Ecopetrol: Mixed Results

Colombia's tax reform was one of the key factors that hurt Ecopetrol last year, experts say. (Photo: Colombia's Mining and Energy Ministry)

Production hit a historic record of 788,200 barrels per day last year, but profits fall.

Inter-American Dialogue 

A year ago, Colombia's Ecopetrol overtook Brazil's Petrobras as the largest listed energy company in Latin America by market capitalization, but its market cap has fallen by around 40 percent since then, and last month Ecopetrol reported that net profit in 2013 was down 10.8 percent year-on-year. Despite that, CEO Javier Gutiérrez said 2013 was a good year for the company, noting that it "grew our reserves and production and maintained strong financial results within a challenging environment for our operations." How did Ecopetrol fare in 2013? What is the outlook for the company this year? What are its challenges, and what is going well? 

David Ross, managing director of Chevy Chase Trust Investment Advisors in Bethesda, Md.: Ecopetrol, as demonstrated by its falling market capitalization, has failed over the last 18 months to build on its past success. Production growth, the company's hallmark by growing at a compound annual growth rate of 13.6 percent during 2007-2012, slowed to 4.5 percent in 2013 and even fell in the last quarter from the previous quarter. In addition to slowing production, the company has failed to significantly build reserves. While the company was able to boost reserves at the end of 2013 to maintain a Reserve Life Index of eight years, this was almost entirely (90 percent) due to revisions and extensions, not discoveries. To the outside investor, Ecopetrol, often referred to as a 'law firm with oil rigs,' appears to be more interested in satisfying the agenda of its main shareholder, the Colombian government (88.5 percent) than in maximizing shareholder value. While the government's budget benefits from a high dividend, the company's payout ratio of 80 percent has hampered its ability to adequately fund its capital expenditure budget, to the detriment of exploration success. Not only has the company been stingy in its capital expenditures, but a large amount has been directed toward downstream assets like refining. For Ecopetrol, the downstream division is not profitable and yet they have allocated billions of dollars to upgrading their refineries, even as U.S. refineries, with their cost advantage, are squeezing margins globally. In a world short of heavy oil due to Venezuela's production declines, investors would prefer seeing capex aggressively allocated toward a successful exploration program to ensure the company's future. 

Luis E. Giusti L., member of the Energy Advisor board, senior advisor at the Center for Strategic and International Studies and former chairman and CEO of PDVSA: By just looking at the numbers it becomes clear that Ecopetrol had good results in 2013. Through a total investment of $3.73 billion in exploration and production, the company increased its production to a historic record of 788,200 barrels per day of oil equivalent and increased P1 reserves by 5.1 percent to a new total of 1.972 billion barrels of oil equivalent. This translated into a healthy 139 percent reserves replacement factor. In addition, it invested $350 million in upgrading its Cartagena Refinery, preparing it for an efficient supply of products to the domestic market and leaving capacity for a volume of exports. Add new alliances nationally and internationally, a strong cash position and a reasonable debt-to-equity ratio, and 2013 was indeed a good year. In 2012, Ecopetrol overtook Petrobras in terms of market value, partly because the latter had two years of $50 billion to $60 billion budgets without significant production growth, while the OGX fall from grace was not helping the Brazilian oil investment climate. In the meantime, Colombia was the Latin American vedette, and its national oil company was still enjoying the benefits of growth and recent partial privatization and internationalization. It is widely understood that capital can move fast to find security and good returns. In 2013, the Colombian oil industry was afflicted by delays in approval of environmental licenses for oilfield operations, and although not severe, a resurgence of violence, which have affected in some degree the market cap of almost every oil company operating in Colombia with an equity position in public markets.

