Once again, the strife-torn Latin American nation of Colombia finds itself facing yet another crisis. After decades of civil conflict, a failed peace deal with the largest guerilla group the FARC, rising violence, and the fallout from the COVID-19 pandemic, the Andean nation’s energy self-sufficiency is deteriorating posing a direct threat to economic development. Colombia’s Ministry of Mines and Energy stated in April 2020 that Colombia finished 2019 with proven oil reserves of just over 2 billion barrels giving the country a production life of 6.3 years. These limited reserves, which are less than Argentina’s, roughly a quarter of Guyana and Ecuador’s and less than a sixth of Brazil’s pose a direct threat to Colombia’s development and economic growth.
You see, the extraction of crude oil has become an important driver of economic growth for the Andean country. It was responsible for Colombia experiencing some of the highest rates of GDP growth over the last decade in Latin America. At the height of the last oil boom in 2013, Colombia’s GDP expanded 5.1% year over year which was higher than many other countries in South America including the continent’s largest economy Brazil which only grew by 3%. It was also higher than South America’s 2013 annual average of 3.4%.
Growth has declined significantly as the price of crude oil weakened after the August 2014 oil price crash. By 2017, the Andean country’s GDP only expanded by 1.4%, its lowest level since the 2009 global financial crisis where the economy only grew 1.1%. Since the oil price collapse, which began in August 2014, Colombia’s economic growth has slowed significantly. The sharp decline in oil prices not only weighed on the economy but also caused the Colombian peso to dive and triggered every growing budget deficits. For 2017, Bogota’s budget deficit ballooned out to 2.5% of GDP, although this was lower than the 3.5% of GDP for 2015 when Brent plunged to below $40 per barrel for the first time since 2009. This year, the twin severe impact of sharply weaker oil prices and the COVID-19 pandemic on the economy has seen Bogota abandon the rule limiting fiscal deficits with the government expecting its budget deficit to explode to a worrying 8% of GDP and then be 5.1% for 2021.
The reasons for these growing fiscal pressures are simple, the production of crude oil before the August 2014 price crash was responsible for generating around a fifth of government revenue. Based on data from DANE oil was responsible for generating around 7% of Colombia’s GDP and 60% of the country’s exports by value, explaining why there is a close correlation between GDP growth and the value of the Colombian peso to the price of oil. Sharply weaker oil prices were responsible for falling GDP growth which for 2019 was 3.3% well below what it had been during the peak of the last oil boom.
More worrying is exports continue to decline because of sharply weaker oil prices. For the first nine months of 2020 total exports had fallen by a whopping 24% year over year in value to $22 billion primarily because of significantly weaker oil prices. Exports of crude for that period fell to $12 billion which was almost half of what they were for the period in 2019, and only made up 28% of total exports by value compared to 41% a year earlier. The March 2020 oil price collapse which saw the North American WTI price benchmark fall into negative territory for the first time ever has sharply jolted Colombia’s economy and its oil industry. That has only been magnified by the COVID-19 pandemic and the central government’s hard lockdown which at five months duration was one of the longest in the world. As a result, Colombia’s economy is forecast to contract by a worrying 8.2% for 2020 and there are signs it could shrink even more with the government statistics agency DANE announcing that second quarter GDP shrank by a whopping 15.7%, one of the worst declines in South America. This severe impact this is having on government finances, with Bogota highly dependent on an extremely narrow domestic tax base, is significant.
Colombia’s economically crucial oil industry is struggling to grow urgently needed petroleum production. For August 2020, the Andean country only pumped on average 742,091 barrels of crude daily which while % greater than July was still a worrying 16% lower than for the equivalent period in 2019. Even moves by national oil company Ecopetrol (NYSE:EC) to bolster capital expenditures to $3 to $3.4 billion from a post March 2020 oil price crash $2.5 to $3 billion may not be sufficient to drive the additional activity to substantially boost production. This is evident from Colombia’s rig count, which acts as a good de-facto indicator of economic activity.
According to data from Baker Hughes, there were 12 operational drilling rigs in Colombia at the end of September 2020. This was 17 rigs less than for the same month in 2019 when production reached 879,497 barrels daily. As the chart indicates there is a close correlation between the price of crude oil and activity in Colombia’s oil patch.
The sharp decline in activity can be blamed for the sustained weakness of oil with the international Brent price having hovered at around $40 per barrel. In recent days, Brent has fallen below $40 per barrel indicating that activity could fall further. The latest weakness for oil prices can be blamed on the surge in COVID-19 cases globally and new hard lockdowns being implemented in Western Europe.
