Ecopetrol's (EC) CEO Juan Carlos Echeverry on Q3 2016 Results - Earnings Call Transcript

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Ecopetrol S.A. (NYSE:EC) Q3 2016 Earnings Conference Call November 15, 2016 8:30 AM ET


María Catalina Escobar - Head of Corporate Finance and Investor Relations

Juan Carlos Echeverry - CEO

Felipe Bayón - Executive Vice President

María Fernanda Suárez - Vice President of Strategy and Finance

Max Torres - Exploration Vice President

Hector Manosalva - Vice President of Development and Production

Patricia Zuluaga - Commercialization and Marketing Acting Vice President

Luisa Lafaurie - CEO of Cenit

Tomas Hernández - Vice President of Refining and Processes

Rafael Guzmán - Technical Vice President

Carlos Alberto Vargas - Vice President of Transformation


Frank McGann - Bank of America Merrill Lynch

Alexander Burgansky - Deutsche Bank

Madalena Costa - Morgan Stanley

Pavel Molchanov - Raymond James

David Gamboa - TPH


Good day, ladies and gentlemen, and thank you for standing by. Welcome to Ecopetrol Third Quarter 2016 Earnings Conference. At this time, all participants are in a listen-only mode to prevent background noise. [Operator Instructions]. We will have a question-and-answer session later, and the instructions will be given at that time.

And now, I would like to welcome and turn the call to María Catalina Escobar, Head of Corporate Finance and Investor Relations.

María Catalina Escobar

Good morning, everyone, and welcome to Ecopetrol's earnings conference call and webcast, in which we will discuss the main financial and operational results of Ecopetrol for the third quarter of 2016.

Before we begin, it is important to mention that the comments in this call by Ecopetrol's senior management can include projections of the Company's future performance. These projections do not constitute any commitment as to future results, nor do they take into account risks or uncertainties that could materialize. As a result, Ecopetrol assumes no responsibility in the event that future results are different from the projections shared on this conference call.

The call will be led by Mr. Juan Carlos Echeverry, CEO of Ecopetrol. Other participants include Felipe Bayón, Executive Vice President; María Fernanda Suárez, Vice President of Strategy and Finance; Max Torres, Exploration Vice President; Hector Manosalva, Vice President of Development and Production; Patricia Zuluaga, Commercialization and Marketing Acting Vice President; Luisa Lafaurie, CEO of Cenit; Tomas Hernández, Vice President of Refining and Processes; Rafael Guzmán, Technical Vice President; and Carlos Alberto Vargas, Vice President of Transformation.

We will begin the presentation with the main achievements of the third quarter of 2016, followed by the highlights by business segments and the financial results under International Finance Reporting Standards. We will close with the outlook for the full year 2016 and a Q&A session.

I will now turn the call to Mr. Juan Carlos Echeverry, CEO of Ecopetrol.

Juan Carlos Echeverry

Thank you, María Catalina. Welcome to all for attending this third quarter 2016 results conference. I am pleased to share with you quarterly results that confirmed the company’s strong operating performance and the success of its austerity, efficiencies and capital discipline measures, despite an oil price scenario that remains challenging.

Throughout the second half of the year, we are facing an uncertain local and international environment. The potential OPEC agreement to limit lower oil production has boosted prices. However this trend is not just solid as United States crude inventories remain high.

In Colombia, the results of the peace [indiscernible] and the proposed tax reform have had an uncertainty. Over the past quarter, Brent prices experienced considerable volatility but on average remained stable compared to the second quarter of 2016 at $47 per barrel. Ecopetrol maintains its spread of $9 per barrel, the same as in previous quarter, thanks to its commercial strategy of capturing greater value from the United States market.

Now let's look at the following slide to review in detail the quarter’s excellent operating performance. EBITDA and EBITDA margin reached the highest levels over the past five quarters of COP$4.9 trillion and 40%, respectively, once again proving Ecopetrol’s ability to maintain solid operating performance and a flexible response to events still in surrounding [ph]. The Group’s average production during the quarter reached 733,000 equivalent barrels of oil per day, a 4% increase versus the second quarter of the year. This result reflects the successful reversion to Ecopetrol of the Rubiales field operation and the startup production at Gunflint field in the Gulf of Mexico. It is in line with our total annual production goal of 716,000 barrels of oil equivalent per day.

