Colombia’s Declining Oil Output Threatens Sustainability of Long-term Economic Growth

Declining oil production is a dark cloud that looms over the long-term sustainability of Colombia’s economic growth. The Latin American country’s oil output has experienced a significant downturn in 2014. In the first seven months of the year, production averaged 979 thousand barrels per day (bpd), somewhat below the government’s target of 1.095 million bpd and down from last year’s peak of 1.030 million bpd. Foreign investment in the hydrocarbons industry has also leveled off. FDI directed towards the oil sector fell 10% in 2013 YOY, and reached a mere US$655 million in Q1 2014, the lowest in any quarter since 2010, continuing the downward trend.

Why is Colombia’s declining oil output concerning?

The oil industry has been a key driver of Colombia’s impressive economic performance over the past few years with oil output nearly doubling between 2003-2007. Oil exports now make up over half of all export earnings and represent around 12% of GDP. Given the importance of oil production to the Colombian economy, declining output has two principal implications for multinationals to consider:

1. The Colombian government relies on oil rents to fund its expansionary fiscal agenda.  Reduced oil output will strain the government’s coffers at a time when it has pledged an increase in social projects and infrastructure development, but is simultaneously constrained by low tax revenues and legal limits on its ability to finance expenditures through debt issuance.

2. A decline in output increases the possibility of decelerated economic growth over the long-term.  According to the Colombian Petroleum Association, if output levels drop even slightly below current production levels, by 2016 Colombia could start to see an expansion of its trade deficit, which could widen from -2% of GDP in 2013, up to 4.2% within the next five years.  Similarly, overall FDI levels could fall from 4.4% of GDP in 2013 to 2.2% in 2016.

Colombia-Hydrocarbon

Why is oil output falling?

 There are three principal factors driving the decrease in oil production:

1. Regulatory hurdles: Significant delays in awarding environmental permits and stressed relations with communities have slowed production and have discouraged investors who see Colombia’s strict environmental regulations and structural bottlenecks as increasingly risky.

2. Sabotage against oil infrastructure: 2013 and 2014 have seen a substantial increase in acts of sabotage against oil infrastructure from Colombia’s guerilla groups. If peace negotiations were to fall through, Colombia is likely to experience a deterioration of its security environment, which would further depress oil output.

3. Low reserve replacement rates: Oil companies have been unsuccessful in finding significant new reserves. Officials estimate that current oil reserves will only last 6.5 years, and reserve replacement rates declined 67% between 2009–2013.Decelerating FDI suggests that the rate of reserve replacement will continue on a downward trend.

How could this trend affect FSG’s clients?

  • Given the dependency of the Colombian government’s fiscal agenda on oil rents, a decline in oil production will force the government to either cut fiscal spending or to look elsewhere for means to finance its initiatives, thus raising the probability of an increased tax burden on consumers and/or corporations.
  • A future deterioration of Colombia’s balance of payments due to a decline in oil exports could cause the government to considerably increase its external debt.  An increase in public debt, particularly if combined with a deteriorating economy, would raise Colombia’s risk premium, thereby increasing interest rates and borrowing costs for businesses seeking to invest in Colombia.
  • The overall pace of economic growth would slow, as oil rents are infused into the internal sector.  This would imply that companies planning to expand their presence in Colombia might have to reconsider their assumptions of Colombia’s long term growth trajectory.

If you wish to learn more about how this trend could affect businesses in Colombia, consider reading our full Q3 quarterly report, which you may access here. Not a client? Contact us for more information.

 

Colombian Elections to Be Decided in Runoff, With Peace Talks Hanging in the Balance

Colombia held first-round presidential elections in late May, and while Uribe-backed opposition candidate Óscar Iván Zuluaga came out ahead of incumbent President Juan Manuel Santos, neither candidate came close to garnering 50% of the vote, necessitating a runoff. Assuming that Zuluaga is able to pick up the votes of supporters of conservative candidate Marta Ramírez and President Santos is able to garner those originally intended for Obregón and Peñalosa, Santos has a chance of eking out a close victory, though the ultimate outcome remains contingent upon who turns out to vote. The most recent polls place the two men in a statistical dead heat.

