Opportunities for the Colombian economy, following the economic and financial impact of falling oil prices.

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1 Proportion of hydrocarbon extraction relative to the GDP Opportunities for the Colombian economy, following the economic and financial impact of falling oil prices. Abstract: Colombia s highest source of revenue comes from the trade of hydrocarbons. According to the Oxford Business Review Group, in 2014 Colombia produced an average of 1 million barrels per day (bpd). This represents an average of 21% of all direct Foreign Investment and with reference to the Central Bank, about 50% of the country s total exports. With a continued fall in oil prices amid global instability, uncertainty and the ongoing climate change debate, there may be some concerns about short-term prospects for the Colombian oil and gas industry. Despite this, Colombia is a nation with many natural, human and other resources that can be utilised to stimulate economic prosperity. According to the 2015 IMF Survey, Colombia experienced an overall economic growth of about 3.5% in 2014 and is forecasted to experience approximately 4.5% in In combination with a floating exchange rate, and a continually improving global image, Colombia is capable of taking advantage of the current climate and use it as an opportunity for progress. According to the BP Statistical Review of World Energy, in 2013, Colombia consumed only barrels of its oil meaning that it had a significant amount of oil for export. The USA have previously been the main destination of exports for Colombian hydrocarbons, but the current economic downturn has led to a reduction income; this is as a result of increasing selfsufficiency in the USA, thanks to the boom of shale oil (better known as fracking ) that began in With reduced economic viability from oil exports, Colombia needs to position itself to take advantage of the current economic climate. The diversification of and investment in other commodity markets means that Colombia will not only be able to weather the current economic storm, but to thrive in spite of it. Figure 1. Extraction of hydrocarbons/gross Domestic Product 7% 6% 5% 4% 3% Source: Bank of the Republic, Deputy Manager of Economic Studies Balance of Payments Author: Sylvester Ayodeji Bamkole Msc Petroleum Geoscience with Exploration University of Manchester, /02/2016 1

2 Exportation price of Colombian crude (U$D) According to the 2016 oil market report by the International Energy Agency (IEA), the current price of oil is largely determined by the oversupply of oil on the world market. This has been increased by the economic slowdown in emerging markets as indicated by the World Bank 2016 analysis of weak growth in the emerging markets and the implications for commodity markets. With information from the Energy Information Administration of the United States (EIA) predicting that oil prices will only rise to about $ 70 a barrel by 2020, diversification of the Colombian economy and internal reform are the best methods to take in attempting to absorb the impact of falling oil prices. Oil prices remain at their lowest and according to the 2015 IMF Survey, this is as a result of two main factors: (1) Change of strategic operations by OPEC and (2) the entry of hydraulic fracturing (fracking) causing an increased supply of oil onto the market 120,0 Figure 2. WTI price vs. European prices FOB (Brent) v. Average exportation price for Colombia 100,0 80,0 60,0 40,0 20,0 - Cushing - WTI Spot Price FOB Europe Brent Spot Price FOB ** Exportation price of Colombian crude Source: IEP-ACP According to Colombia's National Administrative Department of Statistics (DANE), oil exports accounted for an average of 47% of all Colombian exports in the last two years. As expected, the impact of the falling oil price has been felt the most within the oil industry. Ecopetrol, Colombia s largest and leading oil company has experienced a drop in oil prices and lost market value. In 2015, Ecopetrol experienced a loss of 50% in its share price and valuation has been reduced to about $ 10 billion - One of the lowest performing companies in its sector; "Share price of the company has been reduced by more than half in 2015 alone, the worst performance of any other oil company in the world, with a rating of at least $ 10 billion. - Nick Cunningham (December 17, 2015, price.com Oil) ". Instantly, the immediate impacts are obvious: Reduced oil revenues and strict backgrounds. Colombia is an exporter of oil and not an oil dependent country therefore, improved strategic and economic decisions must be taken to survive the current economic situation. 2

