For Petrominerales Ltd. and others, Colombia beckons
A cadre of Canadian firms heads south in search of heavy oil
In September, violent protests at some of Colombia’s more prolific oilfields cast doubt on its recently cultivated image as a stable, business-friendly nation with a wealth of potential that had at last defeated its 1980s caricature as a chaotic banana republic controlled by drug lords and Marxist rebels. The Rubiales and Quifa fields located in the southern portion of this South American country of 44.7 million souls had been rocked by demonstrations as contract workers demanded the same wages as regular employees. The protests caused the operator of the two fields, Toronto-based Pacific Rubiales Energy Corp., to shut down operations and halt 225,000 barrels per day of production.
The company claimed contract employees had burned tents and other equipment, sabotaged pipelines and blocked roads. Pacific Rubiales was not the only Canadian company affected by the strife. Calgary-based intermediate explorer Petrominerales Ltd. had to shut in 30,000 barrels per day of production at its Corcel and Guatiquia blocks after smaller groups of protesters blocked public roads near the installations. (Production has since been restored in both cases.)
But despite a messy September that brought back memories of Colombia’s bad old days, Petrominerales president and CEO Corey Ruttan’s faith in the country was not shaken. “We view Colombia as the absolute best combination of political regime, fiscal regime and geological prospectivity out there,” Ruttan says confidently. “That’s what attracted us to Colombia and continues to attract us.”
For the casual observer, Ruttan’s praise smacks of hyperbole. Colombia couldn’t possibly be more attractive than Petrominerales’ home base of Alberta, could it? But in a world where there are few international destinations without above-ground risk (exhibit A: Libya), Colombia has emerged as a hot jurisdiction. And Petrominerales is part of a not-so-small cadre of Canadian firms who have taken a shine to the South American country. Parex Resources Inc., Gran Tierra Energy Inc, Canacol Energy Ltd., Petro Vista Energy Corp. – the list of Canadian firms operating in Colombia is surprisingly long. With the exception of Nexen Inc. and Talisman Energy Inc., this Canadian cartel is made up almost exclusively of junior and intermediate companies.
This is no surprise. In Canada’s ultra-competitive junior sector, with hundreds of small companies looking for investment dollars, start-ups often have to take risks on unfamiliar and risky locales to stand out from the crowd. “There is a real entrepreneurial spirit in the Alberta oil patch,” says Dana Coffield, president and CEO of Calgary-based junior Gran Tierra. “Because of that you see small Alberta-based companies funded with Toronto risk capital seeking new frontiers in the international arena.”
But only the strong ultimately survive. The juniors who are the most nimble and make the right calls in these risky plays are the ones that have staying power, grow production and eventually graduate from the junior sector into the ranks of mid-caps or intermediates. Petrominerales’ gambit in Colombia is a prime example of how that can be done. In 2006, when the company was created as a subsidiary to Petrobank Energy and Resources Ltd., Petrominerales was producing just 2,000 barrels per day. But from its humble origins as a junior explorer, the company has since amassed two million acres of land in Colombia and is producing approximately 40,000 barrels of oil per day. That rapid growth also resulted in the company being spun out of Petrobank as 2010 came to a close.
It turns out that much has changed in Colombia in the past 10 years to make it a more attractive investment location. Canadian companies who had the foresight to recognize these changes early on are now reaping the rewards. While personal security is still an issue in the country, a strong central government headed by Álvaro Uribe Vélez and his successor, Colombian president Juan Manual Santos Calderón, has improved the security climate, making it a much safer place to operate and conduct business.
These improvements have allowed the country to build on the strengths it already had – namely attractive geology, a pro-business government, a strong legal system and a favorable royalty regime. “There was a long history of security risks in Colombia, but people had a hard time separating that from what is true political risk,” Ruttan says. “Colombia has an unbroken track record of never retroactively changing fiscal regimes. It has a very well established legal framework and a very pro-business environment with some security challenges. We felt those security challenges could be managed. So we got in there early in the game and established a very prospective land base where we operate all of our exploration lands 100 per cent.”
In some ways the country’s notorious reputation may have helped Petrominerales get where it is today. Colombia’s hydrocarbon potential is well known and industry activity has ebbed and flowed there over the past 50 years. Figures published by the Agencia Nacional de Hidrocarburos (ANH) – the government organization that doles out land and administers and collects royalties from industry – says Colombia has 2.06 billion barrels of proven crude oil reserves. Ecopetrol, the country’s largest oil and gas firm, estimates Colombia has 47 billion barrels of oil equivalent in potential reserves. However, oil production peaked in 1999 at 830,000 barrels per day and steadily declined thereafter. The problem? Natural declines in existing oilfields and a lack of sizeable new discoveries to replace the depleting reserves.
The lack of new discoveries was partly related to Colombia’s sketchy security environment in the 1980s and ’90s that kept industry away. Pipelines and energy infrastructure were prime targets for attacks by guerillas. It was also a reflection of the way the oil and gas sector in Colombia was organized. As recently as 1999, Ecopetrol was the industry overlord, a completely state-owned company that not only was in the business of producing oil and gas but was also in charge of land administration. Particularly unappealing for sector players was Ecopetrol’s right to “back in” to any discoveries made by other companies, which allowed it to gain a piece of production after the exploring company had done all the heavy lifting.
