Continued risk to sustainability of Colombian oil industry
After a years-long oil boom, Colombia needs to open up new frontier plays to become a major regional energy player
Colombia has firmly established its place on the global energy map. The government has put attractive investment terms in place and stepped-up military operations have diminished the threat rebel fighters pose in Colombia’s oil-producing regions, spurring a years-long boom in oil production and investment.
But the country has much work to do to sustain its oil boom. Guerrilla attacks continue to plague the oil industry, making security a continued risk to operations and cost of doing business in the country. Relationships with local communities have worsened, which has led to an increase in conflict in Colombia’s oil patch. The country’s bureaucracy is struggling to manage the task of balancing environmental and local community concerns with the industry’s demands, slowing exploration and development. And the pace of new discoveries is failing to keep up with production.
“We believe strongly that through the next decade or so community relationships, security and the environment will be the bottleneck of oil and gas operations in the country,” Mauricio Alvarado, a partner at Norton Rose Group, who advises oil companies in the country told Petroleum Economist earlier this year.
The effects of that bottleneck are already evident. Oil production has stalled over the past year. Government data put oil production in August, the latest data available, at around 918,000 barrels a day (b/d), compared to 953,000 b/d in the same month in 2011. Average production through the first eight months of 2012 is around 932,000 b/d, up only slightly from 915,000 b/d in 2011.
Production has stalled just shy of the symbolic 1 million b/d mark that the Colombian government has long targeted. The government still holds out hope that the milestone can be hit soon as efforts to increase recovery rates from heavy oil projects such as Pacific Rubiales’ Rubiales and Quifa fields continue, though unlike in the past it now does not say when that might happen.
At the same time, the pace of new discoveries has failed to keep up with production, raising concerns over depleting reserves. At the end of 2011, Colombia had reserves of 2.259 billion barrels, equivalent to 6.8 years at that year’s production rate. That was down from 8.1 years in 2009, and the trend has likely continued in 2012 as the country has not reported any major discoveries. “We need to increase the reserves,” Orlando Cabrales, the head of the National Hydrocarbons Agency (ANH), the government’s oil industry regulator, said recently, indicating that the government wanted to see a reserves to production ratio of at least 10 years.
The government hopes to address its reserves issue by opening new hydrocarbon frontiers. That was the aim of Ronda Colombia 2012, the country’s latest licensing round, which put new acreage up for grabs in onshore basins that have yet to see significant exploration, including blocks with unconventional oil and gas potential, as well as offshore blocks off the country’s Caribbean coast.
Through the next decade or so community relationships, security and the environment will be the bottleneck of oil and gas operations
The first round of the auction on 17 October (the second round is scheduled for late November) was a mixed success. It drew investment pledges of over $2bn and attracted new players into the country. Gulfsands Petroleum, which has had exploration success in the Middle East, and London-based Heritage Oil & Gas, which made major discoveries in Uganda, bid for onshore acreage in the country’s heavily-explored Llanos basin.
Notable by their absence though were mainstays of the country’s upstream, such as Pacific Rubiales, which is the country’s largest oil producer aside from state-run Ecopetrol, Talisman, Petrominerales and Equion Energy. Some have seen this as a demonstration of their unhappiness with the current state of day-to-day operations in Colombia.
International majors, for the most part, focused on the offshore acreage on offer. Shell, Statoil, Repsol and Anadarko bid for offshore blocks in the Caribbean, with all but Statoil likely to be successful in the first round (it will get a second chance in November).
The offshore region’s potential has been highlighted by Repsol and Eni’s Perla gas discovery just across the maritime border in the Gulf of Venezuela. Perla holds around 15 trillion cubic feet (cf) of gas in place, making it one of the world’s largest gas discoveries in recent years.
Development of the Perla discovery, though, has been delayed with first gas now expected in early 2013 instead of 2012 as previously planned. Moreover, Repsol and Eni have said that they hope to export the gas at some point, but Venezuela’s ambitious plans to build the costly infrastructure needed to export gas have gone nowhere. The ability to export the gas would mean Eni and Repsol would be able to tap markets offering higher prices than the domestic Venezuelan market. PdVSA has said it will pay $3.69 per million cf for gas from the Perla field. But exports are also not likely as long as Venezuela continues to struggle with domestic gas and power shortages.
Colombia, on the other hand, is self-sufficient in gas and already exports small quantities via pipeline to Venezuela. Moreover, the government has shown itself open to exploring options for liquefied natural gas (LNG) exports. Pacific Rubiales has received approval for a small-scale LNG export plant on the Caribbean coast to ship gas to Central America and the Caribbean.
The majors getting set to explore in the Caribbean, though, are thinking bigger. With the Panama Canal set to expand in 2014, it could open the door to exports from the Caribbean coast to Asian markets, which command a premium price for LNG imports. The country would also be well placed to ship gas to the European and Southern Cone markets.