Colombia Runoff

While multinationals have little to fear in that both candidates are expected to preserve Colombia’s macroeconomic stability and pro-business policies, the candidates differ with respect to peace talks between the government and the FARC. President Santos supports continuing the talks which he helped to initiate and on which he has staked his reelection campaign, while Uribe-backed Zuluaga opposes talks and says he would demand a unilateral ceasefire before agreeing to resume negotiations. The possibility of a peace deal has already helped deliver security gains and has been a driving force behind the robust FDI inflows Colombia has seen in recent years, and thus, a victory for Zuluaga has the potential to undermine some of this momentum.

Colombia’s economy remains resilient despite falling commodity prices and rising social tensions

ColombiaMultinationals have for years considered Colombia one of the safest long-term bets in Latin America, but over the last several months a more negative picture of the country has emerged. Colombia, much like other emerging market countries, has faced weakening external demand and currency volatility in recent quarters. The country has also faced prolonged protests from farmers and laborers against recent currency volatility and lower trade barriers impacting them. Despite all this, Colombia’s economic performance has remained remarkably robust.

FSG expects that Colombia will see 3.8% YOY growth in 2013, with the economy accelerating to 4.6% YOY in 2014, driven by stronger consumer spending and increased government spending, particularly in the first half of the year. Companies have experienced strong revenue growth in the first half of 2013, though local operations mention that increasing energy costs and operational disruptions due to recent protests are hurting both profit margins and productivity. While expectations for the economy and the country’s long-term potential remain strong among multinationals, companies continue interpreting news coming out of Colombia with a heightened sense of uncertainty.

It is against this economic backdrop that FSG believes multinationals should be tracking the following three trends during the last quarter of 2013 as an indication of how the business environment is likely to evolve over the medium term:

  • Increased demand for public services is leading to calls for tax hikes
    • Recent developments: The Santos government is responding to recent protests and recurrent troubles in the healthcare sector by promising increased spending, leading multinationals to expect higher taxes in the near future.
  • Social protests are disrupting operations and hurting confidence
    • Recent developments: Continued protests from unions and social groups across the country in recent months have created significant disruptions for the operations of multinationals in Colombia, leading to a dampening of short-term growth prospects and lower consumer sentiment.
  • The construction sector continues to be a strong driver of growth
    • Recent developments: The Colombian economy’s strong performance amid weakening external demand has been largely driven by resilient construction spending, particularly commercial and residential construction

Colombia’s strong fundamentals still point to resilient economic performance in 2014. While the external environment has remained difficult for exporters, Colombia continues to be among the strongest performers in the region. The potential for progress on peace talks with the FARC and the ELN, as well as higher government spending ahead of elections, should drive improved economic growth in 2014.

US-Colombia FTA Stumbles Out of the Gate, But Trade is a Marathon, not a Sprint: Highlights from FSG’s Bogota Interview with Expert Advisor Juan David Barbosa

Despite general optimism at the opportunities provided by the new US-Colombia Free Trade Agreement, FSG clients have reported unwelcome delays and roadblocks in efforts to take advantage of the agreement, as noted in our recent Quarterly Market Review of Colombia.

On a recent visit to Colombia, I sat down with FSG Expert Advisor Juan David Barbosa to discuss the first 9 months of implementation of the accord. Juan David specializes in trade law at the Bogota law firm of Posse, Herrera, and Ruiz, and previously served as the Deputy Director of Trade Remedies at the Ministry of Commerce of Colombia. Juan David has advised numerous multinationals on trade and market entry in Colombia, and was the featured expert in last year’s FSG teleconference on the new agreement.

