Why Ecopetrol Outperforms Petrobras

Why is Ecopetrol more appealing to investors than Petrobras?

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Last month, Colombian oil company Ecopetrol surpassed Brazil's Petrobras as the largest listed energy company in Latin America by market capitalization, and that despite the fact that Petrobras' production is about three times larger, the Financial Times noted. What accounts for the change in valuation of these two companies? Is Ecopetrol destined to continue its run? What top risks are facing Colombia's oil and gas sector this year, and beyond? 

Rodrigo Villamizar, former Colombian minister of mines and energy: Petrobras is the real petroleum champion in all of Latin America. Indeed, Petrobras not only leads in production with 2.69 million barrels per day (mbpd), but also in reserves with 13 billion barrels (bb) and counting in the hugely unexplored pre-salt formation. Ecopetrol produces 0.95 mbpd and its reserves have been stagnant at 1.9 bb. By comparison, Mexico's Pemex produces 2.96 mbpd and has reserves of 10.42 bb. The market caps of oil companies are mainly about barrels valuation. Even discarding the problems faced by Ecopetrol's pension fund and other questionable asset valuations, its real issue is a simple lack of reserves. Market capitalizations are based on an estimate of a company's value, the perceived future prospects, as well as economic and monetary conditions. Ecopetrol has excelled in those areas thanks to the risky, though correct, management strategy that the company could grow without reserves. Stock prices (and therefore market cap) is also moved by speculation about changes in expectations, profits and potential mergers and acquisitions. The key element that stands out is 'speculation.' In the case of Colombia in general and Ecopetrol in particular, with the inflow of financial investments like Pacific Rubiales and other investments, speculation has been pushing asset values higher than what the market can bear. There is no objective criterion to assure that Ecopetrol has surpassed Petrobras as the largest listed energy company in Latin America by market capitalization. Company size is a basic determinant of asset allocation and risk-return parameters for stocks and stock mutual funds. PDVSA, Petrobras and Pemex continue to be the largest listed energy companies in Latin America by market capitalization.

Daniel E. Velandia O., head of research at Correval in Bogotá: Despite the fact that Petrobras' production is about three times larger than Ecopetrol's, investors have been willing to pay a premium for Ecopetrol's stock, as it has had better operational performance in recent years. According to our estimates, the compounded annual growth rates of Ecopetrol's production and reserves reached 13.5 percent and 8.2 percent respectively in the last six years. Those figures compare to 1.4 percent and 2.5 percent for Petrobras. In terms of EBITDA margin, Ecopetrol was also better in the same period (43 percent vs. 29 percent). With an investment plan of $80 billion between 2012 and 2020, it is likely that investors will continue to pay a premium for the stock, at least in the short term, as this significant amount may imply the continuity of good operational results in coming years. Ecopetrol's success will depend on several factors, including the external scenario, its success rate, security conditions and the solving of administrative issues. The two main risks that Colombia's oil sector faces this year come from the delay in environmental licenses granted by Colombia's environmental authority (ANLA) and protests. Some figures suggest that approximately 105,000 barrels per day are currently paralyzed. Seventy percent of this is explained by delays in the granting of licenses and the remaining by security issues. Regarding the latter, the number of operative disruptions generated by communities of oil-producing regions totaled more than 250 in 2012. Most of them were explained by last year's royalties system changes, which were designed to more equitably distribute oil resources among the country's regions.

