Oil In Ecuador - Extended Essay

Table of Contents Introduction..........................................................................................................................2 Background..........................................................................................................................2 Figure 1: Location of Ecuador.............................................................................................4 Figure 2: Location of the OCP pipeline...............................................................................4 The Problems with Oil.........................................................................................................5 Figure 3: Percent of Population living in Poverty 1998......................................................8 Figure 4: Foreign Direct Investment in Ecuador.................................................................9 Figure 5: Evolution of Oil and Non-Oil Exports...............................................................12 Figure 6: Oil Production, Refinery Capacity and Net Exports in Ecuador.......................13 Figure 7: Trends in Oil Price.............................................................................................15 Figure 8: Trends in Price of Oil, Ecuador Specific............................................................15 Figure 9: Economic Breakdown by Industry - Ecuador....................................................18 Conclusion.........................................................................................................................20 References..........................................................................................................................21

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Introduction Oil is one of the modern world’s most prized resources. It has the potential to give its governing body great wealth and power if handled correctly. This paper addresses the question of whether or not the discovery of oil in Ecuador was beneficial for the people of the nation. Unfortunately the discovery and exploitation of oil in Ecuador has fueled corrupt governance, environmental and cultural degradation as well as climbing debt. Oil money enabled the government to take out loans which contributed to a culture of debt and poverty.

Indigenous people lost large areas of land which contributed to a

cultural decline. Unhappy citizens protested in the streets. Attempts at improving infrastructure and reshaping the economy failed and brought forth insurmountable levels of foreign debt. The oil industry has not been beneficial to Ecuador because poor governance has caused any benefits to be overshadowed by the negative social, environmental and financial consequences. The value in this investigation will come from research in three main areas. The first is a look into issues surrounding globalization and the effect of a global economy on a developing nation. Then this study will act to dispel common notions that oil is the solution to all economic problems and those issues in developing nations can be solved solely by an increase in capital. Finally the feasibility of an economy that relies solely on the production of raw materials specific to a single product will be discussed.

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Background The Oriente region of Ecuador is the easternmost area of land which is the nation’s main oil extraction land. The Oriente is part of the Amazon Rainforest and contains part of the Amazon River basin. This area is considered to be one of the world’s ten major biodiversity hot spots (Wood & Porro, 2002). Before oil extraction began, the area was mostly inhabited by indigenous people who lived untouched by modern society (Amazon Watch, 2006). The search for oil in the Amazon began in 1921. In 1967 the first oil field opened near Lago Agrio (Roos & Van Renterghem, 1997). In current times, oil is piped from the Oriente across the Andes to the Esmeraldas where it is exported or refined. There are two major pipelines to do this job, the trans-Ecuadorian (SOTE) and the Oleoducto de Crudos Pesados (OCP). The trans-Ecuadorian pipeline began shipping oil in 1971, and the OCP followed in 2003. Initially the majority of oil extraction was controlled by Texaco, Standard Oil Company, Shell and a few other foreign enterprises (Roos & Van Renterghem, 1997, p. 49). By law in Ecuador people own the land that they live on, but the government has control over the resources underneath the ground and are able to manipulate them however they see fit. It was not long before the entire Amazon region was deemed an “oil extraction area.” (Roos & Van Renterghem, 1997) In 1971 Ecuador came under military rule (Gerlach, 2003). The government created a state-run petroleum company: Corporación Estatal Petrolera Ecuatoriana (CEPE) also known as the Ecuadorian State Oil Corporation (Roos, 1997). Democracy was restored when Borja became president in 1989 and the CEPE was restructured and given a new name: Petroecuador (Roos & Van Renterghem, 1997).