The Promise

According to Juan David, the FTA’s would change the landscape for FSG clients, particularly those based in the United States or importing products to Colombia from the United States in the following ways:

  • Import tariffs on 80% of U.S. exports to Colombia would drop to zero, including strategic industries such as agriculture, construction, auto and aviation parts, medical products, and IT.
  • Legal and regulatory hurdles would fall as companies no longer needed local branches, suppliers were afforded more protection, and new rules made it easier to exit agreements with local companies.
  • Many of the key provisions of the agreement would enter into force between September of 2012 and March of 2013.

Because of these sweeping changes, 90% of FSG clients expected the FTA to be a factor in increased investment for their companies in Colombia, and 54% of FSG’s expert advisors said the FTA would provide significant advantage for US companies over competitors from other countries without such an agreement.

The Problem

According to Juan David, and in line with recent experiences of FSG clients, Colombia is lagging in implementation of a number of key provisions:

  • Intellectual property rights protections
  • Increased safeguards in agency agreements for multinationals
  • New rules on taxes of alcoholic drinks
  • Electronic certification of origin
  • Rules on urgent shipping requests
  • Implementation of sanitation codes equivalent to the United States

Accordingly, multinationals expecting the FTA to be a panacea for bureaucratic and logistical headaches are growing frustrated with delays of their products at customs and an unclear regulatory and compliance environment.

The Causes:

  • Bureaucratic Entropy:
    • The root of the problem, says Barbosa, is not with laws and regulations now on the books, but rather with the capacity and will of the institutions charged with enforcing and acting under them. Comprehension and processes to enact the new rules is lagging the actual implementation timelines. In short, Colombia’s bureaucracy has not kept pace with the rapid evolution in the rules of the game.
    • Infrastructure Constraints:
      • Likewise, the boom in trade with Colombia has created a parallel capacity constraint in logistics infrastructure. Ports and roads are clogged with an influx of goods. Construction and investment, while significant, has yet to catch up with the expansion in trade (see map below).
      • Protectionist Backlash:
        • Also concerning are recent import tariff hikes slapped on certain sectors of imported goods such as garments, textiles, footwear, agricultural goods, paper products, and some used machinery. While these don’t necessarily violate existing FTAs, they are indicative of political pushback from domestic manufactures threatened by the growth in imports. New free trade agreements, which have come into effect at the same time as a strong appreciation of the Colombia peso, have led to politically powerful domestic producers seeking relief in the form of protection and safeguards from the government.

Colombia port map

The Outlook

The good news is that the Colombian government has recognized that it may have bitten off more than it can currently chew in regards to implementing multiple trade agreements over a short amount of time with limited bureaucratic resources. In response, the government has spaced out the implementation processes of current and upcoming agreements and will promulgate new guidelines by mid-May, 2013. This may buy U.S. based companies more time with a head start in Colombia as upcoming FTAs between Colombia and the EU and South Korean could take longer than anticipated to come into full effect.

Less promising is the outlook for short term improvements in infrastructure bottlenecks. Though the government is currently investing heavily in construction of fixed infrastructure assets, project cycles are long and payoff takes years. Even here, the pace of investment has been hampered by bureaucratic constraints, as the second half of 2012 saw construction spending stumble because of poor project planning and lack of capacity to execute on the ambitious agenda.

Fears of a broader protectionist backlash are probably overblown. Colombia has a strong political orientation towards free trade, and is eager to establish itself as one of Latin America’s most open economies. All politics are local, however, and local producers have shown they have the power to win temporary measures to shield themselves from competition in certain cases. Multinationals, no matter the industry or the country of origin, would be wise to monitor the local political winds to anticipate if their products could be on the wrong side of a tariff.

The Big Picture

Despite these early difficulties, Juan David remains optimistic; “The FTA will mature and offer excellent opportunities for U.S. corporations. Both for more established multinationals and newer entrants, Colombia remains an excellent investment destination. In fact, Colombia is an increasingly attractive place for U.S. companies to open their first emerging markets operation. For now, however, the FTA is less than a year old. It is still a newborn baby and has a lot of growing up to do”, stresses Juan David.

