• Cost overruns risk sustainability of several projects
• USD650mn will be invested to improve operations
• Ecuadorean bonds are on a roll

Audits to oil and gas projects undertaken throughout Rafael Correa’s administration was one of current President Lenin Moreno’s foundations on its plan to fight corruption. Today, we get to see a more complete picture of the magnitude and damage caused by official wrongdoing.

Oil Minister Carlos Perez and Petroecuador CEO Pablo Flores presented this week evidence from audits, including the unveiling of USD2.5bn in cost overruns as well as poor construction and quality controls on some of Rafael Correa’s flagship works in O&G industry. After this, President Lenin Moreno called to denounce and prosecute those involved; nonetheless, the damage is done and it remains to be seen how much of this is reversible.

Cost overruns risk sustainability of several projects and Pacific Refinery is one of the best examples.

Viability of the project developed alongside PDVSA is in serious doubts. Leaving aside the dispute PDVSA and Ecuador have regarding liquidation of the JV, assessment to costs found overruns for 23% – total investment was USD1.52bn when less than USD1.24bn was budgeted. One of several doubts presented by possible investors, besides PDVSA’s involvement, relates to how much is really needed to continue with the refinery construction, and past investment may be useless.

Furthermore, audits found it was unwise to start work without securing financing for the entire project. Nonetheless, worst findings were those related to maximum capacity being much less than advertised (barely above 100kbpd and not the announced 300kbpd) and lack of proper economic and operability studies. Convincing new investors in the short term may prove difficult if viability conditions are not clear.

Findings on Pacific Refinery have Ecuadorean officials on a crossroad, asking themselves what to do with the project. There is a possibility of continuing the project as it is; another, moving the refinery to a location closer to sea; but, the most concerning one, there’s an option to transform the project into one of solar power generation or even agriculture.

• Fiscal agenda is the key for 2019
  • Commitment to fiscal austerity withstands
  • Ecuador is in a long but correct path
  • Preemptive measures mitigates lower oil prices
• 2019 is not the year for public debt management
  • Financing needs are still heavy
  • Most of next year’s debt depends of market conditions
  • Multilaterals, except IMF, will play a key role to cover needs
• Economy improves slowly but surelywth
  • Joint efforts by higher oil income and austerity
  • Inflation will mostly depend on oil prices

Ecuador transits a reform path that will face next year its most difficult stage: Obtaining immediate results that further support current and future economic policies. 2018 saw the entering into functions of renewed policymakers that injected more confidence from international markets.

Some results from new economic policies are already evident – we will detail these results throughout this report –, but 1H19 is, in our view, is the key time lapse to assess whether Ecuador accelerates in its reform path or if a change of direction is required. Among all policy targets, fiscal deficit will be king and, as of today, it looks promising.

Fiscal agenda is the key for 2019

2018 was a rollercoaster for Ecuador in fiscal terms: Going from ministers Carlos de la Torre to Maria Elsa Viteri to current Minister Richard Martinez, views on public spending, fiscal deficit and public debt were all over the place. With Martinez’s position reaffirmed on a recent cabinet shuffle, we believe such-needed stability on how to attack recurrent fiscal deficits, has finally been achieved.

In our opinion, 2018’s fiscal deficit goal at 3.9% of GDP is feasible and limits to fiscal spending are to blame. For 2019, we see commitment to fiscal austerity withstands and helps cement the path that will, eventually, lead to balancing of fiscal accounts. Before digging into next year’s outlook, we will take a look at how the picture is currently framed.

• President Lenin Moreno secures Chinese financing
• Fitch keeps Ecuador’s rating but downgrades outlook
• Modified 2019 budget is on track

President Lenin Moreno secures Chinese financing to cover remaining funding gaps for this year. Thus, the announcement confirms what we advanced in previous Weekly Reports regarding Lenin Moreno’s visit to China being key to signing new financing agreements.

According to Moreno, China lends almost USD1bn with most of it (USD900mn) represented in a 6-yr loan (and an additional two year of grace period), with 6.5% interest rate. Finance Minister Richard Martinez celebrates agreed terms are better than those offered by international markets, using ECUA’26’s 10.6% yield as reference.

Complementing USD900mn’s financing, China also granted USD69.3mn and USD30mn; the first, intended as aid in reconstruction works after 2016’s earthquake; the latter, for military security cooperation. Stealing the show, however, was Moreno’s announcement that loans soon could be coming up to USD3.5bn in new credit lines from China Development Bank and China’s Industrial and Commercial Bank.

Ecuadorean bonds reacted positively –as of Thursday, ECUA’28 went up 1.38%, ECUA’27 (8.875%) closed 1.32% higher and ECUA’26 climbed 1.16%, all compared to Wednesday’s opening (before announcements). Nonetheless, we are of the opinion recent performance shows investors’ excessive caution, leaving space room for way more important price increases.

According to our proprietary model, most of Ecuadorean curve remains severely underpriced. In this regard, we consider the three bonds we mentioned before (ECUA’28, ECUA’27 and ECUA’26, in that order), with their mixture of low price and high coupons, represent currently the best risk-reward bets.

In addition to prices and coupons, we at BancTrust believe yields above 10% are too much of a punishment, all the more considering a country like El Salvador (with similar rating but worse cash constraints and fiscal outlooks) exhibits 7% yields for comparable long-term maturities. Therefore, we expect Ecuadorean curve to experience significant rallies in months to come, especially once evidence of fiscal improvements overwhelms investors.

• USD1.2bn secure to close 2018’s financing
• 2019-2020’s financing figures
• Oil output seen peaking in 2020

Just as we expected, Ecuador opts for multilateral and bilateral financing sources and not bond issuances to scare away public funding concerns flying around international markets. On Monday, Congress approved 5 credit operations and now Ecuador got almost USD1.2bn secure to close 2018’s financing.

• GDP grows below-than-expected rates
• Government prepares stimulus package
• Relations with Venezuela in the freezer

The ugly reality (related to tough reform path) has progressively cooled off overly optimistic economic growth forecasts issued last year. GDP grows below-than-expected rates, but we consider this should not discourage policymakers or investors.