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Figure 1. Location of Ecuador

Colombia Ecuador Peru

Note. From Sheppard Software. Blank map of South America. Retrieved January 11, 2009 from

Figure 2. Location of the OCP pipeline

Note. From Goodland, Robert. Ecuador: Oleoducto de Crudos Pesados (OCP) (heavy crude oil pipeline) Independent compliance assessment of OCP with the World Bank’s environmental and social policies. (2002) Retrieved on January 11, 2009 from

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The Problems with Oil During the 1960s and 1970s Texaco developed the Lago Agrio and Shushufindi oil fields while also helping to build the trans-Ecuadorian pipeline (Whitten, 2003). As oil was a newly discovered resource in Ecuador, oil extraction and processing had begun before the necessary regulations surrounding its exploitation had been created. Lack of environmental law for oil extraction allowed oil companies, primarily Chevron Texaco and CEPE to exploit oil with few laws to protect surrounding areas and people. Water contamination became a large problem. Numerous heavy metals and other harmful substances are brought to the surface during exploratory drilling (Whitten, 2003). Waste pits were used in an attempt to dispose of the dangerous materials. Unfortunately, the waste pits in Ecuador were often unlined so any substances could easily seep out of the pits and contaminate the surrounding area (Brooke, 1994). Waste pits were legal in most countries at the time (Chevron U.S.A. 2008) but pits in Ecuador were not well maintained, leading one to believe that this practice would not have been legal elsewhere. Furthermore, even if waste pits were kept to legal standards, oil extraction has still caused environmental damage that had never before been encountered in Ecuador. At present, most international regulations state that drillers must re-inject these waste products deep into the earth (Brooke, 1994). Without a doubt, the introduction of new industrial materials that contaminated the natural state of the Ecuadorian landscape is a negative effect of oil production in the nation. The degradation of natural habitat will cause negative effects for all who need the natural resources for survival. Industrialization of the Amazon has caused numerous animal species to die out. River dwellers, crocodiles, water birds, and fish populations

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have all been greatly reduced (Amazon Watch, 2006). In the forest areas rodents, turkeys, boar and monkeys have fled due to the increase in noise, light, and loss of habitat from the construction of processing plants (Amazon Watch, 2006). This can only foretell the negative effects on the people who use these same rivers for drinking and bathing. Some of the affected indigenous groups are the Cayapa, Secoya, Huaorani, Oriente Quichua, Cofàn and Shuar (Gerlach, 2003). The Cofàn, Kichwa and Shuar Indians argue that their populations have decreased, although this fact is a largely debated topic. Speculation about the reliability of sources and methods used to measure indigenous populations bring conflict to this issue. However, there have been studies that link cancer rates with people living in areas of oil extraction. Skin diseases, abortions and respiratory problems were also found to be prevalent in people living in these areas (Goodland, 2002). The loss of culture, if not population, can be measured qualitatively and is evident in the Amazon region of Ecuador. The lack of evidence supporting the decreasing Cofàn population does not disguise the fact that the people noticed rashes from bathing in the contaminated water near their residence. They had to avoid drinking the water and could no longer bathe in their traditional fashion (Tayler, 2005). As Gerlach describes in Indians, Oil and Politics (2003) the Cofànes found that vast tracts of their land were turned into roads and extraction sites. The government, fearing conflict between natives and the oil company, placed the indigenous people into villages. Village life did not follow native traditions and at school Christianity was taught instead of indigenous values and culture. Modern farming replaced traditional methods as there was no longer enough land to continue old