3 U$D Millions % participation of the petroleum sector Despite initial concerns, there is a lot of optimism for the Colombian economy, now more than ever. According to the Oxford Business Group, in Colombia, increased consumption, a continually improving global image and a 40% devaluation of the Colombian economy, means there is still a healthy influx of Foreign Direct Investment Figure 3. FDI trends (USD million) & the oil industry s FDI contribution towards the total FDI (%) 100% % 60% % 20% 0% (2.000) -20% -40% Source: IEP-ACP Petroleum Sector Rest of the Sectors % participation of the petroleum sector The 2015 IMF Survey 2015 suggests that with the planned structural economic reforms (such as the formalisation and flexibility of the labour market and pensions) Colombia will experience more economic growth. According to BBVA Research forecasts, economic growth in the Pacific Alliance will mostly come from three countries, Paraguay, Peru and Colombia. There will be a combined growth of 2.4 % from these countries. Despite the uncertainty in the global oil industry, Colombia is forecasted for economic growth - with an increased focus on infrastructure development within the next five years. A floating exchange rate also means that the peso has been allowed to depreciate simultaneously with the oil price. This has not only reduced the impact of falling oil prices, but has also allowed other commodity exports, such as textiles, coffee and manufactured products to become increasingly competitive in the global market. This will help foster stronger economic activity and reduce the trade deficit. 3

4 Index of Economic Freedom Diagram 1. Economic impact of the falling oil Price Oversupply of oil on the world market Falling oil prices leading to reduced revenue streams for the Colombian economy Reduced demand for the Colombian peso Depreciation in value against the dollar, Euro and the pound sterling. Imported goods and services become more expensive Increased purchasing power for foreign consumers Stimulation of local goods and services as imported good are too expensive. Globally, governments perform better when they stimulate private investment and gain taxes, royalties, concessions and also through the sale of assets and licenses. Compared to other emerging markets, data from the 2016 Index of Economic Freedom suggests that Colombia is far ahead of its peers in terms of performance. There is still foreign capital inflows into Colombia and when compared to other emerging markets, Colombia has a higher growth rate higher than the Indonesia, Vietnam, Turkey, etc. The current situation of falling oil prices should trigger economic managers in Colombia to find new sources of income and diversify sources of contribution to GDP Figure 4. Index of Economic Freedom for the five favoured emerging markets against the World average Source: 2016 Index of Economic Freedom Colombia Vietnam Indonesia Egypt Turkey World Average 4

5 GDP ($billions) % change in the volume of exported goods Colombia's gross national savings ( % of the GDP) 22 Figure 5. Colombia s gross national savings This graph shows the forecasts for the gross national savings Colombia for up to As shown in the graph, the deficit in 2014 was due to the significant drop in oil prices greatly affected the global oil market, this is also an impact on the main earner Colombia. Figure 6. Percentage change in the volume of exported goods This graphic shows the forecast percentage change in Colombia in the volume of exported goods. With economic growth forecast due to the reform of the infrastructure and taxes, the analysis of these data suggests that a diversification of its economy, with a focus on internal growth, positively increase the percentage change in the volume of exported goods. This trend is not uniform in time, but there is another increase in Figure 7. Colombia s annual GDP Annual GDP of Colombia seems to be increasing every year and this is evident from their status as emerging market economy, but this figure does not tell the whole story. Using IMF data, calculated the percentage change in GDP growth each year is not constant through the year. Source: IMF, October

6 Foreign Direct Investment into the Petroleum Sector (M U$D) The analysis of the data is consistent with previous studies carried out by the International Monetary Fund (IMF) on, The medium-term outlook for Colombia after the fall in oil prices.. The data suggests that with the expected results, 2018 will be the year when the economic boom begins in Colombia, given that all other factors are held constant. Recommendations/Application going forward 1. Diversification of the economy: Colombia has an abundance of natural resources that can be exploited. Palm oil, fruits, sugar, fish, manufactured products, textiles, etc. are just some of the non-oil commodities that Colombia exports to the EU, the USA and Africa. With data suggesting that a floating exchange rate will fluctuate depending on earnings and economic activity, this will further boost the growth and development of the Colombian economy. The effect of the Colombian peso falling simultaneously with oil prices has already been widely discussed in this report. The export of other non-oil commodities means that these products are more competitive on the global market. Foreign consumers have more purchasing power in relation to the Colombian peso therefore, they are not only able to buy at competitive prices, but they can also buy in larger volume Figure 8. Foreign Direct Investment into the Petroleum Industry (M U$D) Source: Bank of the Republic 6