Peak production at Gunflint field for Ecopetrol totaled 11,800 equivalent barrels per day in the third quarter. The Gulf of Mexico is a promising part of our exploration and production strategy for coming years. The reversion of Rubiales was accompanied by outstanding efficiency results. We achieved a record of six days of drilling per well in the field versus eight days prior to its reversion. We currently have 17 active recovery pilot wells in testing stage, 11 of which showed favorable production results.

Our commitment to efficiency in all business segments remains firm. Cumulative savings totaled COP$1.9 trillion, exceeding 2016 initial target of COP$1.6 trillion.

Finally, quarter end operating results reflected solid cash position of COP$7.7 trillion. These achievements reflect the entire company’s commitment to the operational and financial excellence needed for Ecopetrol’s sustained growth.

I will now turn over to Carlos Vargas, who will speak to you about the principal results of the business transformation plan.

Carlos Alberto Vargas

Thank you very much, Juan Carlos. As we have already explained in the previous report, in 2015, Ecopetrol set a goal to structural optimize its cost by gain of 2020 COP$4.5 trillion over the base cost of 2015. The strategy implemented has allowed Ecopetrol to incorporate in the third quarter of 2016, COP$1.9 trillion, which overcame the goal of COP$1.6 trillion expected this year. It is worth mentioning that Ecopetrol has incorporate in the period of 2015 to September 2016 a cumulative structural efficiencies for COP$3.4 trillion, led by six large groups of levers which amount for 80% of efficiency, among which there is upstream dilution transportation and operation and maintenance, and midstream operation and maintenance and supply change efficiency.

With this result, we expect to exceed by the end of the year the initial structural saving goal set for 2018, and we will continue consolidating efficiencies in the cost structure of our operations.

Now Rafael Guzmán would talk about production.

Rafael Guzmán

Thank you, Carlos. In terms of production, during the third quarter of this year, the equivalent production of the business grew by 4% compared to the previous quarter, reaching a total of 723,000 barrels of oil equivalent per day. This behavior is mainly explained by the increase in our participation in the Rubiales and Cusiana fields, the sustained production in Castilla and the beginning of production in the Gunflint field in the U.S. Gulf of Mexico. The behavior of the oil price allowed us to continue the strength in Castilla. Reactivating investments in Rubiales and La Cira-Infantas and restart production in the Caño Sur field which has been temporarily suspended due to lower prices observed during the beginning of the year.

These activities are part of our plan called 25K that seeks to increase production level to December, ensuring a better starting point for 2017. This shows the strength of our investment portfolio and Ecopetrol’s ability to restart activities in a short time. Starting it in July, the company successfully received Rubiales and Cusiana fields, ensuring an efficient operation and with no HSE incidents.

Considering that the investments in the Rubiales fields concentrate on infill drilling campaign, Ecopetrol has focused its efforts in obtaining time and cost efficiencies in drilling under its operations. Taking this into account, we are pleased to inform you that to-date we have obtained a reduction in drilling time close to 25%, from eight days in 2015 to six days in the current campaign. In cost, the reduction achieved is approximately 20% compared to the drilling campaign of 2015.

In terms of optimizations and efficiency, the following slide shows that the value of the lifting cost for the last 12 months is 14% lower than the one obtained during 2015. This result are based mainly in the well service, surface maintenance, energy and fluid treatments plants, which accumulated savings close to COP$100 million in years 2015 and 2016. In the same way, the components of heavy oil dilution in transport have concentrated the largest contribution in terms of sales.

Ecopetrol achieved a 20% reduction in the percentage of diluent required in heavy oil crude operation compared to year 2014. This reduction represents savings of around $400 million. In total, operating cost savings come around $500 million in years 2015 and 2016.

In terms of development costs, Ecopetrol continues reducing the cost and time of drilling activities. For the year 2016, we have reached record levels in drilling days in our assets Castilla and Chichimene, where the reduction is close to 40% compared to the levels of 2014. The newly incorporated Rubiales assets, as a direct operation, has also been benefited from the application of new technology and the improved drilling process that have been implemented in Ecopetrol as mentioned above.

As far as our increased recovery program is concerned, the following slide shows the progress achieved in two of the most important assets for our business plans, mainly Castilla and Chichimene. In Chichimene field, despite existing water injection patterns showed a positive pressure increase response and two of them have already shown an increase in production. In the patterns where there is an increase in production, the growth has been 82% over the natural decline base line of the prior period, which is equivalent to close to 2,400 barrels of oil.