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practices. The loss of native culture is a definite negative effect of the oil industry in Ecuador. The Cofanes are the most notable case of indigenous rebellions against large oil companies. They filed a law suit against Chevron Texaco, an oil company that began oil production in Ecuador. In the Chevron Texaco and Cofàn court case, Texaco argues that they can not be at fault because regulations surrounding the dumping of waste did not exist at the time of the alleged infraction (Chevron U.S.A. Inc. 2008). This court case was very controversial as both sides accused the other of skewing results of tests and the case was tried in both Ecuador and the Untied States after allegations of unfair trials (Chevron U.S.A. 2008). Since indigenous people did not traditionally have the resources available to them to make statements against the government, there is reason to believe that the Cofànes’ situation was dire. The fact that an indigenous group asserted their rights in this specific situation can be considered a positive effect of the oil industry. It is, however, overshadowed by the reason behind the act of protest: that indigenous culture was destroyed. Indigenous people have not seen any improvement in their lives within the last thirty years (BBC News, 2002). This is unnerving especially because it is these people specifically who suffered the most from the expansion of oil and who face the most severe forms of poverty, as can be seen in Figure 3. In 1988 the wealthiest 10 percent of the population held 47 percent of the income while the poorest 20 percent held only 2.55 percent of the nation’s income. This trend became more severe in 1993 when the wealthiest 10 percent held 54.7 percent of the income and the poorest 20 percent held only 1.68 percent (Gerlach, 2003). Yet again, indigenous people protested against the

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government on the topic of oil. Protesters blocked almost sixty oil wells and five refineries on one occasion. Their aim was to have more oil revenues spent on investments in their communities rather than to pay off external debt. (BBC News, 2002). It is clear that in many cases oil has not brought improved the quality of life for citizens, only civil unrest. Figure 3. Percent of Population living in Poverty 1998 % of population living in % of population living in extreme poverty poverty National 62.5 26.9 Indigenous 86.9 55.6 Non61.1 25.2 Indigenous Note. From Georgetown University (2006). Indigenous peoples, democracy and political participation / pueblos indígenas, democracia y participación política. Retrieved January 11, 2009 from

As can be seen in Figure 4, foreign investment in Ecuador has drastically increased since the discovery of oil. Kunkel reported in 2003 that ninety percent of foreign investment goes to the oil industry. However the foreign companies that are invested in Ecuador are doing little to benefit the people of the nation. Money gained by multinational corporations (MNC) does not help the growing poverty in the nation. The bulk of the profits go overseas to the already wealthy people. This phenomenon only contributes to a larger worldwide gap between the rich and the poor.

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Figure 4. Foreign Direct Investment in Ecuador ECUADOR: Inversión Extranjera Directa

1400 1200

millones de USD dólares

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Note. From World Trade Organization (2005). Trade policy review report by Ecuador. Retrieved January 12, 2009 from <www.sice.oas.org/ctyindex/ECU/WTO/ENGLISH/WTTPRG148_e.doc>

By 2003 the trans-Ecuadorian pipeline had broken more than thirty times spilling more than 16.8 million gallons of crude oil into the Amazon basin. (Roos & Van Renterghem, 1997) This oil was never cleaned up. The most serious of all spills occurred in March 1987 when an earthquake left the trans-Ecuadorian line out of commission for over five months (Gerlach, 2003). This oil spill destroyed nearby lakes and rivers and delayed export of oil. One can assume that an oil spill of this magnitude will have a lasting effect on living creatures in the area. People who rely on nearby streams for water will no longer have that essential resource. This event also points out the fragility of Ecuador’s economy. Since the nation’s financial well being essentially relies on the export of oil, any pipeline leaks have dramatic impacts on the economy. Construction of the OCP pipeline has been controversial since its very conception. Frequent oil spills from the preexisting Trans-Ecuadorian pipeline made citizens hesitant to allow the pipeline to cross their land. On a worldwide scale, this pipeline follows a path through seven national parks and protected areas, splitting the Mido Nambillo Cloud

