Ecuador’s Anti-OPEC Decision Raises Fear of Contagion Amongst Other Members Countries

Ecuador straining relations with the OPEC

Ecuador has publicly stated that it will not adhere to OPEC’s (Organization of the Petroleum Exporting Countries) production curbs. The steep slide in oil (OIL) (USO) prices since mid-2014 led OPEC members, in November 2016, to sign a pact to curb oil production by 1.2 million barrels a day starting January 1, 2017. In December, non-OPEC members such as Saudi Arabia (KSA) and Russia (RSX) had also agreed to reduce output by 558,000 barrels a day to help address price slide triggered by the supply glut. Accordingly, OPEC oil production had dropped by 32.5 million barrels a day from January 1st, lending some respite to the steep fall in oil prices since mid-2014.

The price of crude oil has now recovered nearly 50% since its lowest point seen in January 2016.

Need to plug the economy’s fiscal deficit

Ecuador’s decision is backed by the country’s need to plug its fiscal deficit. According to Ecuador’s oil minister, Carlos Perez, “we are not meeting the quota imposed on us because of the obvious needs the country has……… there’s a need for funds for the fiscal treasury, hence we’ve taken the decision to gradually increase output.” The Latin American (ILF) (GML) economy’s compliance on its agreed quota of 26,000 barrels a day cut in oil production was seen falling to 69% in June. Accordingly, the country has been falling short by about 10,000 barrels a day.

According to Perez, Ecuador remains committed to the pact and its support towards the Organization. However, as per a non-written agreement with OPEC on flexibility in terms of production needs, the economy could now be curbing production by approximately 16,000 barrels of oil per day.

June 2017 has already seen OPEC production up by 1.2% vis-à-vis May. Output for OPEC averaged 32.61 million barrels a day last month, with Ecuador contributing 1.75% of it. Besides, countries such as Libya and Nigeria, which are exempted from the output-cut agreement on account of social instability, have been pumping in more oil.

Ecuador’s decision raises the fear of a contagion

Markets fear the risk of a contagion to other OPEC economies. Ecuador’s move could encourage other OPEC nations such as Algeria, Angola, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Qatar (QAT), UAE (UAE), and Venezuela to rethink their commitment to the production curb. Other OPEC members following suit could impact the recovery in oil prices achieved since last year. Kazakhstan’s intended ‘soft exit’ from the deal be taken as a hint.

No More Border Wall: Ecuador to Mend Relations With Peru

Suspension of the Ecuador-Peru border wall

On July 14th, Ecuador’s Foreign Minister Maria Fernanda Espinosa announced that the country had decided to halt the construction of the border wall with Peru (EPU). The wall was built as a flood precaution by Ecuador. It has been the center of controversy for some time now, straining diplomatic relations between the two countries. The issue had gained prominence following US President Donald Trump’s pledge to build a wall between the US (SPY) (IWM) and Mexico (EEW).

Peru, which believes that the wall infringed on a 1998 deal which prohibits construction within 10 meters of the border, recently recalled its ambassador from the country to express its rage over the decision. Subsequently, the foreign ministry of Ecuador announced the suspension of the construction of the mile-long, 13-foot high wall between the two Latin American (ILF) (GML) countries.

Ecuador mending relations with Peru

The suspension should bode well for Andean (AND) countries. The wall would have led to about 5,000 job losses on each side of the wall, primarily in the local fish trade. Currently, fishermen cart their fresh catches over the canal which outlines the border across bamboo footbridges. With the wall in place, workers would have had to take a lengthy detour to unload their catches in Peru probably putting an end to the trade.

Moreover, Peru counts among the top 3 export destinations of Ecuador. Close to $1 billion worth of goods are exported from Ecuador to Peru, accounting for 5.1% of its exports (see chart above). The wall would have certainly impacted cross-border trade volumes.

Now, while on one hand, Ecuador has taken a step to mend its diplomatic relations with Peru, on the other hand, it stands a chance to strain its relations with the OPEC (Organization of the Petroleum Exporting Countries). The next part of this explains how.

Why Money Managers Are Rejigging Their Latin America Portfolios From Mexico To Brazil

 

Strong inflows into Brazil ETFs; Outflows from Mexico

Brazil’s efforts to revive the recession-stricken economy are closely monitored by fund managers and institutional investors. Meanwhile, Mexico continues to struggle under Trump’s uncertain protectionist policies. Venezuela and Chile are also reeling from political issues. However, Latin American funds have seen strong inflows in 2017 as expectations of structural reforms drive inflows into the region.

Among the funds investing in Latin America, the iShares Latin America 40 ETF(ILF) has seen the highest inflows, amounting to $378 million since 2016. Comparatively, the SPDR S&P Emerging Latin America ETF (GML) has received a mere $1.5 million inflows during the same period. Year to date these funds have received inflows of $133 million and $5.1 million, respectively.

Foreign investors are also betting on individual countries in the Latin American continent even though many are braving poor economic growth and political tensions.

Investor interest in Brazilian equities has been high given lofty inflows over the past one year standing at $1.8 billion. YTD investors have plowed in $795 million in the iShares MSCI Brazil Capped ETF (EWZ).

In contrast, Mexico has seen heavy outflows in 2017 as Trump’s anti-migrant policies have hampered foreign interest in the country. YTD investors have redeemed $813 million from the iShares MSCI Mexico Capped ETF (EWW).

The Best And Worst ETFs For Investing in Latin America

Investing in Latin American equities

Directly investing in Latin American markets can be risky for foreign investors as most of the countries are frontier markets. ETFs investing in Latin America stock markets are largely concentrated in two major markets – Brazil and Mexico. While some countries have opened up their stock markets to foreign investors, these economies remain difficult to access due to illiquidity and poor trading exchanges.

Investors betting on the revival of Latin American economies have two options. They can either consider investing in ETFs providing exposure to the entire Latin American region or place their bets in the continent’s largest markets through country-focused ETFs.

Regional ETFs

The iShares Latin America 40 ETF (ILF) provides exposure to the overall Latin American region but 80% of its holdings are concentrated in Brazil and Mexico, followed by Chile, Peru and Colombia. It invests in a portfolio of the 40 largest companies in the region, which are more than 50% dedicated to the financial and consumer defensive sectors. YTD, this ETF has climbed up 14%.

Another popular Latin American ETF is the SPDR S&P Emerging Latin America ETF (GML). This ETF invests in a basket of 245 stocks, thereby providing larger exposure to various stocks in the region. YTD this ETF has gained 15.1%.

Country ETFs

Investors seeking concentrated exposure in specific countries can consider investing in the following country ETFs:

  • iShares MSCI Brazil Capped ETF (EWZ)
  • iShares MSCI Mexico Capped ETF (EWW)
  • iShares MSCI Chile Capped ETF (ECH)
  • Global X MSCI Argentina ETF (ARGT)
  • iShares MSCI All Peru Capped ETF (EPU)
  • iShares MSCI Colombia Capped ETF (ICOL)

ETFs investing in Brazil have outperformed in the last two years as the country continues to recover from a recession. YTD the iShares MSCI Brazil Capped ETF has gained 13.4% as investors are pinning their hopes on reforms in a recession-struck country.