Ecopetrol Downgraded By Moody’s To Baa3/ba3, Persistent Low Oil Prices Cited

Moody’s Investors Service announced yesterday that it has downgraded Colombia’s government controlled petroleum company Ecopetrol’s senior unsecured ratings to Baa3 from Baa2. At the same time, the company’s BCA (Baseline Credit Assessment) was lowered to ba3 from baa3. The ratings are on review for further downgrade.

Above photo: A tanker takes on 200,000 barrels of gasoline & 50,000 barrels of Jet-A aviation fuel destined for the US & some Caribbean islands, refined at Ecopetrol’s Reficar refinery in Cartagena (photo courtesy of Ecopetrol).

Headquartered in Bogotá, Colombia, Ecopetrol S.A. (Ecopetrol) (BVC:ECOPETROL)(NYSE:EC)(TSX:ECP) is the largest integrated oil and gas company in Colombia. It is responsible for over 60% of total Colombian oil production and has a proved hydrocarbon reserve position of roughly two billion barrels of oil equivalent at the end of 2014. For the twelve months September 30, 2015, the company generated revenues of $22.5 billion USD and it had total assets of $59 billion through three business segments:

1. Exploration and Production (E&P, 51% of revenues and 56% of EBITDA for the last twelve months ended September 31, 2015)
2. Refining activities (34% of revenues and 5% of EBITDA)
3. Transportation and logistics (15% of revenues and 39% of EBITDA). Its production averaged 740.9 mboe (million barrels of oil, equivalent) in the third quarter of 2015, 2% below that of the year before.

Ecopetrol’s ratings downgrade was triggered by persisting stressed oil prices, which will continue to negatively affect the company’s cash flow generation and credit metrics, increasing its credit risk. While Ecopetrol has no material debt coming due in the next two years, weaker cash generation and higher leverage, coupled with limited funding availability overall for the oil industry, will hurt the company’s ability to continue with its capital spending program to sustain reserves and production.

Ecopetrol responded in a statement, that (translated from Spanish) “The company continues its efforts to reduce costs and protect the generation of revenues in light of the continued slump in international petroleum prices. The enterprise has embarked on a transformation plan that reduced costs by $2.2 billion COP in 2015. Ecopetrol is launching new efficiency and cost-savings initiatives for 2016.

Moody’s joint-default analysis continues to assume a high probability of support from the government of Colombia (Baa2 stable). In addition, the agency’s assumption for default dependence between Ecopetrol and the government continues to be moderate. This assessment now results in a three-notch uplift of Ecopetrol’s senior unsecured rating to Baa3 from its ba3 BCA.

Moody’s review of Ecopetrol’s Baa3 senior unsecured ratings and ba3 BCA will focus on the degree of the impact that depressed oil prices will have on the company’s cash generation. The analysis will also consider opportunities that the company may have to reduce costs further, as well as on its flexibility to adjust capex down or sell assets in order to protect liquidity. In addition, Moody’s will assess the government of Colombia’s ability to support the company on a timely manner.

Downgrades:

• Issuer: Ecopetrol S.A.
• Issuer Rating (Local Currency), Downgraded to Baa3 from Baa2; Placed Under Review for further Downgrade
• Multiple Seniority Shelf (Foreign Currency), Downgraded to (P)Baa3 from (P)Baa2; Placed Under Review for further Downgrade
• Senior Unsecured Regular Bond/Debenture (Foreign Currency), Downgraded to Baa3 from Baa2; Placed Under Review for further Downgrade

Outlook Actions:

• Issuer: Ecopetrol S.A.
• Outlook, Changed To Rating Under Review From Stable

Ratings Rationale

Despite Ecopetrol’s strong efforts to improve operating efficiencies and reduce capex to protect its liquidity position, the company’s credit metrics will deteriorate further as a consequence of persistent low oil prices. “Moody’s estimates that Ecopetrol’s leverage will exceed 5 times by the end of 2017, from 3.3 times in September 2015, with low prospects of recovery in the medium term”, said Nymia Almeida, a Vice president and Sr. Credit Officer at Moody’s.

The company’s Baa3 ratings and ba3 BCA continue to reflect Ecopetrol’s status as Colombia’s leading oil and gas producer, accounting for about two-thirds of the country’s production and 100% of the supply of oil products. The ratings also take into consideration that Ecopetrol counts upon stable cash flows from its midstream subsidiary, which includes Ocensa (Baa3 positive).

In late 2015, Ecopetrol announced a cut on its 2016 capex program to $4.8 billion USD, which compares to the $6.7 billion previously planned for the year, and to the $7.4 billion spent in 2014. Over 60% of Ecopetrol’s capex is focused on exploration and production. Lower annual capex starting in 2016 will be driven mostly by reduced investments in downstream, which will decline materially during the year as the upgrade of the Reficar refinery approaches completion, expected by the company for the first half of 2016.

Moody’s expects that, during this period of lower operating cash flows, the government take as a percentage of the company’s net income will remain below the usual 80%; the ratings agency notes that the dividend payout ratio in 2014 (paid in 2015) was 70%.

Ecopetrol has a weak liquidity position that includes $3 billion USD of cash and cash equivalents as of September 30, 2015 to cover the company’s short term maturities of about $1 billion for 2016 and 2017 plus interest, capex and dividends. For the next twelve to eighteen months, Moody’s expects a weakened EBITDA in the USD1.5 billion neighborhood, along with $4.8 billion in annual capex, and around $3 billion in interest, dividends and taxes. Further depreciation of the Colombian peso would affect the company’s financial flexibility, despite it generating around half of revenues and EBITDA in US dollars, because about 85% of its debt is denominated in hard currencies. While Ecopetrol could sell certain non-core and core operating assets, this would be a challenge under current oil market conditions.

The principal methodology used in these ratings was Global Integrated Oil & Gas Industry published in April 2014. Other methodologies used include the Government-Related Issuers: Methodology Update published in July 2010. Investors, analysts, and other interested individuals may see the Credit Policy page on www.moodys.com for a copy of these methodologies.

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