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Forest in half (Foley & Jermyn, 2006). Environmental destruction was inevitable as the forest must be cleared to construct the pipelines, but almost no attempt to assess the environmental impact of the new pipeline has been made by the government (Amazon Watch, 2006). The addition of a new pipeline causes imbalance to the fragile ecosystems in areas with high biodiversity. Moreover, any environmental degradation resulting from the pipeline reduces the amount of natural landscape which harms any tourism in the area. Not only does the OCP pipeline allow the government to rely on greater income from oil, it destroys some aspects of the tourism industry, which could have provided a much needed facet of a diverse economy. Yet another problem was revealed after construction of the line had begun. Construction was suspended because of environmental management plan violations, proof that the construction of this line had serious negative effects on its surroundings. (Amazon Watch, 2006) The pipeline did not meet the minimal World Bank environmental standards. This is an extremely serious problem if one considers the number of national parks the pipeline runs through and the level of biodiversity of the area. The cost was almost $200 million over budget and the government was forced to take out a loan. (Amazon Watch, 2006) This decision could have major consequences especially considering that in 2001 Ecuador had the highest per capita debt in South America (Amazon Watch, 2001). On May 17, 2001 two indigenous coalitions, the Confederation of Indigenous Nationalities of Ecuador (CONAIE) and the National Federation of Indigenous Afro-Ecuatorianos and Peasants, Ecuador (FENOCIN) worked together to oppose the construction of the OCP. (Goodland, 2002) Upon completion the pipeline had a capacity of 450,000 bpd, however only 180,000 bpd is currently being shipped.

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(Kunkel, 2003) Bill Kunkel, a reporter on the status of the OCP in Ecuador has said “[the OCP] may face serious difficulty unless ways are found to diffuse the sore spots: restore damaged countryside and heal the rift with indigenous peoples and environmentalists.” (2003, ¶ 22) Traditionally Ecuador has been a producer of a single export which accounted for the majority of the nation’s Gross Domestic Product (GDP). The discovery of oil has only enabled this type of economy to remain prevalent. Two major export changes within the twentieth century alone are one indicator of the unstable nature of this type of economy. The main export changed from cocoa to bananas and finally to oil. This type of economy continues to go through cycles of boom and bust. Ecuador experienced an oil “boom” in the mid 1960s and somewhat of a “bust” beginning in the 1980s (Handelsman, 2000). When oil has finally run dry in Ecuador the government will be forced to restructure the economy for a third time since the early 1900s. Hopefully this time the economy will be structured for long term stability, something that has escaped the nation in recent years. Figure 6 shows that the amount of oil extracted is far more than is refined in Ecuador. Figure 5 shows that when oil is not exported, the economy has the ability to gain income from other sources. Perhaps an increase in the refinery capacities would be a step towards economic independence through diversification in future years.

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Figure 5. Evolution of Oil and Non-Oil Exports Exportaciones Petroleras y No Petroleras

Oil and non-oil exports

4,050.00

Millions of dollars f.o.b.FOB Millones de dólares

3,550.00 3,050.00 2,550.00 2,050.00 1,550.00 1,050.00 550.00 1993

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Oil exports

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Note. From World Trade Organization (2005). Trade policy review report by Ecuador. Retrieved January 12, 2009 from <www.sice.oas.org/ctyindex/ECU/WTO/ENGLISH/WTTPRG148_e.doc>

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Figure 6. Oil Production, Refinery Capacity and Net Exports in Ecuador 1980

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Total Oil Production (thousand barrels per day Rounded to nearest thousand)

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GDP)

Notes for Figure 6. Dashes indicate that data was not available. Adapted from: EconStats (2008). Ecuador. Retrieved January 11, 2009 from and Energy Information Administration (2008). Ecuador energy profile energy data series. Retrieved January 12, 2009 from

When an economy relies so heavily on the international price of a good, their government and people lose some level of control over their economic success. Volatile world market prices dictate the economic success of the Ecuadorian nation. Figures 7 and 8 show the dramatic changes in oil price starting in the early 1990’s. One can see the obvious fluctuations in these years that were not as noticeably detrimental to the economy of Ecuador. The Ecuadorian government can not dictate any changes that may occur. (Gerlach, 2008) Fluctuations in price can not be controlled in any real way by the government. It would be far more beneficial to support a variety of income sources in order to achieve economic stability. A successful long term goal was not necessary when oil was discovered as the cash flow was sufficient to support the extravagant spending needs of the politicians and keep unhappy protesters at bay. The success of oil acted as a cover for inefficiencies in the overall economic plan for the nation. Unfortunately for the people of Ecuador the government during the oil boom was not one that consistently kept the best interests of the citizens in mind.