Offshore exploration, though, remains at a very early stage as the first offshore wells were sunk earlier this year by Equion, a company created last year when an Ecopetrol-Talisman joint venture bought BP’s assets in the country.
Colombia also hopes to explore its unconventional potential. Colombia put 31 unconventional blocks up for bidding and had hoped that it would be able to attract investors with improved fiscal terms for shale investment. At a road show event in London ahead of the round, Cabrales said that Colombia’s La Luna shale formation, the focus of early shale exploration in the country, had drawn favourable comparisons with the Eagle Ford shale in the US and the Vaca Muerta shale in Argentina.
In the end, though, interest in the unconventional blocks was disappointing, with only five of the 31 blocks attracting bids. The turnout fell short of the government’s expectations. Just weeks before bidding, the head of Ecopetrol, Javier Gutiérrez, told Petroleum Economist that interest in the round was high. “It’s exciting because the majors are totally interested... many people are interested.”
Carlos Garibaldi, an executive at Argentine service company Tecpetrol, said that companies were unwilling to commit to a potentially expensive shale exploration campaign with the limited data on Colombia’s shale available.
He said that companies were also concerned that the unconventional blocks were located outside the country’s main oil patch, which would make consultation with local communities more complicated. Unconventional exploration requires intense activity during certain periods of exploration and development to bring in the large amounts of equipment needed for hydraulic fracturing. That could prove disruptive to local communities, particularly those that are not used to oil development.
Colombia may also have itself to blame for the lack of bids. The rules for bidding on unconventional acreage required minimum levels of reserves, production and capital, which precluded some smaller independent players from bidding in the round. One small independent active in shale exploration in Europe told Petroleum Economist earlier this year that it was interested in Colombia’s shale, but the bidding rules excluded it from taking part in the round.
The one bright spot that Colombia could take away from the unconventional round was that ExxonMobil, which is establishing a foothold in prospective shale plays around the world, bid for two blocks. The bid will add to ExxonMobil’s shale position in the country. The company paid $50 million for a stake in Canacol Energy’s Block VMM 2 in the east of the country earlier this year. The duo started drilling their first well targeting the La Luna shale in late September and plans to drill another well later this year. Clearly, ExxonMobil has seen enough from that early exploration work to increase its exposure to the La Luna shale.
Shell, too, is exploring the La Luna shale in the same area after signing its own deal with Canacol Energy. And although Shell did not bid on any of the blocks specifically designated as having unconventional potential, it did bid on block COR 46, which lies near its unconventional exploration programme and adjacent to one of the blocks that was being marketed as having unconventional potential.
The only other foreign investor to bid for unconventional acreage was Harvest Natural Resources.
State-run Ecopetrol, which has little shale drilling expertise, was the most active bidder. Ecopetrol says that it hopes to be producing 50,000 barrels of oil equivalent per day (boe/d) of shale oil and gas by 2020. Gutiérrez, though, said that the company will need help from foreign partners with experience developing shale projects in North America.
While offshore and unconventional production offer long-term growth prospects, over the short term Colombia will continue to rely on its oil-producing heartland in and around the Meta region. And it is here where problems are mounting.
Although military operations in recent years have allowed the government to take back control of much of the territory it had lost to rebel groups, security remains a challenge and major cost for operators in the country.
The industry, then, will be watching the latest round of peace talks with the Revolutionary Armed Forces of Colombia (Farc) intently. As the oil industry met in Cartegena on 17 October to submit bids in the latest licensing round and take part in the country’s biggest conference of the year, government negotiators were preparing to begin talks the next day in Oslo, Norway with Farc commanders.
The talks mark president Juan Manuel Santos’ attempt to strike an elusive peace deal with Farc, a diminished but formidable guerrilla group that at the peak of its insurgency, in the early 2000s, controlled around a third of the country.
Previous talks have broken down in acrimony, and while observers are cautiously optimistic, claiming Farc is a spent force, the two sides remain far from a peace deal. Farc commanders have singled out the oil and mining industries as a focus of their anger.
"The mining and oil economic engine is like a demon of social and environmental destruction," Luciano Marin, Farc’s lead negotiator told reporters after the first day of talks in Norway.
There has been no ceasefire agreement ahead of the talks, and some warn that attacks could increase during the talks as each side tries to maintain the upper hand. The other major guerrilla group still active in the country, the National Liberation Army (ELN), which has been left out of the talks, could also step up attacks to make sure its voice is still heard.
“The ELN are likely to increase their attacks against commercial assets to show the government that it is still a force to be reckoned with and that they deserve a place in negotiations. Such attacks are likely to remain confined to the ELN strongholds of Arauca, Norte de Santander, Nariño and Chocó provinces,” says Carlos Caicedo, director of Latin America research at London-based risk analysis firm Exclusive Analysis.
The numbers appear to show that attacks have indeed picked up ahead of talks. Attacks affecting oil and gas infrastructure or operations or are in areas important to the industry have increased from around 15-25 attacks a week in the Spring and Summer of this year to around 60 attacks a week over the past month, according to data compiled by Hydrocarbons Colombia.
