Despite negative press, Latin America is experiencing an increasing level of M&A transaction activity. New entrants in the form of national oil companies (NOCs), niche players and small-cap E&Ps are underpinning the increase in the number and value of transactions. The hottest market is emerging in Colombia, while Argentina continues to attract attention despite continued government intervention. Transaction activity in Venezuela, Ecuador and even in Bolivia may make a comeback once their contractual and fiscal systems stabilize.

The region is a modest contributor to global oil and gas supply (13% of production), with two globally relevant resource countries (Mexico and Venezuela holding more than 80% of reserves). Venezuela, Mexico, Ecuador and Bolivia are net exporters. Argentina and Colombia are marginal exporters that risk becoming importers, while Brazil has recently achieved a heavy-oil surplus capacity.

Increasing uncertainty in political-risk perceptions has resulted in a partial refreshing of private-sector players, with the higher-risk-takers replacing the more risk-averse. Super-majors seem to be harvesting or abandoning most non-glamorous plays and leaving interstitial niches for others; they now hold just 13% of reserves.

The hosts' "client" base is gradually shifting to aggressive NOCs, such as China's CNPC and Sinopec and India's Oil & Natural Gas Corp. (ONGC); pragmatic international oil companies (IOCs), such as Occidental Petroleum, Perenco SA and Apache Corp.; entrepreneurial small-cap E&Ps (many Canadian and British); and indigenous private micro-independents. This small-company mushrooming phenomenon is noteworthy, with Argentina and Colombia appearing to be their favorite areas.



Petro-nationalism

After the perceived failure of "Washington Consensus" privatization and deregulation policies of the 1990s, the pendulum reaction came in the form of a perceived "swing to the left."

It is in reality an eclectic populist movement, with some of these leaders becoming pragmatic once in power ("blink to the left, then turn right") while others indeed brought an about-face in economic policy and drastic (and often retroactive) changes in the rules of the game. This has surprised and alienated quite a few foreign energy investors.

In response to high oil prices and the stresses affecting the industry-psychology of matters such as resource scarcity, access issues and NOC globalization-several local governments have then chosen to adapt their E&P contractual and fiscal regimes to increase state control and profit participation. Venezuela, Argentina, Ecuador and Bolivia have taken aggressive stances towards rent capture and resource control, while Colombia and Peru have done just the opposite in their quest to attract investments.

Brazil and Trinidad & Tobago have remained contractually and fiscally stable thus far.

Bolivia. Bolivia's confiscatory hydrocarbons law and Evo Morales' militarized nationalization announcements have not deterred contractors, however, who have proven to be pragmatists and have all reached an agreement with the state, which has promised stability point-forward. If, despite the 50% turnover tax and 34% profit tax affecting new service contracts, the economics are still positive, a transaction market may materialize.

Venezuela. In Venezuela, tough royalty and tax increases and contract changes in the government's favor present a further deterioration in the investing environment. Royalties were increased to 30% for oil and 20% for gas, and income tax is now 50%. The operations contracts have now been replaced by minority equity stakes in joint-venture companies that, in essence, hold concessions.

Some companies felt the sting, but not all seem unhappy given the possibility of access to the largest resource in the region. Once the dust settles, there will be a basis for transactions again. However, government interference in recent transaction attempts and its refusal to promise future fiscal stability give reasons for concern.

Ecuador. Inhospitable investment conditions also continue in Ecuador as the government delays transaction approval and proceeds with the confiscation of Occidental Petroleum's Block 15 in apparent retaliation for a VAT-related arbitration defeat. The last four years have seen a string of divestments or complete exits by Western companies, including EnCana Corp., Kerr-McGee Corp., Sipetrol, Vintage Petroleum, ConocoPhillips and Europe's OMV. The only significant investments of late have been made by the Chinese.



A&D hot spots

After an abrupt slowdown in A&D activity that touched bottom in 2004 as a result of the often uncomfortable political climate, activity rapidly regained momentum in 2005-06.

Deal benchmarks for the region tripled during 2002-04, from an average of around $2 to $6 per barrel of oil equivalent (BOE) of proved reserves. Since then, the average has grown to about $8 on a median basis, or $6.50 on a weighted-average basis. Transaction activity in 2006 has been restricted to Argentina, Colombia and Brazil.

Colombia is the latest hot spot in the region with reserves in the country commanding premium prices. The government is keen to attract investments, and besides excellent contractual and fiscal terms, it offers a tradition of political stability, judicial independence and steady economic growth. Personal security continues to be a problem, but it seems an inflection point has been reached, and improvements, albeit still incomplete, are evident.