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Figure 7. Trends in Oil Price

Note. From Energy Information Administration (2008). Annual oil market chronology. Retrieved January 11, 2009 from

Figure 8. Trends in Price of Oil, Ecuador Specific

Note. From Energy Information Administration (2009). Petroleum navigator. Retrieved January 11, 2009 from

Petroecuador, the state run oil enterprise, has few regulations. The government allows for environmental regulations to be broken in order to hold revenue (Gerlach, 2003). Furthermore, all of the Amazon area including Indian Territory and national parks

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has been designated oil extraction region (Roos & Van Renterghem, 1999). The amount of oil extracted exemplifies the current economic ideologies in Ecuador. Between 1980 and 1985 the price of crude oil fell (Gerlach, 2003). To combat falling prices, the Ecuadorian government increased production of oil by almost 1/3. This act was in direct conflict with the Organization of the Petroleum Exporting Countries (OPEC), and Ecuador was forced to leave the organization (Roos & Van Renterghem, 1997). The drastic measures taken to protect the oil industry clearly demonstrate Ecuador’s reliance on this single product. By 1990 1.5 billion barrels of oil had been extracted, this was believed to be about half of the nation’s oil reserves (Roos & Van Renterghem, 1997). The speed at which the oil was extracted shows little planning by the government. If the economy relied so heavily on the export of this single product, and it was believed that half of the reserves were extracted, it would not be in the best interests of the nation to increase the rate of extraction. Data from Figure 6 shows that there was a definite increase in the oil extraction rate at this time. In the early 1970s, when oil was first exported, Ecuador’s political situation was not ideal for correctly handling the excess money that was available. In 1972 Guillermo Rodriguez Lara led a coup d’état which overthrew the previous dictator. The army decided that politicians were unable to spend Ecuadorian money with the best interests of the people in mind, so the nation was ruled by the military. Lara was overthrown in 1979 when he lost public support due to lack of public spending of oil revenue (Gerlach, 2003). During military rule the state’s share of oil profits increased and this money financed military operations. From 1972 to 2000 45% of Ecuador’s oil revenue went to the armed forces (Gerlach, 2003). This outrageous spending was not legislatively

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approved; however poor government structure and corruption allowed this to go unnoticed (Gerlach, 2003). The corrupt political situation in Ecuador caused the increase in capital made through the oil industry to be spent on resources that did not affect the quality of life of the citizens. As previously seen in Figure 3 the poverty rate in Ecuador was extremely high, the money made from the oil industry should have helped those living in poverty, rather than to fund an industry that inflicts pain and suffering. The less than stable government seemed to have too much control over the economic outlook of the nation. Prospective oil income allowed leaders to take large loans to finance import substitution. Between 1972 and 1982 public expenditures increased 12 percent annually (Gerlach, 2003). Public service jobs were created and the government provided subsidies for a variety of goods. State owned industrial companies were established in hopes of building a strong industrial sector (Roos & Van Renterghem, 1997). High tariffs contributed to the import substitution philosophy, providing less competition so that local businesses could flourish. Tax collection dwindled, and citizens became accustomed to living tax free (The World Bank, 1991). Even the oil industry could not obtain the capital necessary to run this type of economy. Large loans needed to be taken out in order to cover the costs of financing modernization and import substitution (Gerlach, 2003). With oil reserves backing the loans, Ecuador had no problem receiving large sums of money. Unfortunately the industrial sector Ecuador was hoping to build never materialized (Roos & Van Renterghem, 1997). Figure 9 shows that in fact, the industrial sector of the economy in Ecuador has shown little improvement over the past twenty years.