In spite of the spike in guerrilla activity, Gutiérrez said that attacks were having a minimal impact on oil output. Ecopetrol expects attacks to cost it around 9,000 barrels of oil equivalent a day (boe/d) of production, a relatively small percentage of expected output of 780,000 boe/d for 2012. Ecopetrol, though, had to downgrade its estimated production in July this year from 800,000 boe/d.
Even if the attacks are not having a major effect on the industry’s activities in the country, a peace deal could go a long way towards addressing the perception among potential foreign operators that Colombia is a dangerous place to operate. It could also ease the security burden for companies in certain parts of the country where they feel a heavy army or private security presence is required.
Although it is the security issue that tends to attract the most media attention, operators say that an inefficient permitting process and troubled relationships with many local communities are the bigger challenge for the industry.
Operators face a bewildering bureaucratic maze when they go to the government for permits. The environmental, interior, defence, minerals ministries, as well as the ANH, all have jurisdiction over the oil industry, and where one departments authority ends and another begins can often be confusing.
The bureaucratic inefficiencies are causing significant delays to operations and is part of the reason exploration and production has slowed. Pacific Rubiales said recently that $200m, or 40%, of its 2012 exploration budget has not yet been spent because of delays to the companies environmental permits. It is a complaint that is echoed across the industry.
Perhaps the most important issue for the sustainability of Colombia’s oil industry, though, is improving relations with the local communities where companies are working. Recent years have seen a deterioration of relations between the industry and many local communities, resulting in a rise of protests and social conflicts in oil-producing regions.
Making a commitment
Table 1: Colombia oil production ('000 b/d)
There are many reasons behind the conflicts, but there is a general sense that local communities, which often lack basic services and infrastructure, are not sharing equally in Colombia’s oil boom. For the most part, communities would like to see development happen and enjoy the economic fruits of the oil industry, but they also want to be seen as an equal partner in the development process. Some in the industry have not approached local communities on an equal footing and that has bred ill will among many.
“We truly believe that companies need to create a joint future with the local communities starting from the beginning, even before the exploration stages,” says Carlos Velasco, a senior executive at Equion Energy.
Part of that means committing to social investment. The Colombian government will require a social investment of at least 1% of spending for blocks awarded in the 2012 licensing round. Experts, though, warn against seeing social investment in strictly dollar terms. Instead, they say, companies should seek projects with lasting benefits to the community such as establishing training programmes for local doctors, nurses or teachers.
Velasco also recommends working with other investors in the region to establish programmes to encourage local communities to set up small businesses that can service the incoming oil industry and other sectors of the local economy. “It has become impossible to operate without having a strong local content policy,” Velasco says, adding that there are “a lot of challenges in implementing these strategies”.
Changing the way some approach their relations with local communities, though, will be a lengthy process.
“For the next few years we are going to see companies oscillating between two scenarios,” says Monica Heincke, a specialist in sustainability and corporate social responsibility at Business for Life, a consultancy. “One, there will be companies that continue to be very [resistant] to change and are going to continue to do business the way they have been. This will lead to conflict with the local communities, and then the companies having to decide whether to stay or leave.”
She adds: “Scenario two will see more proactive companies... that are going to start looking to establish strategic alliances with local communities and governments. There won’t be any one model, but these strategic alliances will show the way.”
The responsibility of local development, though, cannot fall on the industry alone. The government has a leading role to play.
Central to that role is ensuring that royalties from oil production go back into the community. Here the government has taken steps to change the way royalties are distributed that has attracted criticism from local communities and governments, but could lead to some long-term improvements in the way oil royalties are spent at the local level.
The central government earlier this year revised the collection of royalties so that all payments now go to a central government fund instead of directly to local governments. Critics of the previous system say that it encouraged corruption and investment in vanity projects that delivered few lasting benefits at a local level. There is plenty of evidence to support that criticism. One state governor was fired earlier this year after being found guilty of authorising the embezzlement of millions of dollars in oil royalties, which were then funnelled to an investment company.
Another local mayor in the Meta region attracted scorn for using oil funds to stage an elaborate concert featuring Shaggy and Daddy Yankee, singer of the aptly titled reggaeton hit Gasolina, in a town with few basic services and infrastructure.
The new system commits royalties to the communities where they were generated, but decision making over how the funds are spent has been taken over by Bogota, which has said that it will do a better job of making sure spending is focused on critical services and infrastructure. Local communities, though, have complained that under the new system they have seen even fewer benefits than before.
As the central government focuses on using oil royalties to deliver long-term projects, companies are likely to come under increased pressure from local communities that had previously counted on local government spending directly contributing to local economies in a way that is not happening under the new system.
In the end, though, this is likely to be money well spent, as relations with those communities will be critical to future operations. “What I would caution is that you can get support from the government, but in the future it will be very difficult to operate if you can’t somehow get support from the local community. Support just from the government is not enough, it has be on both sides,” says Velasco.