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Juan David BarbosaJuan David has more than 10 years of experience in customs and international trade proceedings and litigation, as well as in the development of import-export tax efficient strategies. Juan David has also worked in several international unfair trade practices (dumping) and safeguard investigations, as well as in the negotiation and implementation of free trade agreements. Before joining Posse Herrera & Ruiz, he worked in the Colombian Government as Deputy Director of Trade Remedies at the Ministry of Commerce, Industry and Tourism where he was responsible for all anti-dumping and safeguard investigations. He has a JD and a graduate degree in Taxation from Pontificia Universidad Javeriana and an LL.M. in International Business and Economic Law from Georgetown University.

 

 

Latin America’s Moment: Making the Case and Capturing Opportunity

Making the Case for Latin America Has Historically Revolved around the Region’s Untapped Growth Potential

Making the case for resources has long been a challenge for emerging markets executives—while emerging markets represent tremendous growth opportunities, they have historically been viewed as risky, volatile, and fragmented, undermining corporate willingness to commit large amounts of resources. On a regional level, many of the Latin America executives we work with have expressed frustration at having to defend the region’s potential when top-line growth has been higher elsewhere in the world, particularly in Asia.

At Frontier Strategy Group, we have long strived to help our clients overcome such skepticism and communicate upwards effectively by emphasizing the region’s hard-won macroeconomic stability, relatively under-penetrated markets, and growing middle class. While these drivers remain in place and multinationals’ growth targets for Latin America are now on par with those seen in Asia, sluggish global growth has raised the stakes, and emerging markets are increasingly expected to deliver both top- and bottom-line growth.

However, Sluggish Global Growth & Underperformance in 2012 Have Undermined Confidence in Latin America

In the wake of Venezuela’s recent devaluation and the death of President Hugo Chávez, as Argentina continues to impose heterodox capital and import controls and Brazil edges towards stagflation, it is easy to understand why multinational executives face growing skepticism from risk-averse corporate centers as they strive to make the case for resources in Latin America.

Fortunately, Executives Compelled to Reassess the Region’s Potential Can Walk Away Reassured

While we certainly acknowledge the endogenous and exogenous factors undermining Latin America’s near-term outlook, we remain bullish about the region’s potential over the medium-to-long term, and our optimism is grounded in a demonstrable belief that the region’s core advantages have in fact remained intact, and will be reinforced by positive secular trends.

Not Only Do Latin America’s Core Advantages Remain Intact…

Latin America’s core advantages can be divided into four buckets, including profitability, relative growth, stability, and concentrated financial resources. Of these four advantages, profitability stands out as the most salient given the pivot to profitability that emerging markets executives are experiencing. As growth remains stalled in developed economies and corporate places increasing pressure on emerging markets, 73% of FSG clients in Latin America have experienced or expect to experience a shift in corporate emphasis towards bottom-line growth over the near-term. With this in mind, it is certainly reassuring to consider that available data on publicly traded companies indicate that average operating margins in Latin America are 55% higher than in the BRICs excluding Brazil.

At present, Latin America derives its profitability advantage vis-à-vis other emerging market regions primarily from a host of demand-side factors which allow multinationals to sell at higher margins and maximize the gains associated with realizing economies of scale. However, these advantages have the potential to diminish over time as competition within the region increases, meaning the time to build market share and brand loyalty is now.

When it comes to GDP growth, while the pace of growth in other emerging markets is expected to decelerate in comparison with pre-crisis rates, LATAM has remained relatively resilient and will accelerate in the coming years.

If you’re tempted to dismiss growth and profitability out of fear of resurgent instability, think again. More conservative corporate centers have historically associated Latin America with hyperinflation, uneven growth, and overexposure to commodity boom-and-bust cycles. Part of the story we’re striving to help our clients communicate is that while these sorts of risks persist in specific markets, the region as a whole has progressed tremendously thanks to orthodox macroeconomic reforms.

