Petroleum Development in the Ecuadorian Amazon: Setting the Record Straight (Part I: Was Ecuador ever subservient to foreign oil firms?)

By Douglas Southgate -- February 15, 2012

[Ed. Note: In this three-part series, Douglas Southgate, an economist and professor at Ohio State University, addresses key issues at the heart of Ecuador’s claims of “reckless environmental damage” against Chevron, and, through them, international oil companies (IOCs). Part II and Part III will address two other charges: that the small, South American nation has benefited little from energy-resource development, and that environmental damage is the responsibility of foreign firms alone.  These postings are timely in light of a recent article in The New Yorker,[2] a new book about the construction of a trans-Andean pipeline,[3] and other literature in which IOCs’ actions in Ecuador are criticized.]

Part I in this series challenges the charge from the Ecuadorian régime’s (and its U.S. backers) that:

(1) Ecuador was an innocent seduced by the siren song of Big Oil, and became a vassal to their interests;

(2) Ecuador’s relationship to its oil potential was merely passive; and

(3) Oil development monies did not benefit Ecuador.

In fact, the country moved aggressively to capture the lion’s share of the benefits created by private investment. Nationalization and taxation left the government with 97.3 percent, or $22.7 billion, of the monetary returns created by the concession originally developed by Texaco and Gulf between 1972 (when production and exports began) and 1992 (when the state oil company gained complete ownership of the concession).[1]

The Legal Setting

Continuing appeals of a February 2011 ruling by a district court in the Amazonian lowlands of eastern Ecuador and charges of fraud leveled against plaintiffs’ counsel [4] are recent and noteworthy developments in a legal campaign launched nearly two decades ago against Texaco, which along with Gulf Corporation began drilling for petroleum in the region during the 1960s and which has been affiliated since 2001 with Chevron.

More broadly, the court’s ruling and fraud allegations mark the latest turn in a long-running movement involving Ecuadorian environmentalists and their international confederates to block fossil fuel extraction in the Oriente (as the area is known locally).

Underlying both the legal campaign and the movement against petroleum development is a narrative about IOCs’ involvement in places like Ecuador. A key element of this narrative is that host governments are ever-accommodating in their dealings with firms like Texaco. The Ecuadorian government, for example, allegedly has been “too weak to control powerful industries.”[5] Specifically with respect to the early years of Ecuador’s petroleum industry, “the leadership of the state oil company or energy ministry was taken over by people who were openly at the service of multinational corporations or by people who knew nothing about the industry.”[6]

Never a Banana Republic

This portrayal of incompetence and accommodation cannot be squared with Ecuador’s consistently stiff defense of its own sovereignty. Devastated by the Great Depression, the country nevertheless adopted limitations on foreign land-holdings and other measures in the late 1930s to prevent companies like United Fruit from dominating banana production and exports.[7] And in 1952, Ecuador joined Chile and Peru in declaring that territorial waters extend 200 miles out from the coast. This precipitated a “Tuna War” with the United States, which objected to any extension of territorial waters beyond the traditional 12-mile limit. As measured by the scores of U.S. fishing vessels seized by the Ecuadorian navy, this conflict was especially acute during the late 1960s and early 1970s[8]—exactly when Texaco and Gulf were discovering and developing petroleum deposits in the Oriente.

Never submissive to foreign interests, the Ecuadorian government moved first to safeguard national borders, so that the Oriente and its subsoil resources would not be lost to neighboring nations. Once this was accomplished, a process leading to nationalization of the oil industry was set in motion. Thanks to the dividends created by nationalization as well as the ratcheting up of production royalties and income taxes, the government ensured it would be the main beneficiary of petroleum development.

