(Idea) Investors Are Underappreciating How Positive Espriella Will Be For The Colombian Energy Sector
Neglect, dislike, or whatever you want to call it, investors in the energy sector are completely misreading the situation unfolding in Colombia. Following Abelardo de la Espriella’s victory on June 21, investors have seemingly responded to Colombian oil producers with a “meh”.
It doesn’t help that, since the start of Espriella’s rise in the polls, Brent has tumbled by ~35%, dampening enthusiasm for energy stocks. However, the investment community should pay closer attention to all the producers in the country, namely, the potential for more deals and exploration.
In particular, something very important came out today from Espriella’s Vice President, José Manuel Restrepo, in an interview with El Tiempo and Portafolio. This was his comment on Ecopetrol and on the state of Colombia’s oil and gas industry. I highlighted the most important part:
Regarding the issue of Ecopetrol, the vice president-elect pointed out that “it is very unfortunate. He has attacked it structurally and strategically (the current president, Petro) by preventing it from signing new gas and oil exploration contracts, by preventing unconventional exploitation in Colombia or abroad. He has attacked it operationally and financially, to the point that today, exploitation is more costly than it was 2 years ago. He has also attacked it in terms of corporate governance by intervening in decisions such as the one Ecopetrol had ready, and they threw it back after nearly 2 years of decision-making. And he has attacked it in reputational terms by keeping the current president in place.”
With that said, Restrepo stated that what needs to be done at Ecopetrol “from day 1 of our government is to call the assembly so that the assembly changes the board and the board of directors changes immediately. That is an immediate decision. I have no doubt that the assembly will be called. The assembly must change the board of directors and the board of directors must change the presidency of Ecopetrol as quickly as possible. Certain terms must be respected.”
The context is important to understand here because Colombia is the 5th largest oil producer in South America, and Ecopetrol, the national oil company, handles oil and gas contracts with independent oil producers. Every deal that gets signed needs to be vetted by Ecopetrol to some extent and by the Colombian government, which creates tedious delays and bureaucratic hurdles.
Under Petro (the left-wing current president), oil and gas exploration took a severe hit as he banned new E&P contract rounds and shortened long-term contract terms. In addition, Colombia’s gas reserves began to fall, making it more import-dependent, and its oil reserves now sit at just under 8 years at the current production of 734k boe/d.
This is not a situation you want to be in when you are an oil exporter. Colombia, under the left, was going to see oil and gas production fall in the coming years if capex didn’t increase meaningfully.
Political Godsend
It’s important to first understand the oil and gas deal structure in Colombia to give you a flavor of what to expect. Historically speaking, Ecopetrol has relied on outside capital to fund growth capex and increase total production. Deals are usually structured as follows:
50/50 split in production sharing, the operator partner gets 50% of the production.
Capex is usually weighed on the operator partner first, and then split 50/50 later, or in some cases, it is just paid for by the operator partner.
Royalty is charged on the 50% production piece of the operator, so Colombia benefits from 1) the capex spent by the operator and 2) the royalty payment made.
From Ecopetrol’s standpoint, which is majority-owned by the Colombian government (88.49%), the capex spend gives it optionality for production upside and exploration potential. The royalty payment maximizes cash flow, and the even split in production gives the operator every incentive to increase production as much as possible.
It’s a win-win deal.
But under Petro, Ecopetrol suffered because 1) he banned exploration and 2) he vilified oil and gas and pivoted the economy towards renewables.
Now that he’s gone, Ecopetrol will embark on a new era of exploration and deal-making. There are 4 years of pent-up demand for deals that have been sitting in the back office, cluttered by bureaucracy. For the sake of due diligence, we have hired on-the-ground political consultants to inform us about the labyrinth we need to navigate in such a hostile political environment, and let me just say that it is more torturous than poking your own eyes with needles.
Under Espriella, his campaign was pro-hydrocarbons. He wants to restart oil and gas exploration, something Petro banned. He wants to issue new contracts, allow responsible fracking, offshore Caribbean oil and gas, and push Ecopetrol’s reserves higher. He stated in his campaign that he wants to push Colombian oil production from ~734k boe/d to 1.35 million boe/d. That’s not possible without the support of other operators, as I explained above.