Inflation targeting regimes, reduced deficit spending, and the liberalization of trade and capital flows have brought down inflation, empowered consumers and provided the stability necessary for sustained growth. Latin America also remains well-positioned to ride out any future global downturn, as its economy is less dependent on trade than APAC, and less integrated into the global financial system, reducing the risk of Eurozone contagion. Concentrated financial resources also bode well for B2C and B2B multinationals—per capita private consumption spending and government expenditure in LATAM outpace other EM markets including India and EMEA, and are on par with China.

But investment and reform are positioning the region to build on these strengths moving forwards, unlocking new opportunities for multinationals:

Most importantly, Latin America is well-positioned to build on these core advantages, and secular trends are already yielding proof points. Trends we’re tracking range from Peña Nieto’s ambitious reform agenda and the resurgence of manufacturing in Mexico to Colombia’s peace dividend and Peru’s rapid rise. On a pan-regional level, energy resources will bolster government coffers and empower investment in infrastructure and human capital, while the rise of the Pacific Alliance will provide a decidedly pro-business counterweight to the increasingly anachronistic Mercosur. The region is on the rise, and there has never been a better moment to make—and win—the case.

PODCAST: Colombia’s Balanced Growth Model Under Strain

Podcasts Blog

Listen as Frontier Strategy Group’s CEO, Richard Leggett, interviews Senior Analyst for Latin America, Antonio Martinez, regarding trends likely to impact multinationals’ performance in Colombia during Q1 2013.

Key points discussed include:

1. Multinationals have seen the benefits from recent free trade agreements somewhat delayed due to difficulties in modernizing customs processes and delayed government implementation of some of its commitments

2. The Colombian government is expected to propose more pro-investment reforms in the mining and hydrocarbon industries in 2013, which will lead to greater inflows of foreign direct investment into these industries. This could exacerbate the imbalances in the economy that are hurting the manufacturing sector

3. The financial duress facing Colombia’s healthcare system will lead the government to increase its role in the country’s private healthcare markets and to be more assertive in its use of reference pricing for patented products

To listen to or download the podcast, click on  this link to access the iTunes store.

Multinationals Reevaluating Growth Targets in Latin America

Weaker regional growth in the first half of the year has driven multinationals to reevaluate their growth targets for 2012 as Argentina’s business landscape grows increasingly unnerving, Brazil’s economy slows, and devaluation risks in Venezuela swell as President Chavez drives up fiscal spending as part of his reelection campaign. However, many regional executives are looking towards new opportunities in Mexico as higher labor costs in China and election of business friendly Enrique Peña Nieto leads executives to believe the new administration will be able to implement structural reforms aimed at boosting higher and sustainable long-term economic growth. Meanwhile, many multinationals are undeterred by the weaker first half growth as they continue to invest in Brazil, hoping that government stimulus measures to revive consumer spending and industrial production in Brazil in the second half of 2012.

Argentina: Multinationals are dealing with an increasingly dire business environment by decreasing investments and lowering growth expectations

Brazil: Foreign investors shake off short-term woes as some multinationals position themselves for the long-term rewards that Brazil offers

Chile: The forecast is upbeat as production, consumption, and high consumer sentiment all point to a favorable economic outlook for 2012

Colombia: Colombia’s economy will continue to be a growth leader in 2012, but sluggish retail and falling industrial production dim its prospects

Mexico: Multinationals remain bullish on Mexico’s growth prospects as a new administration offers hope for necessary structural reforms

Venezuela: Multinationals remain cautious as ballooning fiscal spending contributes to rising currency devaluation risks for the beginning of 2013

Antonio Martinez and Erick Soto contributed to this piece.

Latin America – Emerging Markets Insights – June 2012


LATAM

Multinationals are taking note of the strength of the Andean economies of Colombia and Peru, but the increasingly negative outlook in Argentina and Brazil is weighing down growth in the region.  Stagnating industrial output and diminishing consumer demand in Brazil led economists to trim economic growth expectations to less than 3% for 2012. The race for the Mexican presidency heats up as PRI candidate Enrique Peña Nieto maintains a steady lead heading into the July election. Meanwhile, the race for Venezuela’s presidency in October is underway contributing to market uncertainty as president Chavez registers to run for a third term despite his poor health.