Rodrigo Villamizar, former Colombian minister of mines and energy and professor at the Instituto de Estudios Bursátiles at the Universidad Complutense in Madrid and the University of San Diego: Ecopetrol's greatest problem is declining reserves. The official goal of growth in production of 1 million barrels per day by 2015 requires an addition to reserves higher than what the company has achieved so far. Today, Ecopetrol has only 8.1 years worth of reserves. A 40 percent decrease in the stock price in an election year doesn't look like a promising run for Ecopetrol. Perhaps the peso's slump could prove to be a blessing since Ecopetrol generates more than two-thirds of its revenues from oil exports. This, of course, requires that prices don't fall due to pressure from increased production in the United States and the new Iranian oil coming on stream. Colombia's strong resource base and business-friendly policies could offset some of the headwinds against the company but not its fundamentals. And those are more closely related to geology than to geopolitics. Financial metrics like net debt/EBITDA, EBITDA margin and ROA present a bright side of Ecopetrol when compared with some of the majors, such as Petrobras, BP and Exxon. It has increased production consistently (meaning higher efficiency and investment in mid-stream). It's clearly one of the best-performing energy groups until you check its fuel tank. Its market capitalization has risen impressively, even briefly surpassing that of Petrobras, the Brazilian major which produces about three times as much oil. In the oil world nothing scares more than when the variation in output growth is higher than the variation in the addition of reserves. Since 2000, Ecopetrol, with the only exception being 2009, has shown a decline of 5.9 percent in the useful life of its oil reserves. No wonder Ecopetrol's shares have fallen by 42 percent in New York over the past year and have come under renewed pressure. Bancolombia has said that, "Since 2012, the market has begun to question the sustainability of Ecopetrol due to the poor growth in its reserves."

Daniel E. Velandia O., head of research and chief economist  for Colombia at Credicorp Capital: The reduction of Ecopetrol's market capitalization since the first half of last year has been explained by both market factors and company-related issues. In general, Ecopetrol represents 20 percent of the main local stock index, being the natural vehicle for foreign investors to have exposure to the Colombian market. Hence, it is 'normal' to observe outflows from Ecopetrol's stock amid scenarios of higher risk aversion to emerging markets as has been the case since May 2013. On the other hand, financial results came in below expectations as net income fell 11.3 percent in 2013. Throughout last year, the financials were affected mainly by the increase of effective taxes after 2012's tax reform, a pension provision and goodwill impairments in the downstream subsidiaries. We consider these factors to be non-recurring events so that we would expect margins to stabilize in the upcoming quarters. At the same time, reserves addition, which continues to be the main concern for the long term, surprised the market on the positive side as reserves (1P) increased 5.1 percent year-on-year, while the replacement ratio was 139 percent, maintaining the reserves/production ratio unchanged at 8.1 years. Accordingly, we expect 2014 to be a better year for Ecopetrol in terms of both financial and stock performance. In fact, we believe the steep stock price decline over the last 12 months has taken the share to trade at levels more consistent with its fundamentals, and there is room for upside. Going forward, we will be focusing on the company's exploratory success and its ability to reach the ambitious production targets for 2015 (1 million barrels of oil equivalent) and 2020 (1.3 Mboe). The management seems confident the company will meet the 2015 goal from four fields: Castilla, Chichimene, Akacías and Caño Sur.

Enrique Gómez-Pinzón, executive partner at Holland & Knight Colombia: It is certainly true that Ecopetrol's market capitalization fell significantly during calendar year 2013. Petrobras' market capitalization fell significantly during 2013 as well. In both circumstances, the stock value fell at the same time that Brazil's and Colombia's currency lost ground against the U.S. dollar. According to data from Feb. 6, Ecopetrol's market capitalization was $72 billion, while Petrobras' market capitalization was $74 billion. In 2013, three main events took place that strongly hit Ecopetrol's profit-and-loss statement: (i) Colombian tax reform. The new tax (CREE) hit Ecopetrol hard, (ii) the loss in value of Ecopetrol's public securities portfolio (TES), which in turn triggered the need to set up large reserves to fund the pension liabilities, and (iii) the creation of Cenit, a subsidiary owned 100 percent by Ecopetrol, which is paid market rates for crude transportation. In 2013, there was a significant increase in the transport expense line in Ecopetrol's profit-and -loss statement which will be compensated in 2014 by profits from  Cenit. On the positive side, during 2013 Ecopetrol's proven (1P) reserves grew more than 5 percent and the replacement index for reserves grew more than 130 percent. 

Republished with permission from the Inter-American Dialogue's weekly Energy Advisor