SIGNIFICANCE: Bolivian President Evo Morales acknowledged that his country would be unable to deliver on its natural gas supply commitments to Brazil and Argentina. Current shortages are already affecting Argentina. However, the situation is expected to become much worse starting in June, the Southern Cone's winter season, when gas demand tends to increase.

ANALYSIS: The February 23 summit of the presidents of Argentina, Bolivia and Brazil represented an unsuccessful bid to ameliorate likely natural gas shortages. It was premised on the hope that Brazil might allow 1 million cubic metres per day (mcm/d) of the 30 mcm/d it imports from Bolivia to be diverted to Argentina. However, Brazil refused to relinquish any of its contracted gas, promising only to study the possibility of exporting 200 megawatts (MW)/hour of electricity to Argentina. The three countries agreed to form an energy study group and to convene a meeting -- this time between energy ministers -- in La Paz in ten days.

The current crisis started on February 14, when Brazilian state hydrocarbons company Petrobras issued a short press release stating that it had informed Bolivian Vice-President Alvaro Garcia Linera that it was impossible to cut its current natural gas demand below the full contracted volume of 30 mcm/d. The communique was issued after a meeting between Petrobras President Jose Sergio Gabrielli, the company's gas and energy director, Maria das Gracas Foster, Linera, and the Bolivian hydrocarbons minister, Carlos Villegas. The meeting, which followed another held in Brasilia with President Luiz Inacio Lula da Silva, had been convened by Bolivia to announce that the country would not be able to honour its contracts this winter season. At issue was President Evo Morales's desire to balance supply provisions between Argentina and Brazil.

Bolivia's predicament. According to estimates from the Brazilian consulting group Gas Energy (based on official statistics for the period of January to August 2007) in 2007, Bolivia's production is estimated to have reached 39.8 mcm/d. Of that amount:

¨ 1.5 mcm/d were lost or consumed in the system;

¨ 6.4 mcm/d were consumed in the domestic market;

¨ 26.4 mcm/d were exported to Brazil (on average); and

¨ 5.5 mcm/d were exported to Argentina (on average).

These amounts fell short of Bolivia's international commitments of 40.7 mcm/d, which involve:

¨ 30.0 mcm/d on a Guaranteed Sales Agreement with Brazil;

¨ 2.3 mcm/d contracted with a thermal generating plant in Cuiaba, Brazil;

¨ 0.7 mcm/d contracted with BG for distribution by Comgas in Brazil; and

¨ 7.7 mcm/d contracted with Argentina.

This total does not take into account the domestic market, which is expected to demand 7 mcm/d in 2008. To date, Bolivia had managed this situation by shorting the Cuiaba contract, and by not delivering in full to either Brazil or Argentina. However, with the impending winter season ahead, and low reservoir levels in Brazil -- translating into increased demand for natural gas to power electricity generation -- Bolivia finds itself in a difficult situation. It would prefer to sell as much as possible to Argentina, which pays 7.00 dollars per million BTU, in contrast to the 5.60 dollars paid by Petrobras. Nonetheless, Petrobras is an important producer of natural gas in Bolivia. Consequently, maintaining a balanced business relationship with Brazil -- including ensuring investments to maintain current and future production -- is paramount for Bolivia's ability to fulfill these and other contracts in the future.

The situation is even more tenuous as Bolivia has clearly overreached its ability to deliver. Morales has agreed to increase exports to Argentina to 27.7 mcm/d by 2010, as well as committing 8.0 mcm/d to India's Jindal Steel and Power Limited for exploitation of Mutun's iron ore deposit for the same time period. Unfortunately, following the renationalisation of the hydrocarbons sector in 2006, investments in exploration and production have fallen sharply.

Nationalisation fallout. In the last few years, many changes have been introduced to the fiscal and contractual hydrocarbons regime in Bolivia:

¨ State company YPFB has been reinstated as the sole controller of all hydrocarbons produced in the country -- including the responsibility for all exports, allocation of volumes, and contract negotiations.

¨ The reaction from the business sector has been to withdraw funds and adopt a "wait and see" posture. According to a report by the Bolivian organisation Fundacion Milenio, investments of 198.0 million dollars in 2006 and 49.8 million to April 2007 (the last official figures available) are a fraction of the 600 million dollars averaged yearly in 1998 and 1999.

¨ The statistics for drilled wells are also dismal -- approximately ten per year for 2006 and 2007, in comparison with 64 per year between 1998 and 2000.

These figures suggest that if there is an increase in investment now, Bolivia will at best be able to replace declines in production. Securing the increase in production necessary to meet all contracted amounts will be extremely challenging given the current relations between the Morales government and the private sector and other international investors.

Regional impact. The consequences of Bolivia's faltering will be felt across the Southern Cone:

¨ Brazil. The impact on Brazil is likely to be the least severe. The country does have the ability to use natural gas for electricity generation before the winter sets in, saving its reservoirs for a possible dry winter season when gas will be at a premium. Moreover, advances in technology have allowed electricity production from sugar cane bagasse. Currently 2,000 MW are delivered from this source (and it is expected that production may rise to 10,000 MW by 2015.) Yet, if reservoirs do dry up Brazil will need all of its contracted amount to ensure that lack of energy is not a constraint on economic growth.

¨ Argentina. With natural gas tariffs frozen since 2002, and gas accounting for around half of the energy matrix, domestic output has failed to keep pace with demand in recent years, leading to the decision to import gas from Bolivia, albeit at a higher cost. Gas shortages have already led to restrictions on supply to industrial and commercial users, as well as residential supply shortages. The situation is expected to become more critical this year given that, with reservoir levels critically low, thermal generators may prove unable to make up the shortfall, potentially forcing rationing of both gas and electricity.

¨ Chile. Chile has no domestic natural gas supplies and relies on exports from Argentina, which have periodically been reduced or halted altogether in recent years, forcing Chile to resort to costly and polluting liquid fuels to power its electricity generation. This will be the case at least until next year when a liquefied natural gas regasification terminal will come onstream. In the meantime, electricity rationing is expected.

CONCLUSION: Although Argentina, Bolivia and Brazil all have the capacity to increase gas production in the longer term, in the short term there is little prospect of averting shortages in the Southern Cone. A cold winter and continued dry weather would exacerbate the situation, and Argentina and Chile in particular may both face politically controversial gas and electricity rationing.