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Figure 9. Economic Breakdown by Industry - Ecuador

Note. From The World Bank Group (2008). Ecuador at a glance. Retrieved January 12, 2009 from

The government relied on loans to continue growth until the 1980s when the price of oil began to fall. The levels of corrupt government were known internationally and high levels of state involvement in the economy paired with the high tariffs made Ecuador undesirable among foreign investors (Gerlach, 2003). At the same time, modernization and globalization made the international market much more competitive. Ecuador went into recession, interest rates rose as did inflation and foreign debt continued to grow. Between 1982 and 1988 per capita GDP decreased 17 percent (The World Bank, 1991). There were numerous nationwide strikes as the government could no longer satisfy the conflicting needs of the citizens with their excesses. The falling price of oil had made loan repayment almost impossible. The lack of capital made it impossible to keep up with the quickly industrializing world. Ecuador could not be competitive on the world market, nor could they improve the quality of their goods. Poverty became more common. Agencies such as the International Monetary Fund, World Bank, InterAmerican Development Bank, Andean Development Corporation, and the Paris Club all pressured Ecuador to reduce its spending (Gerlach, 2003). The International Monetary Fund (IMF) supports the exploitation of oil in Ecuador. This type of income creates revenue in the short term, the type necessary for the

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repayment of loans that Ecuador had taken out to finance previous economic problems and corrupt rulers (Roos & Van Renterghem, 1997). Up to eighty percent of the earnings form the oil in the newly developed OCP pipeline will be used to pay back loans to the IMF (Amazon Watch, 2006). Ecuador was forced to ask for balance-of-payments support from the IMF on multiple occasions. The IMF has built a repayment plan that supports oil exploitation and cutting government spending on social services (Roos & Van Renterghem, 2003). Other reductions in spending include selling off of costly or inefficient state enterprises and reducing subsidies on gas, transportation, electricity and food. Education and health care subsidies will also be reduced as the IMF does not see these practices as being sustainable for the Ecuadorian government. Thousands of state sector jobs were lost and twenty thousand government employees were fired (Roos & Van Renterghem, 2003). The government had to begin collecting taxes again. Opposition has been met from unions, indigenous groups and nationalists (Kunkel, 2003). The loss of subsidies on consumer goods such as food and gasoline would have had a dramatic impact on the lives of poverty stricken citizens of the nation, especially with the influx of state sector workers who had been recently laid off. Numerous people protested the increase in domestic fuel prices. The protesters were such a strong force that the government called a state of emergency in January of 2001 (BBC News, 2001). In their 1975 report (p.1, ¶ 1), the General Secretariat of the Organization of American States had stated “The long run benefit to Ecuador from the oil industry will depend in large measure upon how the profits from the oil production are used.” Today it is clear that the government did not make wise choices with the use of their oil money and as a result the Ecuadorian nation has suffered.

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Conclusion This study has concluded that the discovery of oil in the Oriente region of Ecuador enabled inefficient government and economic systems to exist. The government was unprepared to handle the new level of wealth that oil brought to the nation. While Ecuador was lacking environmental regulations, foreign businesses took advantage of the indigenous people and the landscape causing damage to the biodiversity of the area. The government increased spending and incurred huge debts, but was unable to control the falling price of oil on the world market. Significant aspects of Ecuadorian culture were lost due the industrialization of the Amazon region and a subsequent decline in indigenous populations. Citizens lost their jobs and fell into poverty; protests broke out in the streets. The overall effect of oil on Ecuador was not positive during the time frame studied. Since oil has only become a major industry in Ecuador within the last forty years, one would expect that the next twenty years will be a decisive time for the future of the nation. If attempts to stabilize the declining economy are effective and the demand for oil increases, the results of a similar study made in the near future could yield dramatically different results. Moreover, as more studies surrounding the effects of living in an oil extraction region are undertaken, the largely debated topics in this study such as the effects of oil on drinking water and the decline of indigenous populations will have conclusive evidence to support or contradict the arguments made in this paper.

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General Secretariat of the Organization of American States. (1975). The impact of trade policy on exports in oil rich countries the cases of Ecuador and Trinidad & Tobago. Washington, DC: International Trade Unit Department of External Cooperation.

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