That system worked fine when there were giant finds to be had. But Colombia’s basins had matured and the elephant fields that attract large multinational players with deep pockets had already been found. So a government hungry to provide jobs and business opportunities made some sweeping reforms. One key change was turning Ecopetrol into an oil and gas company that had no involvement in putting up land for bids and couldn’t back into discoveries. Another critical reform was the creation of the ANH in 2003. It was given the important job of administering land sales and royalties and promoting Colombia’s potential to international investors.
The royalty regime in Colombia was also changed, with the country adopting a sliding scale system calculated on each producing field. The royalty rate ranges from eight per cent to 25 per cent, depending on how much each field produces. Prior to those changes, a flat 20 per cent royalty was charged no matter how much or how little the field produced. Considering only fields with an average daily production of 125,000 barrels or more are now subject to royalty rates of 20 to 25 per cent, this has been an important change for cash-strapped juniors and even intermediate producers. That’s because discoveries in Colombia’s modern-day oil patch are typically under 20 million barrels, with discoveries between two to 10 million barrels much more common. “There is now a fiscal regime that sets you up so you don’t lose your shirt if you find the expected outcome,” says Wayne Foo, president and CEO of Parex Resources Inc., a Calgary-based junior that produced 9,300 barrels of Colombian crude per day in the third quarter of 2011. “And there’s still opportunities to have discoveries that are better than average – to get something in the 10 million barrel range – and that provide a really good return.”
The recent production and investment numbers coming out of Colombia indicate that the measures are working. Production has gone from averaging 518,000 barrels per day in 2006 to 906,000 barrels per day as of August 2011. The Colombian government has set a goal of having production reach 1.5 million barrels per day by 2015. In 2010 the country’s oil and gas sector attracted US$2.68 billion in direct foreign investment and there are approximately 70 international companies participating in the Colombian industry, including a fair number of Canadian companies.
The investment community is also taking notice of what companies like Parex and Petrominerales have been able to achieve in Colombia. “We believe that Colombia ranks among the best international jurisdictions for oil and gas investment,” stated Calgary-based investment boutique Peters & Co Ltd. in a recent research note. “It has a stable fiscal regime, with developing industry and expanding infrastructure.”
It’s also a jurisdiction with a petroleum mix that is getting heavier. Peters notes that 60 per cent of the increase in production from 2006 to 2011 has come from heavy oil growth, particularly in the prolific Llanos basin in central Colombia. John Chambers, managing director and president of Calgary’s FirstEnergy Capital, has been watching the Colombian story closely. He also sees heavy oil becoming a larger part of the production mix as more discoveries come online and more exploration takes place. “Heavy oil is going to be a huge part of the future in Colombia. They are just starting the development phase of that now,” Chambers says.
If that turns out to be the case, it could make the operating environment more difficult for the smaller Canadian juniors. Heavy oil is an expensive game and as activity levels in the Llanos basin ramp up, cost inflation and regulatory and infrastructure delays will inevitably follow. “Experienced operators with access to infrastructure … will have an advantage over smaller entities,” Peters notes in an overview on Colombia’s heavy oil sector. “We also expect there will be a significant increase in [merger and acquisition] activity in the next 12 months, as less experienced operators will be forced into looking to farm out opportunities.”
Petrominerales has no intention of farming out anything. It finds itself in a strong position, with a good land base in heavy oil country and an ownership stake in two pipelines. In June it acquired a five per cent interest in the 829-kilometer OCENSA conduit that transports 560,000 barrels of oil per day. It’s also committed to own 10 per cent of the proposed OBC pipeline, which would ship 450,000 barrels of oil per day from the Llanos basin to the port of Covenas.
As production in Colombia continues to increase, pipelines are a challenge. The country’s network isn’t extensive and lacks capacity to handle the amount of crude oil that will be produced. Future production could be shut in for operators who don’t have space locked up on existing or planned pipelines. Ruttan says Petrominerales has alleviated that concern with its ownership stake in two pipelines. “Those are the types of investments a company of our size typically wouldn’t make in Canada,” he says. “But we felt it was important enough to commit to those things. That’s really going to help accommodate our growth over the next five to 10 years here.”
Of course, growth is what oil and gas companies, big and small, are looking for. But is there room for more Canadian juniors to pull off what Petrominerales has accomplished? FirstEnergy’s Chambers thinks there is; noting that there are still large amounts of land available and the success rates for exploration have been very high. Producers also benefit from the fact that Colombian crude is not – unlike Alberta – landlocked. With pipelines that reach tidewater on both its Pacific and Caribbean Sea coasts, producers have access to multiple markets, which has seen Colombian crude blends trading at a premium compared to West Texas intermediate in recent months. Combine sizeable swaths of prospective land, with access to multiple markets along with the Canada-Colombia free trade agreement that came into force in August, and the country still holds promise for new Canadian entrants.
At Petrominerales, Ruttan remains focused on keeping the company on an upward trajectory. Its 2011 and 2012 operations will concentrate on heavy oil fairways and it has a large land base in Peru. The company has evolved from its days as a junior producing a couple of thousand barrels a day of oil. “Each of the new areas provides the opportunity for a step change in our growth,” Ruttan says. “We plan to be a very active participant in the Latin America oil sector for many years to come.”