Oil Price Increase and The Colombian Government: From Honeymoon To Nightmare

The Colombian economy has benefited from the increase in oil prices during the last couple of years, which has stimulated exports and foreign direct investment in the country, and the payment of higher dividends and taxes by Ecopetrol, the state-owned company. In 2007, oil exports increased by 15,6% and FDI in the oil sector grew by 90%, reaching US$3.4 billion in 2007. By the same token, in 2007 the government received US$1.5 billion in dividends from Ecopetrol, 50% more than in 2006. But the recent increase in oil prices has turned into a nightmare for the Colombian Government due to its negative impact in the fiscal and exchange rate fronts.

The reason is that, beginning in 2006, the government decided to gradually eliminate fuel subsidies (according to the original plan, gasoline subsidies would be completely eliminated by 2008 and diesel subsidies by 2009). In addition, to turn Ecopetrol’s refining business into a competitive one, beginning 2007 the government is required to actually pay for the difference between its export price, and the local price the company receives from its gasoline and diesel sales. This is to compensate Ecopetrol for the portion of the oil that is does not export, but rather stays in Colombia to supply the local market, but at a much lower price.

For 2008, the government’s budget included a US$700 million subsidy payment (assuming an average WTI of US$70/barrel), but because of the increase in oil prices, just for the first four months of the year, the amount of subsidies almost doubled the initial estimate, according to the preliminary figures of the Ministry of Finance. This means that, if prices remain at current levels, the government will have to pay Ecopetrol and the Cartagena Refinery (owned by Ecopetrol and Glencore) a total of US$2.7 billion, the same amount it will receive in dividends in 2008. As a result, the oil windfall for the government (excluding the additional income tax payment) will amount to zero for this year, and could even become negative.

But this is not the only headache for the government. The exchange rate has appreciated by 14% year-to-date. Last week, the Colombian peso reached its 9-year low. In addition, inflation is now at 6.4%, well above the latest estimate of the Central Bank for 2008 (4.9%). Even excluding the food component of the CPI, inflation has been increasing as a result of higher gasoline and diesel prices, which affects public transportation prices, among other things.

Between January 2006 and May 2008, gasoline prices have increased 24% and diesel prices 42%. In order to reduce the impact of increasing oil prices, the government has adopted some measures. First, it announced that the elimination of subsidies would be delayed, to mitigate the price increase to consumers. Second, the government proposed to change some of the variable gasoline taxes, for a lump-sum tax. In addition, to reduce the negative cash flow fiscal impact, the government will pay Ecopetrol the subsidies generated this year only until 2009, when the company pays dividends. Third, desperately trying to control the appreciation of the peso, the Ministry of Finance announced last Friday a tightening of capital controls, including a minimum 2-year stay requirement for any FDI. Finally, President Uribe said that taxes paid by private oil companies will be increased in future contracts, in order to compensate for the payment of subsidies.

What all this shows is that, at this level, oil prices are becoming a difficult problem to manage, even for oil producing countries like Colombia.

One Response to "Oil Price Increase and The Colombian Government: From Honeymoon To Nightmare"

  1. Anonymous   February 24, 2009 at 1:15 pm

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