In 2006 through November, there were four deals of significance in the country. Buyers have included NOCs (Sinopec and ONGC acquired Ominex Resources) and small-cap E&Ps (Gran Tierra Energy entered the Putumayo Basin by acquiring Argosy Energy International, Pacific Stratus acquired Sipetrol's assets, and PetroLatina Energy acquired Petróleos del Norte).

Argentina, despite continued tightening of investment terms and the corresponding negative press, is seeing a rapid recovery of investment interest. While the macro-economy has made a remarkable comeback, it needs energy security to continue to grow. Natural gas prices are slowly thawing out of state control, and have recovered lost ground. Devolution of resources from the federal sphere to the provinces creates interesting dynamics too.

Interventionist measures are nevertheless expected to continue al least until the October 2007 elections. In 2005-06, there were a number of M&A transactions including, most significantly, Occidental's return to the country through its acquisition of Vintage, and Apache's acquisition of Pioneer Natural Resources' assets in Neuquén and Tierra del Fuego, and consolidating its holding in the Tierra del Fuego portfolio by acquiring Pan American Energy's interest. On a smaller scale, junior E&Ps such as Gran Tierra, Pluris Energy and Trefoil Ltd., have been actively acquiring positions from local players.

Brazil is also seeing an up-tick in A&D activity. Despite market domination by Petrobras, private-transaction activity has been increasing. The highest-profile deals include Norsk Hydro's acquisition of EnCana's share in the heavy-oil Peregrino Field in Block BM-C-7, and ONGC's purchase of a stake in BC-10 from Shell, which had increased its share by pre-empting ExxonMobil's divestment.

Norse Energy Corp. bought Petroserv's position in Block B-CAM-40 and in the Manatí gas field. The country has remained contractually neutral and has again heightened interest from international companies since the seventh round. Momentum is increasing with respect to several heavy-oil projects-such as Polvo and Frade-in the shelf.

Trinidad & Tobago. In the rest of the region, activity has been very thin. Trinidad & Tobago, while highly sought after by industry investors, has only seen one recent A&D deal as access remains tough. Repsol YPF and Petrotrin (Petroleum Company of Trinidad and Tobago Ltd.) acquired the mature oil fields Teak, Samaan and Poui from BP in 2005.

Peru. Deal flow in Peru, despite offering an excellent investment environment, has also been thin for structural reasons. Activity in the country is dominated by a joint venture of Pluspetrol and Hunt Oil and their Camisea project, although the Marañón Basin could be experiencing a revival, as there have been recent discoveries in blocks 39 and 64. The only deal of note has been Repsol YPF's acquisition of a stake in the Camisea LNG project from Hunt.



Open for business?

The continuity of a pro-market government in Mexico suggests that there may be a further opening in its energy sector, which is in dire need of investment and needs a food-chain to replace the state monopoly. The field-enhancement potential is mind-boggling. Several firms-including Repsol YPF, Petrobras, Lewis Energy, Pluspetrol, Teikoku Oil, Tecpetrol, Mexican drilling company IPC and Colombia-based Petrotesting-already have their "noses inside the tent" by daring to participate in multiple-services contracts (MSCs) in the Burgos Basin gas play.

There have been plans to extend the service-type model to marginal oil fields, but this proved more difficult because oil has stronger emotional and political connotations. In fact, a bidding round had been announced for January 2005 and was soon derailed by disagreement within state oil company Pemex itself. The would-be "marginal" oilfield grouping had 10 billion barrels of original oil in place, and 1 billion barrels had already been produced.

The grouping had been severely neglected since the 1930s-there have been only sporadic pulling operations since then-and was still producing about 5,000 barrels per day with a 50% water-cut, while many original wells-from the 1910s and 1920s-still flow well and without offsets. If Pemex insists on glamour by venturing into the deepwater Gulf of Mexico, it should leave the low-hanging fruit to the rest. In any case, any further liberalization should necessitate a constitutional reform.



Conclusion

In conclusion, Latin America has been troublesome since the turn of the century, but still offers abundant exploration and exploitation opportunities. This region is not alone in its transfer of bargaining power from investors to hosts, and consequent changes in the rules of the game. M&A activity has been steadily picking up pace, mainly in Argentina, Colombia and Brazil. In the longer term, once the dust settles in Ecuador, Venezuela and Bolivia, transaction activity there may start returning to normal. Believing in the might of market forces, one should also nurse hopes for Mexico.



Carlos A. Garibaldi is a managing director with U.K.-based M&A advisory firm Harrison Lovegrove LP in Houston.