Declining oil production is a dark cloud that looms over the long-term sustainability of Colombia’s economic growth. The Latin American country’s oil output has experienced a significant downturn in 2014. In the first seven months of the year, production averaged 979 thousand barrels per day (bpd), somewhat below the government’s target of 1.095 million bpd and down from last year’s peak of 1.030 million bpd. Foreign investment in the hydrocarbons industry has also leveled off. FDI directed towards the oil sector fell 10 percent in 2013 YOY and reached a mere US$655 million in Q1 2014, the lowest in any quarter since 2010, continuing the downward trend.

Why is Colombia’s declining oil output concerning?

The oil industry has been a key driver of Colombia’s impressive economic performance over the past few years with oil output nearly doubling between 2003 and 2007. Oil exports now make up over half of all export earnings and represent around 12 percent of GDP. Given the importance of oil production to the Colombian economy, declining output has two principal implications for multinationals to consider:

1. The Colombian government relies on oil rents to fund its expansionary fiscal agenda. Reduced oil output will strain the government’s coffers at a time when it has pledged an increase in social projects and infrastructure development, but is simultaneously constrained by low tax revenues and legal limits on its ability to finance expenditures through debt issuance.

2. A decline in output increases the possibility of decelerated economic growth over the long-term. According to the Colombian Petroleum Association, if output levels drop even slightly below current production levels, by 2016 Colombia could start to see an expansion of its trade deficit, which could widen from a negative 2 percent of GDP in 2013, up to 4.2 percent within the next five years. Similarly, overall FDI levels could fall from 4.4 percent of GDP in 2013 to 2.2 percent in 2016.

Why is oil output falling?

There are three principal factors driving the decrease in oil production:

1. Regulatory hurdles: Significant delays in awarding environmental permits and stressed relations with communities have slowed production and have discouraged investors who see Colombia’s strict environmental regulations and structural bottlenecks as increasingly risky.

2. Sabotage against oil infrastructure: 2013 and 2014 have seen a substantial increase in acts of sabotage against oil infrastructure from Colombia’s guerilla groups. If peace negotiations were to fall through, Colombia is likely to experience a deterioration of its security environment, which would further depress oil output.

3. Low reserve replacement rates: Oil companies have been unsuccessful in finding significant new reserves. Officials estimate that current oil reserves will only last six and a half years, and reserve replacement rates declined 67 percent between 2009 and 2013. Decelerating FDI suggests that the rate of reserve replacement will continue on a downward trend.

How could this trend affect FSG’s clients?

• Given the dependency of the Colombian government’s fiscal agenda on oil rents, a decline in oil production will force the government to either cut fiscal spending or to look elsewhere for means to finance its initiatives, thus raising the probability of an increased tax burden on consumers and/or corporations.
• A future deterioration of Colombia’s balance of payments due to a decline in oil exports could cause the government to considerably increase its external debt. An increase in public debt, particularly if combined with a deteriorating economy, would raise Colombia’s risk premium, thereby increasing interest rates and borrowing costs for businesses seeking to invest in Colombia.
• The overall pace of economic growth would slow, as oil rents are infused into the internal sector. This would imply that companies planning to expand their presence in Colombia might have to reconsider their assumptions of Colombia’s long term growth trajectory.

If you wish to learn more about how this trend could affect businesses in Colombia, consider reading our full Q3 quarterly report, which you may access here. Not a client? Contact us for more information.