Peru: The impact of Ukraine’s invasion on the energy industry

Paul Súmar Gilt

Santivañez Abogados, Lima

paul.sumar@santivanez.com.pe

Roberto Santivanez

Santivañez Abogados, Lima

roberto.santivanez@santivanez.com.pe

World

Covid-19, high levels of debt and increasing interest rates, the invasion of Ukraine and the ghost of a nuclear war: the imminent arrival of El Niño Global. These are some of the reasons that more and more analysts use the word ‘polycrisis’ to refer to the situation in which the effects of several problems of different natures or origins are bundled up and strengthened. Some analysts, though, have started using a far eerier word: ‘permacrisis’.

For the time being, it seems that the most prominent crisis is precisely the one that affects the energy industry as a consequence of the war against Ukraine.

The world is in the midst of its first global energy crisis – a shock of unprecedented breadth and complexity. Pressures in markets predated Russia’s invasion of Ukraine, but Russia’s actions have turned a rapid economic recovery from the pandemic – which strained all manner of global supply chains, including energy – into full-blown energy turmoil. Russia has been by far the world’s largest exporter of fossil fuels, but its curtailments of natural gas supply to Europe and European sanctions on imports of oil and coal from Russia are severing one of the main arteries of global energy trade. All fuels are affected, but gas markets are the epicentre as Russia seeks leverage by exposing consumers to higher energy bills and supply shortages.

International Energy Agency (IEA), World Energy Outlook 2022

Peru within the world

Peru is a country integrated into the world’s economy thanks to several factors: the political Constitution, low or null tariffs for international trade, dozens of valid and enforceable free trade treaties, free foreign currency exchange and many other characteristics reinforce the benign process that began 25 years ago. Of course, integration into the world has brought several benefits to the country, such as economic growth and poverty reduction. Nonetheless, it has also brought a series of risks, such as being exposed to the political and economic crises that affect other countries like the United States, China and European countries, or even organisations like Organization of the Petroleum Exporting Countries (OPEC) and North Atlantic Treaty Organization (NATO), as well as to the decisions taken to solve these crises.

As Peru is a country with a small economy, the effects of foreign crises have amplified internal repercussions. Peru suffers, aside from the aforementioned global issues, from a profound political crisis that’s been ongoing for seven years (it started in 2016). In that period of time, six presidents have taken office: two chosen by elections, two vice presidents who assumed office by succession due to presidential vacancy and two appointed by Congress due to succession vacancies; a world record.

At the beginning, it seemed that the strength that the Peruvian economy had made it immune to the ongoing political crisis; however, in recent years, the situation has changed. It is clear today that the political crisis has impacted private investment perspectives, as well as being the cause of delay and the poor quality of public investment. These are later passed on to the public as growing unemployment, and loss of trust in the system by consumers and lower expectations by producers

As seen everywhere, the high price of petroleum pushes the prices of other goods and services upwards. This situation creates notorious inflationary pressures that cause a fall in real income. Additionally, as a country, Peru is facing a high interest rate (even though it does not have a high indebtedness rate). If we add to this mix the massive national political crisis and the small size of the Peruvian economy within the international context, the result looks like a perfect storm: all the ingredients for a recession are on the table and can be perceived by everyone.

Natural gas

Natural gas production in Peru amounts to 15,923 MMcf/d (2022). This production comes from the Camisea oil fields (so-called lot 88 and lot 56) located in the Amazon river region north of Machu Picchu (Cusco).[1]

From that total, in 2022, 7,073 MMcf/d was consumed in Peru and the rest was exported to different countries as liquefied natural gas (LNG) (produced in the Melchorita liquefaction plant).

Peruvian natural gas consumption was distributed in the following ways: 72 per cent was burned by thermal power stations to produce electricity and 28 per cent was used as fuel for different industries, businesses and residences, mainly in Lima (Peru’s capital) and, to a lesser extent, in other regions.

Pipeline transport and distribution are completely regulated services. Tariffs are set and periodically revised by the regulatory agency Organismo Supervisor de la Inversión en Energía y Minería (‘Osinergmin’). Distribution tariffs are updated every three months considering the prices of polyethylene, steel and the US Producer Price Index (PPI). On the other hand, transportation tariffs are updated twice a year considering the PPI. This makes tariffs directly or indirectly exposed to the international petroleum price and global inflation.

Wellhead gas prices are fully regulated if consumed within Peru (applicable to power generators and industry) according to the license agreement executed by the Camisea Consortium and Peruvian State (2000). Particularly, the gas price is updated annually (every first working day of the year) according to the WPU1191[2] and WPU05[3] factors.

In that sense, it could be said that the variation of natural gas and petroleum prices due to the invasion of Ukraine has an impact on the final price that internal consumers pay for natural gas (be it for power generation or other uses).

Currently, there are no plans to expand the natural gas reserves, nor the transport and/or distribution capacity dedicated to the internal market due to the fact that Peruvian industries are not very intensive in natural gas consumption and because it is assumed that future power generation capacity will be covered by renewable resources (solar and wind).

Power

In 2022, power production came from hydroelectric (41.3 per cent), thermoelectric (53.5 per cent), wind (3.7 per cent) and solar (1.4 per cent). Thermoelectric production uses natural gas almost in its entirety. Its costs have grown along with the wellhead natural gas prices, and transport and distribution tariffs, as global inflation and international petroleum prices affected the costs, but not these prices.

This makes the invasion of Ukraine have a tangible effect on inflation and petroleum prices, not so much on production cost, but in the power prices for final consumers.

In the case of transmission services, the same happened because their tariffs are indexed according to inflation and the devaluation of the Peruvian sol.

Fuel

Local production of crude oil is small. Almost all local production is imported (be it crude or processed). The fuel industry in Peru is completely exposed to the variation of international prices of petroleum due to the fact that the refining capacity installed in Peru is small.

Conclusion

Considering that it is a globalised free market economy, every crisis, including the effects of the Ukraine invasion, are reflected in Peru. Due to its small economic size and the political instability that has characterised the country in the last few years, it can’t be ruled out that the country could go into recession.

The increase of global petroleum and natural gas prices has had an impact directly or indirectly on the local price of natural gas paid by the final consumer, as well as the prices of power that final consumers pay, especially those under regulated price agreements.

Notes