Roger Tissot, member of the Energy Advisor board and independent energy economist: Petrobras is by far a much bigger company if measured by production, reserves and asset values. As the Financial Times suggests, perception is important. On the one hand, Ecopetrol and Colombia, which has a market-friendly environment, continue to benefit from the support of foreign investors, particularly those desperate for yield. Ecopetrol has indeed delivered production growth. On the other hand, Petrobras and Brazil have fallen out of favor lately. Investors may be penalizing the less 'friendly' investment climate in Brazil, which changed the petroleum contracts for the pre-salt areas and has costly local content rules. One must also look carefully at the long-term drivers in these two countries. Colombia's record-high oil production can only be secured if additional reserves are found. To increase reserves, Colombia requires massive exploration investments. A deteriorating security situation can also challenge Colombia's optimistic outlook. The main challenge for Petrobras is demonstrating to an increasingly skeptical market its ability to successfully develop the vast resources located in the pre-salt area while respecting resource nationalist legislation. However, if it were politically feasible, the Brazilian government could improve the market perception of Petrobras by reducing the so-called 'Brazil cost.' In short, Ecopetrol's excessive market cap is the result of a perceived generous fiscal and regulatory environment. However, it seems to ignore the deteriorating security situation and the fact that no new large-scale reserves have been discovered. The future of Colombian oil relies on costly and complex EOR technologies. Petrobras' decline in market cap seems to be the result of a perception that the company is operating under less-than-optimal conditions because of nationalistic/pro-development policies. But it seems to ignore the fact that the reserves are there, and despite high levels of violence in major urban centers, Brazil's oil industry does not suffer the same 'above ground' risks of guerrilla activity.

Carlos Bellorin, senior petroleum analyst at IHS in London: On one hand, the market perceives Ecopetrol as an extremely well managed oil company with a decent resource base that has fulfilled many of its operational and financial goals in recent years. Government intervention in Ecopetrol is very limited and Colombia's business-friendly legal, fiscal and regulatory regimes for the oil and gas sector make a good environment for its operations. These reasons and many others have boosted Ecopetrol's shares in recent years. On the other hand, Petrobras, which is undoubtedly a company with a huge resource base, very good operational capabilities and a major producer, has found many operational obstacles (such as cost overruns and massive downstream unit losses) and had below-expectation production in recent years. As a matter of fact, Petrobras' year-end 2012 financial results were the company's worst in eight years. This situation has taken a toll on Petrobras' shares. As it was put recently in a report from IHS Herold, 'Petrobras continues to be the most deeply discounted company among its integrated peers on a relative valuation basis, trading at a two-thirds discount to its most recent appraised net worth.' If it continues being well managed, makes the right operational and financial decisions and oil prices maintain their current levels, Ecopetrol's shares may continue performing well. The top risk facing Colombia's oil and gas sector is without a doubt maintaining and strengthening the security of its operations. Guerrilla attacks have increased dramatically since mid-2012 and are not showing signs of slowing down. This situation affects Colombia's oil sector performance and increase the pressure on its already insufficient hydrocarbons transportation capacity.

Luis Giusti, senior advisor at the Center for Strategic and International Studies, former chairman and CEO of PDVSA: Two decades ago, Brazil's long-time objective of becoming energy self-sufficient triggered an ambitious oil and gas strategic plan, which built Petrobras into arguably the world's most important national oil company. Brazil copied Norway's oil and gas institutional model, in which the government is in charge of policy, a specialized agency is in charge of regulation and administration, and companies are left to operate in a competitive business environment. This attracted international capital and technology, marking the dawn of a new oil industry in which Petrobras had a subtle upper hand. Production increased steadily, reaching 2 million bpd, but at 11 billion barrels, reserves were still shallow for an economy the size of Brazil. However, in recent years with the offshore sub-salt discoveries, the country's oil future took a quantum leap, with estimated reserves of at least 30 billion barrels. In this new stage, Petrobras has taken the leading role. The considerably larger costs of the operations have overextended Petrobras' budget, which added to the higher risks involved and have no doubt affected investor appetite. Ecopetrol, on the other hand, has grown steadily, not only increasing oil production, but also leading the way in all downstream Colombian operations, adding selected international, profitable acquisitions. Additionally, Colombia's long-time security problems have diminished substantially, providing a healthy backdrop for Ecopetrol to operate. Although official reserves are still shallow, a lot of the new discoveries have yet to be booked, the future looks bright and investors see it as a safe bet.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor