Colombian Oil Major Reports Surprise Profits Despite Market Downturn - InvestingChannel

Colombian Oil Major Reports Surprise Profits Despite Market Downturn

The March 2020 oil price crash and COVID-19 pandemic has hit the global energy sector hard. In response oil companies are slashing capital spending, driving down costs and shuttering uneconomic operations. The key goals being to preserve cash flow, shore-up balance sheets, protect dividend payments and retain investor confidence in the current harsh operating environment. This, however, may not be enough. The severity of the crisis recently forced oil giant BP to slash its dividend by half after posting a shock $16.8 billion second quarter 2020 loss. One integrated oil major considered especially vulnerable is Colombia’s national oil company Ecopetrol.

For almost a decade it has been battling high operating expenses, cost overruns, declining petroleum production and low proven oil reserves. It was feared that even after slashing billions of dollars from planned 2020 spending and aggressively dialing down costs, Ecopetrol would still report a large loss. Such an event would significantly impact Colombia’s petroleum dependent economy and the finances of an already fiscally challenged national government, which is Ecopetrol’s single largest owner.

The prolonged oil price slump, which began in late-2014, has profoundly impacted Colombia, which was one of the fastest growing economies in Latin America. Annual GDP growth has been spiraling ever lower bottoming at 1.4% for 2017, the worst performance since the 2009 global financial crisis. Colombia’s plight is worsening as the COVID-19 pandemic and oil price collapse bite deeper. The IMF believes that the Andean country’s economy will contract by almost 8% during 2020, potentially its worst performance on record.

Colombia is particularly vulnerable because its economy is heavily reliant on oil. Crude, as well as refined petroleum products, according to DANE the national statistics agency, account for 40% of Colombia’s exports by value. This makes them a key source of government revenue accounting for around 16% of fiscal income in 2014 according to the OECD. The sharp decline in oil prices since late-2014 has weighed heavily on government revenue, leading to ever larger budget deficits. When the international Brent oil price plunged below $30 per barrel in 2016 Colombia’s budget deficit ballooned out to 4% of GDP, the worst in over a decade, despite drastic spending cuts. That forced the central government to look elsewhere for urgently needed funds to meet pressing financial obligations, notably upgrading Colombia’s poor transport infrastructure and implementing the 2016 FARC peace accord.

That saw Ecopetrol’s dividends become an important revenue source for an increasingly cash-strapped Colombian government. For 2018, Ecopetrol paid $2.6 billion in profits to the central government making it a key source of income. By 2019, the worsening economic climate, driven primarily by the ongoing oil price slump, saw President Duque’s administration announce it would tap Ecopetrol for a $948 million special dividend to meet fiscal targets.

This came on the back of an earlier 2019 announcement, stating the government was considering selling an almost 9% interest of its 88.5% stake in the integrated energy major to raise urgently required capital. While the sale didn’t eventuate, those events triggered considerable consternation among financial markets and investors because they gave the impression that Duque was using Ecopetrol as a state-controlled piggy bank. Years earlier, the Brazilian government had destroyed billions of dollars of private shareholder value in that country’s national oil company Petrobras by using it to fund government spending.

Bogota’s fiscal position has worsened appreciably since the end of 2019 because of the latest oil price crash and growing COVID-19 pandemic forcing a nationwide shutdown. That heightens the importance of Ecopetrol as a source of desperately needed fiscal revenue, heightening the risk that the central government will seek further extraordinary dividends as the economic crisis deepens. The magnitude of the catastrophe facing Latin America’s fourth largest economy is underscored by the IMF predicting 2020 GDP will contract by up to 7.8% and Bogota abandoning its fiscal deficit limits after forecasting a budget shortfall of 6.1% of GDP.

The bleak outlook for oil means that Ecopetrol may not be in the position to provide the considerable financial assistance the central government requires. Sharply weaker oil prices, coupled with the depressed economic outlook, forced the integrated oil major to slash planned 2020 spending twice, ultimately by a total of $2.5 billion, sharply impacting oil production and ultimately earnings.

As a result, Ecopetrol forecast an 8% year over year reduction in 2020 oil production, to around 664,000 barrels per day and that second quarter oil output would plunge to between 660,000 to 680,000 barrels. This combined with sharply weaker oil prices saw analysts predict that Ecopetrol would report a second quarter 2020 loss. However, in a surprise turn of events, Ecopetrol defied market expectations to report a second quarter profit of almost $7 billion. The company’s quarterly oil production of 677,000 barrels was at the upper end of its revised May 2020 guidance.

It was Ecopetrol’s ability to significantly dial down operating overheads that was responsible for the surprise profit. The company reduced first half lifting costs by 20% year over year to $7.10 per barrel and transportation expenses fell 9% to $3 a barrel. That saw Ecopetrol report a first half 2020 cash breakeven price of a low $19.90 per barrel or almost 2.5 times less than a year earlier. This confirms that Ecopetrol is profitable even at $30 per barrel Brent, with the international benchmark price averaging $29.70 for the quarter. It also explains why Ecopetrol’s April 2020 $2 billion bond offering was oversubscribed and ranked investment grade by international credit ratings agencies.

This is an important outcome for Colombia, its economically crucial hydrocarbon sector and cash-strapped central government. Ecopetrol’s ongoing profitability in such harsh circumstances will act as a bulwark against Bogota’s fiscal weakness. It will ensure that Colombia’s oil resources are profitably exploited despite significantly weaker oil prices and the poor economic outlook.

By Matthew Smith for Oilprice.com