Colonizing the Amazon to Protect Borders

So that no foreign power would be tempted to encroach on Ecuadorian territory, the country’s eastern and northeastern boundaries were fortified. Additionally, “living borders” were created, similar to what other South American states were doing at the time. Attorney Judith Kimerling, a long-time critic of petroleum development in the Oriente, observes that national authorities treated the region as a “frontier to be conquered” and pursued “aggressive policies” to promote colonization by outsiders. As she also points out, the central government had another reason to encourage the settlement of Amazonian rainforests, which was to reduce human numbers and ease political pressure for land redistribution in the migrants’ places of origin.[9]

The discovery of oil provided Ecuador’s government with a golden opportunity to promote colonization. Texaco and Gulf were ordered to spend $55.5 million on roads and other public works.[10] The farmers using this infrastructure to migrate east of the Andes were informed that property rights would be awarded only if they cleared forests to make way for new cropland and pasture. This same arrangement applied to the Oriente’s indigenous inhabitants.[11] As economist Sven Wunder points out, agriculture’s geographic expansion at the expense of tropical forests also resulted from governmental restrictions on imports of livestock products. Due to these restrictions, Ecuadorians’ demand for livestock products, which rose quickly along with earnings as energy resources were developed, was satisfied mainly from deforested land within the country’s borders.[12] In addition, fuel was subsidized, which was particularly advantageous for farms in remote locations such as the Oriente. [13]

To summarize, research shows that national leaders pushed for the infrastructure required for agricultural colonization and instituted various policies to encourage farmers to settle in the Oriente, which solidified Ecuador’s hold on the region.

Keeping Foreign Businesses in Check

As it was countering potential threats to territorial integrity, the Ecuadorian government took care to establish its authority over IOCs operating in the Oriente.

New conditions were imposed on petroleum companies within two years of the initial oil strikes by the Texaco-Gulf consortium. In 1969, the consortium was given a schedule for replacing expatriate staff with Ecuadorians and was ordered to return approximately two-thirds of its original concession, which encompassed more than 1,400,000 hectares.[14]

The industry was reorganized in 1973, barely a year after the armed forces took over the government, just as oil production and exports were beginning. Each IOC’s interest in the consortium was reduced to 37.5 percent, to create the 25 percent equity share turned over to the newly created national oil company – now called Petroecuador.

In the wake of this reorganization, Gulf decided that continuing to do business in the Oriente was unrewarding; indeed, Kimerling opines that the Ecuadorian government “forced Gulf to pull out.”[15] In 1976, the company gave its share of the consortium to its state-owned partner. This transaction was completed the following year, so from 1977 to 1992 the state company held a 62.5 percent stake. At the end of this period, Petroecuador acquired Texaco’s interest in the consortium as well.

Seizing the Prize

With governmental control of the Oriente and foreign firms operating there cemented, national authorities concentrated on capturing oil wealth. The first fiscal changes, made in 1969, were modest: a land tax originally set at $0.25/hectare gradually rose to $0.40/hectare and production royalties were adjusted from 6 to 11 percent of export revenues. [16]

As already mentioned, far-reaching changes were made in 1973. Aside from taking the first steps toward nationalization of the industry, officials in the new military government raised the royalty rate, from 11 to 16 percent of export revenues, and introduced an income tax.[17] According to reports submitted to the Ministry of Finance, from 1972 to 1977, the tax rate on the consortium’s earnings rose from 44.4 percent to 87.31 percent.

Milking the Cash Cow

Kimerling estimates that, from 1972 to 1982, the Ecuadorian state received dividends, production royalties, and income taxes totaling $7.4 billion from the concession originally developed by Texaco and Gulf. [18] However, this figure is an underestimate. According to data obtained from Ecuador’s National Hydrocarbons Directorate, company reports, and other sources, benefits accruing to the national government—consisting of (1) accounting profits earned by the state oil company, (2) royalties paid either in cash or in the form of crude petroleum, (3) income taxes paid by Gulf (before 1977) and Texaco, and (4) sales of crude oil at prices below prevailing levels in international markets—amounted to $22.7 billion from 1972 to 1992. These benefits dwarfed the after-tax profits of $480 million that Texaco earned during the same period, not to mention Gulf’s after-tax profits of $149 million before 1977.[19] In other words, the national government captured 97.3 percent of the monetary returns created by Texaco and Gulf’s investment in eastern Ecuador, which left 2.7 percent for the two U.S. firms.