For a more detailed insight on key trends in Latin America, here are the analyst headlines for our key markets:

  • Argentina:A thriving black market for dollars and widespread withdrawals from local banks signal a growing belief that boom times are over
  • Brazil: Multinationals are facing increasing headwinds as the effectiveness of government stimulus falls short of expectations and credit markets soften
  • Chile: Higher-than-expected export growth is keeping Chile’s economy buoyant, but protests continue to mar President Piñera’s government
  • Colombia:Colombia’s potential is no longer a secret, but popularity brings a pricey peso that is eroding competitiveness
  • Mexico: Multinationals look to Mexico as a safe haven to weather the European storm
  • Peru: Stellar performance is only somewhat dimmed by concern over tax reform increasing the cost of doing business in Peru
  • Venezuela: Oil-fueled spending is succeeding at supporting higher growth this year, but Chavez’s poor health is creating political uncertainty

*Erick Soto contributed to this piece.

May 2012 Latin America Outlook: Taking Global Volatility In Stride

Frontier Strategy Group’s clients are revising growth forecasts for Latin America’s major economies upwards as the outlook for the global economy begins to stabilize. Growth leaders are emerging in the Andean region, and we expect that Chile, Colombia, and Peru will contend for the highest growth rate in Latin America in 2012. Strong fundamentals are keeping the Mexican economy remarkably stable while Brazil continues to miss the mark. Finally Argentina and Venezuela’s risk profile is increasing significantly, forcing MNCs to reconsider whether the potential rewards warrant the blood, sweat, and tears.

For a more detailed insight on key trends in Latin America, here are the analyst headlines for our key markets:

  • Argentina: The nationalization of YPF has become the clearest indication of the Fernandez Administration’s hostility to investor concerns
  • Brazil: The Brazilian government remains committed to revitalizing the economy, but it has not yet had a discernible impact on industry
  • Chile: Strengthening domestic demand, higher copper prices and an improving international outlook point to continued strength for Chile’s economy
  • Colombia: Strong growth in an uncertain global environment is forcing Colombia to deal with an appreciating currency and rising wages
  • Mexico: Economic prospects appear to be stabilizing, but drug war violence sustains tension
  • Peru: Growing pains in spite of robust consumer spending
  • Venezuela: Chávez looks to foreign patronage to offset the deleterious effects of economic domination by decree

*Melissa Pegus, Senior Analyst – Latin America contributed to this piece

Capitalizing on Colombia to Achieve Aggressive Growth Targets

US President Obama’s visit to Colombia signals a significant shift in how Western multinationals are approaching the Colombian market. Juan Carlos Echeverry, Finance Minister, was quoted in a recent article in the Washington Post alongside Clinton Carter, Frontier Strategy Group’s head of Latin America research, about the Colombian miracle:

Clinton Carter, head of Latin America research, said that there is still “an outdated mentality” about Colombia but that it is becoming easier to convince investors of the country’s possibilities. Frontier Strategy Group works with more than 200 Fortune 500 companies, the majority of which have substantial investments in Latin America.

Carter ticked off the advantages of Colombia: a free-trade agreement with the United States, its location in the center of the hemisphere, institutions that are more stable than in some neighboring countries and a well-trained workforce.

“It’s a sophisticated business community that places a premium on education,” Carter said.

ThyssenKrupp Elevator, a division of the German conglomerate, said Colombia is now its fastest-growing market in Latin America. The company is installing elevators and escalators in the country’s airport projects and newly built malls and is bidding on other projects, said Stuart Prior, the Texas-based chief operating officer of ThyssenKrupp Elevator.

“It’s a place we decided 10 or 12 years ago to invest in, and each year it got better and better,” he said. “We saw this coming five or six years ago.”

The full article can be found here:

http://www.washingtonpost.com/world/the_americas/colombian-miracle-takes-off/2012/04/13/gIQAsnEdET_story_1.html