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Matthew Smith

Matthew Smith

Matthew Smith is Oilprice.com's Latin-America correspondent. Matthew is a veteran investor and investment management professional. He obtained a Master of Law degree and is currently located…

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Colombia’s OIl Exploration Ban Could Crush Its Economy

  • In a hotly debated move, the Petro administration hiked taxes for Colombia’s oil industry.
  • Ending oil exploration will compromise Colombia’s energy security.
  • For 2022 alone, crude oil was responsible for earning 34%, or $18 billion, of Colombia’s legitimate export income.
  • The Petro administration simply cannot eschew the fiscal and economic contribution of petroleum to Colombia’s economy and government budget.
Colombia

The future of Colombia’s battered oil industry is once again in doubt. The plans of the strife-torn country’s first leftwing President Gustavo Petro, who was inaugurated in August 2022, to transition Colombia from fossil fuels to cleaner renewable forms of energy are weighing heavily on the hydrocarbon sector’s outlook. The controversial leftwing senator and former guerilla campaigned on a platform of ending contracting for hydrocarbon exploration and banning hydraulic fracturing. In a hotly debated move, the Petro administration hiked taxes for Colombia’s oil industry. Those propositions are weighing heavily on the outlook for Colombia’s oil industry, which is still struggling to return to a pre-pandemic tempo of operations. There are considerable risks for Colombia and the economy if Petro implements those policies.

While speculation was growing that Petro was considering easing plans aimed at banning new oil exploration licenses recent statements from his energy minister at the Davos World Economic Forum indicate he is committed to that course of action. Colombia’s Minister of Mines and Energy Irene Vélez Torres ratified the country’s commitment (Spanish) to transitioning away from economic dependence on fossil fuel extraction and exports. The economic contribution of extractivist industries, primarily hydrocarbon production and coal mining, will be replaced by ramping up agriculture, tourism and clean energy investment. Such a move, according to Vélez, will prepare Colombia for the ecarbonization of the global economy, primarily by reducing economic dependence on oil, natural gas and coal production and the tremendous earnings their export generates. 

While a rapid plan to transition to a greener, more sustainable economy is admirable it is fraught with risk. The ramping-up of Colombia’s petroleum industry over the last three decades, which was responsible for driving the strife-torn country’s economic miracle as it emerged from a long low, intensity multiparty civil war, makes this a difficult plan. Data from the government statistical agency DANE shows that for 2022 alone, crude oil was responsible for earning 34%, or $18 billion, of Colombia’s legitimate export income, producing around 3% of gross domestic product and generating roughly a fifth of government income. Recent tax reforms removed royalty payments as an income tax deduction and added a scalable surcharge which increases as the Brent price rises will substantially increase the amount of government revenue earned from the industry. That will play an important role in funding many of the Petro administration's social programs aimed at bolstering spending on education and healthcare, reducing poverty and improving basic infrastructure.

The additional tax revenue now being generated by the hydrocarbon sector will go a long way to reducing a ballooning budget deficit that is placing considerable fiscal pressure on Bogota. During 2020 Colombia’s deficit blew out to $18.9 billion or an alarming 6.98% of GDP. While as a percentage of GDP, it fell to 6.84% during 2021, due to higher nominal GDP, the funding shortfall widened to $21.5 billion. A ballooning budget deficit, due to the impact of the pandemic and a narrow tax base, was responsible for rating agencies downgrading Colombia’s sovereign credit rating from investment grade to speculative during 2021. That compounded many of the existing fiscal headwinds facing Bogota, where a lack of tax revenue has weighed on budget planning and government spending for decades.

For those reasons, the Petro administration simply cannot eschew the fiscal and economic contribution of petroleum to Colombia’s economy and government budget. Colombia’s Autonomous Fiscal Rule Committee (CARF – Spanish initials), an independent body attached to Colombia’s finance ministry, which monitors fiscal rules, is alarmed at Petro’s plans to end contracting for hydrocarbon exploration. Such a move, according to the committee (Spanish), will sharply impact public finances, potentially precipitating a financial catastrophe for a country facing an uptick in borrowing costs, demand for greater public spending and an economic slowdown.

While the Petro administration is committed to honoring existing (Spanish) oil and natural gas agreements the fear is that without new hydrocarbon exploration, Colombia’s limited reserves will expire in less than 10 years. Colombia’s proven oil reserves at the end of 2021 (Spanish) amounted to a mere two billion barrels, significantly lower than its petroleum-producing neighbors and only sufficient to support another 7.6 years of production. For the same period, natural gas reserves totaled 3.16 trillion cubic feet which will support another eight years of operations at the current rate of production. Unless hydrocarbon exploration continues, Colombia’s reserves will more than likely be incapable of supporting commercial extraction within a decade.

Such an event will impact Colombia’s balance of trade, possibly leading to a large deficit that could cause the value of the peso to plummet. A sharp devaluation of the peso will impact government finances by causing the real cost of U.S. dollar denominated debt to rise. That will also lead to greater inflationary pressures, with imports experiencing a marked increase in value. There is also the threat of a sharp decline in fiscal income, due to the loss of an important source of tax revenue, which will ratchet up budgetary pressures. Those impacts will be compounded by a decline in GDP, with the loss of oil and gas likely to shave 3% off Colombia’s national output. These developments will be further complicated by plummeting foreign investment. Colombia’s hydrocarbon sector is responsible for attracting around a 10th of all offshore capital inflows. Foreign direct investment is an invaluable source of revenue which has become an invaluable economic driver and source of hard income.

Ending oil exploration will compromise Colombia’s energy security. This risk had already emerged because of the pandemic and sharply weaker oil prices, with the Andean country’s petroleum industry yet to return to pre-2020 production. Energy Ministry data shows Colombia only pumped 747,953 barrels per day for the first nine months of 2022, which is significantly less than the 885,863 barrels per day produced for the full year of 2019. Prior to the 2022 oil price rally, those notably softer production volumes were impacting Bogota’s finances and the economy. If the Petro administration halts oil exploration the fallout will potentially be far worse. Colombia, which is a net oil exporter, will see its energy self-sufficiency and security challenged. Such a move poses the very real risk of triggering an energy crisis that could roil Colombia’s economy.

By Matthew Smith for Oilprice.com

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