7 % flow of Foreign Direct Investment into the Colombian Peteoleum Industry Figure 9. Percentage flow of Foreign Direct Investment into the Colombian Petroleum Industry 60% 50% 40% 30% 20% 10% 0% -10% % -30% -40% Source: Bank of the Republic, Deputy Manager of Economic Studies Balance of Payments 2. Internal development: Income from sales, taxes or tariffs, licensing, and Foreign Direct Investment should be used to develop Colombian products and services in their homeland. The graphs of foreign direct investment in Colombia show that there is still a continual influx of FDI into the country despite widened fiscal and current deficits (- due to the shortfalls in oil revenue) 3. Infrastructural and tax reform: According to Reuters 2016, the objective of the proposed tax reform is to evenly distribute the tax burden among companies and larger individuals. The plan is to ensure that the reform takes care of everything from corporation tax to income tax to value added tax. It is also planning a new, scheme to expand the tax base. The effect of lower oil prices is that the Colombian government can afford to remove the current existing subsidies with lower political costs. A well structured and implemented tax reform displays the financial responsibility and awareness to avert the effects of the global recession underway within the oil industry. 7

8 Future of Colombia Proexport, an organisation that promotes international tourism, foreign direct investment and non-traditional exports from Colombia in 2013 identified at least 818 different exports and with free trade agreements with the USA and the EU, Colombia is well positioned to capitalise on this opportunity. The country can still afford to raise prices of exported commodities, and they would still remain relatively competitive compared to local prices for consumers in the EU and in the USA. The second avenue to explore in Colombia is tourism. According to the Bureau of Economic studies in Colombia ( MinCIT ) in 2014, tourism in Colombia was at a record high, as when compared to the previous year, the number of tourist visa travellers increased by 17.5 % (This figure is represented by nonresidents visiting Colombia ). With a growing reputation and global image, Colombia is ready diversify its tourist industry. Moreover, the World Tourism Organization, suggests that the rate of growth of tourism has greatly exceeded average world tourism growth ( 4.7% ) and continental growth in South America ( 5.7 %). With increasing Foreign Direct Investment and increasing tourist interest, government figures indicate a predicted $ 6 billion tourism revenue in Despite the proposed recommendations, this does not imply that the oil industry in Colombia has reached its full potential. The oil price varies globally through various time cycles. Oil and gas experts predict that with a growing world population, there is still a need for massive power generation on the scale at which fossil fuels can operate. The impact of the diversification of the Colombian economy will be beneficial for the oil industry. According to the PwC 2014 report on the oil industry in Colombia, the main problems lie in the development of the infrastructure within the oil industry. There is insufficient capacity and infrastructure necessary to improve the recovery factor from existing fields, as well as other factors. An improving economy presents an environment for the development and progression of oil and gas infrastructure. This will be the impetus to revive the oil industry in Colombia and set it off on an upward trajectory. 8

9 Conclusion Colombia is in a transition phase. With the shortfalls in oil revenue, the initial analysis may suggest a negative impact on the economy, but taking into account other variables with a more detailed analysis, there is an abundance of opportunity and optimism. Combining the current economic climate, floating exchange rate and a strong financial background to constantly and continually increasing foreign direct investment, Colombia is ready to diversify its economy, change its focus away from oil exports and start developing its very poten non commodity market. 9

10 Bibliography Carpenter, J. (2015). The Biggest Oil Producers in Latin America Investopedia. Investopedia. Retrieved 4 February 2016, from Dos Santos, E., Posadas, C., Faci, A., Cubero, J., & Falbo, R. (2016). Growth will stay low in Latin America in 2015 and BBVA Research - Latin America Economic Outlook, Retrieved from Eu.procolombia.co,. (2016). European Union Agreement: The "Mega-highway" of Opportunities Trade Agreement Colombia - European Union. Retrieved 4 February 2016, from Fagenson, Z. (2016). Colombia tax reform set for 2016: finance minister. Reuters. Retrieved 4 February 2016, from Fernando Madero, J. (2015). Challenges and opportunities in Latin American legal markets in 2015 and 2016 Thomson Reuters. Thomsonreuters.com. Retrieved 4 February 2016, from Garzón, M. (2016). Challenges for 2016 in Latin America - BBVA NEWS. NEWS BBVA. Retrieved 4 February 2016, from Husain, A., Arezki, R., Breuer, P., Haksar, V., Helbling, T., Medas, P., & Sommer, M. (2015). Global Implications of Lower Oil Prices. Staff Discussion Notes, 15(15), 1. Shobhith, S. (2016). Investopedia. How OPEC (and Non-OPEC) Production Affects Oil Prices. Retrieved 4 February 2016, from OPEC (and Non-OPEC) Production Affects Oil Prices Weak growth in emerging market economies: What does it imply for commodity markets?. (2016). Commodity Markets Outlook, Global Economic Prospects - World Bank,