distancing, and off-setting shift hours to separate staff.

“These steps can preserve the workforce and allow operations to continue,” the agency said.

Industry may get an opening as President Donald Trump voiced a desire on Monday to avoid a complete shutdown of the U.S. economy, Hufbauer said.

Trump said he was considering ways to restart the economy in the coming weeks and wanted to avoid the pandemic becoming “a long-lasting financial problem”

Pennsylvania imposed a stay-at-home order in seven counties, mainly in the Philadelphia and Pittsburgh areas on Monday evening. Steel mills are allowed to operate, but not some critical suppliers such as metal fabricators and producers of limestone used in blast furnaces.

“Without the continued operation of these businesses, steel mills will not be able to continue their physical operations in Pennsylvania and elsewhere,” Tom Gibson, president of the American Iron And Steel Institute, wrote in a letter to Pennsylvania Governor Tom Wolf.

As of late Monday afternoon, those metal fabricators were not on a list here of the types of businesses that could stay open from Wolf’s office.

“We are issuing these orders because Pennsylvanians’ health and safety remains our highest priority,” Wolf said in a statement.

Pennlive.com reported here that 10,000 businesses in Pennsylvania were seeking exemptions from the order.

The Aluminum Association called on local state and federal agencies to ensure that industry operations and employees are designated as “essential” and exempted from any “shelter in place” orders.

Groups representing the ports, chemical industry and hazardous waste transport also urged officials to keep them open as essential businesses

Auto dealerships, which repair vehicles and perform warranty and recall work, also should stay open, to “ensure that our nation’s motor vehicle fleet remains as safe and operational as possible” two automotive trade groups said in a letter here to Trump.

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South Africa's coronavirus cases reach 554, country braces for lockdown

JOHANNESBURG (Reuters) – South Africa’s confirmed number of coronavirus cases rose to 554 on Tuesday from 402 a day earlier, as businesses raced to make plans for a nationwide lockdown from midnight on Thursday.

President Cyril Ramaphosa announced the 21-day lockdown in an address to the nation on Monday, saying Africa’s most advanced economy needed to escalate its response to curb the spread of the outbreak.

South Africa has the highest number of confirmed coronavirus cases in sub-Saharan Africa, and public health experts are worried that the virus could overwhelm the health system if infection rates rise steeply.

Health officials are working to expand the country’s coronavirus testing capacity and develop a plan to ensure there are enough intensive care beds with respirators.

“The numbers, we mustn’t be shocked when we see them increase. But these measures if we all work together must turn the curve around,” Health Minister Zweli Mkhize told a televised news conference, saying South Africa could reach an inflection point in its infection curve two or three weeks after its lockdown restrictions enter into force.

Two patients are in intensive care, but there have been no deaths from coronavirus in the country, Mkhize said.

Agriculture Minister Thoko Didiza said the government had taken steps to ensure the lockdown would not affect food security.

“There is no need to embark on panic-buying, the country has enough food supplies,” Didiza said, adding the government would be monitoring food retailers to ensure sellers do not inflate prices.

Aviation company Comair, a franchise partner of British Airways (BA), said it was suspending all flights it operates for BA and services on the kulula.com low-cost airline from Thursday until April 19.

Tsogo Sun Gaming said its casinos and bingo sites would be closed by Wednesday.

A bargaining council for the clothing manufacturing industry said it had reached a collective agreement for guaranteed pay for 80,000 workers for six weeks.

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Dollar falls for a second day on Fed stimulus

LONDON (Reuters) – The dollar slipped for a second consecutive day on Tuesday after the U.S. Federal Reserve unveiled fresh measures to supply precious liquidity into funding markets, sending risky currencies such as the Australian dollar soaring.

The Fed announced unlimited quantitative easing and programs to support credit markets on Monday in a drastic bid to backstop an economy reeling from emergency restrictions on commerce to fight the coronavirus.

Against a basket of its rivals =USD, the dollar fell 0.5% to 101.52, down more than 1% from Monday’s highs and having hit a more than three-year high of 102.99 on Friday.

“The dollar funding conditions are easing slightly compared with a week ago, though I wouldn’t say things are normal. While the Fed is pumping dollars, we still need to wait and see if that money will flow to every corner of the economy,” said Koichi Kobayashi, chief manager of forex at Mitsubishi Trust Bank.

While the Fed’s latest measures were seen to have effectively broken the spreading freeze in the dollar funding markets in the short-term, the shock to the real economy is expected to last for a far longer period with latest PMI data offering a glimpse of the pain.

Japan posted its biggest ever services sector decline and factory activity shrank at its fastest in a decade, consistent with a 4% economic contraction this year. The picture in Australia was similar.

Ulrich Leuchtmann, head of FX and commodity research at Commerzbank said in a note that as more economies enact draconian measures to lock down their economies, the global economy would be massively constrained in the near future and markets could quickly turn back into risk-off mode.

But in early London trading, battered currencies rallied.

The euro gained 1% to $1.0834 EUR=EBS, bouncing back from a near three-year low of $1.0636 in the previous session.

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The British pound also rose 0.9% to $1.1650 GBP=D3, up more than two cents from its 35-year low of $1.1413 set last week.

The Fed announced various programs including purchases of corporate bonds, guarantees for direct loans to companies and a plan to get credit to small and medium-sized business.

Trading remained volatile, with the Australian dollar rising 2.0% to $0.5952 AUD=D3, extending its recovery from a 17-year low of $0.5510 touched last week.

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