If Brent remains at or below $40 per barrel it will have a deleterious impact on Colombia’s oil industry because the average breakeven price is estimated to be around $40 per barrel. That means investment in exploration and development will dry up for as long as Brent remains under the cost of production. This is being further magnified by the deteriorating internal security situation in Colombia. President Duque’s failure to fully implement the 2016 peace accord with the largest guerilla group the FARC has seen a sharp increase in dissident groups with it estimated that 1,500 former fighters have rearmed. The last remaining major guerilla group the ELN is ratcheting up operations as it seeks to seize former FARC territory and valuable coca cropping areas and drug trafficking routes. The largest neo-paramilitary group the Gulf Clan, involved in narco-trafficking, extortion, kidnapping and murder for hire, is also focused on expanding territory and its control of lucrative coca cropping areas and trafficking routes. This has led to clashes between them and the ELN, notably in the impoverished western department of Choco.
There is also considerable unrest in many of Colombia’s major cities with civil dissent rising over the failing of Duque’s administrations, corruption and heavy-handed police tactics. This sparked nationwide protests in November 2019, which organizers have promised to restart this year once the national health emergency winds down. In such an environment attacks on energy infrastructure remain an ever-present problem. Deteriorating security, notably in regional Colombia, will act as a deterrent to investment in the Andean country’s oil industry, leading to lower exploration activity which does not bode well for further major oil discoveries.
A further deterrent to investment by energy majors in Colombia’s oil industry is that the main types of crude oil produced in the country are heavier sour varieties. The two main benchmarks are Vasconia and Castilla which have API gravities of 23 and 17.7 degrees and sulfur content of 1.09% and 1.83% respectively. That makes them more difficult and costly to refine than the lighter sweet crudes produced from Brazil’s offshore pre-salt oil fields and offshore Guyana.
It is the ongoing push globally to significantly reduce the sulfur content of fuels which has triggered a marked increase in demand for light sweet crude oils, notably in Asia. A key driver of this was the introduction of IMO2020 in January of this year which significantly reduces the sulfur content of maritime fuels to less than 0.05% mass per mass. The growing sweet tooth of Asian refiners was responsible for a notable uptick in the volume of crude being exported to the region by the U.S. because the majority of oil produced by the shale industry is light with a low sulfur content. Diminishing U.S. shale oil production means that Asian refiners will look to other sources of supply for light sweet oil, notably Brazil and ultimately Guyana once ExxonMobil expands production.
A lack of petroleum discoveries in Colombia, with no major discoveries since 2009, is another headwind for the oil industry and economy. It is this dearth of oil and natural gas finds which is responsible for the emerging energy crisis faced by the Andean country. According to Colombia’s Ministry of Mines and Energy the country only has proven oil reserves of just over 2 billion barrels with a limited production life of six years, stressing the urgency with which new oil discoveries need to be made. A moratorium imposed by Colombia’s courts on fracking which was upheld by the Council of State, the country’s top administrative court, continues to stymie government plans to boost oil reserves and production through unconventional production. Significant community opposition and ongoing legal battles have created substantial uncertainty as to the future of fracking in Colombia further deterring investment in the Andean country’s oil industry.
The growing severity of that crisis is underscored by Colombia commencing imports of natural gas in 2016, with import volumes expanding significantly, and the ongoing push by the government to start unconventional oil exploration and production, through the use of hydraulic fracturing. The waning appeal of operating in Colombia is highlighted by national oil company Ecopetrol commencing operations outside of the Andean country after establishing an agreement with Occidental Petroleum (OXY). In fact, deeply indebted energy major Occidental recently sold its Colombian onshore oil assets to private equity outfit the Carlyle Group for initial consideration of $700 million and an additional $125 million if price and production targets are met. The mature nature of those assets, including rising decline rates, the lack of major onshore oil discoveries and ongoing security issues which regularly forced those fields to be shut-in illustrate why the sale makes sense.
Ecopetrol is even looking outside of Colombia for opportunities to bolster its low proven reserves of 1.89 million barrels. The national oil company has entered into a partnership with Occidental to develop acreage in the prolific Permian Basin where it plans to drill 100 wells by the end of 2021. Ecopetrol also has an interest in 51 blocks in the Gulf of Mexico. This further highlights the considerable headwinds being experienced by Colombia’s oil industry because of a perfect storm of sharply weaker oil, high breakeven prices, deteriorating security and lack of proven oil reserves. For these reasons, Colombia’s energy security is threatened, as is its economic growth because of the correlation between oil, the value of the Colombian peso and the economy. For as long as the economy remains weak major Colombian NYSE listed ADRs such as Group Aval (AVAL) and Bancolombia (CIB) as well as the country ETFs Global X MSCI Colombia ETF (GXG) and iShares MSCI Colombia ETF (ICOL) will fail to perform.
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