The water injection pilot in the Castilla field started after Chichimene and continues to provide valuable information for the concentration of the technologies in the field. To-date this pilot has presented an increase in production of 60% close to 800 barrels of oil per day. Ecopetrol continues building the business cases for the expansion of the recovery technology in its field. The positive results of this pilot and the efficiencies achieved in the execution of investment will allow us to make viable expansions with their respective research in corporation at the prices established in Ecopetrol’s business plan.

Now I pass on to Max Torres, who will comment on the results of exploration.

Max Torres

Thanks, Rafael. Currently the following wells ended operation. Payero-1 located in Niscota block where Ecopetrol affiliates Hocol holds a 20% participation with Total of 50% and Talisman 30%, where the operator is Equion. Boranda 1 located in the Playón block where Ecopetrol holds 50% working interest and Parex holds a 50% working interest, and is the operator of the block. The well Warrior 1 located in Gulf of Mexico operated by Anadarko who holds a 60% working interest with NCX 15% and Ecopetrol America with the remaining 20%.

On the seismic campaign, the acquisition of 88 kilometers of the 3D seismic in Nogal block operated by Emerald was completed. Also 213 kilometers of the 3D seismic in the Cardón block operated by Ecopetrol was also completed. Both global blocks are situated in the Caguán-Putumayo Basin. In the YDSN 1 block, seismic survey in underway operated by Hocol and is expected to be completed by the end of December. The processing of the 3D campaign of 854 square kilometers of 3D in block POT-M-567 in the Brazil offshore in the Potiguar Basin is ongoing. Also in progress the operation evaluation of mature fields with diverse operation opportunities and to be included in the operation portfolio by year-end.

The outlook over the fourth quarter is to finalize the drilling of the wells Payero-1, Boranda 1 and Warrior Gulf of Mexico. Reinitiated drilling of the two more well located in the Canyon 2 [ph] block operated by Ecopetrol, the Pegaso well located in L.A., 26 block operated by Hocol and the Bullerengue-2 well operated by Hocol located in SSJN-1 block. Also to start the Purple Angel 1 Block in the Purple Angel block which is the appraisal well for the Kronos discovery and is operated by our partner Anadarko who holds a 50% working interest and Ecopetrol holds the remainder 50%. We are also preparing our 2017 exploration drilling campaign.

Now Luisa Lafaurie will comment on the Midstream results.

Luisa Lafaurie

Thank you, Max. Good morning. First, I would like to refer to the changes that are currently taking place in the Midstream.

For the past few years, the segment has developed a successful optimization process, which led us to increase our cash generation in a significant way. In September of this year, Cenit and Ecopetrol took further steps and decided to integrate its Midstream operations with the objective of the improving even more our operations and our maintenance planning activities. This integration seeks for new efficiencies in order to keep delivering the same good operational results despite a lower volume environment.

As for the operating results for the third quarter, during this period we transported 1,076,000 barrels per day, representing a decrease in 119,000 barrels per day which is 9.9% less versus the same period of 2015. Crude oil transported decreased 14.4% as compared to the third quarter of 2015, mainly due to the lower volumes produced by shippers.

Out of the total volume transported, approximately 65% belong to Ecopetrol. On the other side, the total volume of refined products transported increased 7.3% mainly as a result of a higher use of the Cartagena-Barranquilla system to fulfill the demand on the northern region. Approximately 20% of the total volumes transported to refined product pipelines belong to Ecopetrol.

Regarding our investment portfolio, the main projects continued the execution. In this sense, I would like to highlight that we start activities to implement the adjustment needed in our system to be able to transport higher viscosity crude oil to Coveñas Port for its further dilution and export. We also continue executing San Fernando-Monterrey project as planned.

In general terms, the outlook for the Midstream remains positive and we expect to continue adding value to the Group results.

With these, I hand over to Tomas Hernández, who will comment on the Downstream results.

Tomas Hernández

Thanks Luisa. During the third quarter of 2016, the Cartagena Refinery stabilization process and unit performance test continued. During this period, five units had the process design capacities tested, operational limits verified and operation stabilized.

The refinery stabilization process will continue into the fourth quarter of 2016 and first quarter 2017, and following completion of all unit performance tests, entire refinery operation will be stabilized and begin the optimization process to maximize this economic return.

In August, the Cartagena Refinery reached an average throughput of 130,000 barrels per day and throughput between 140,000 and 150,000 barrels per day during the last two weeks in September.

The gross margin of the Barrancabermeja Refinery was $13.4 per barrel, $3.3 lower than the third quarter 2015, mainly as a result of lower product price differentials against crude oil prices and alignment with international market trends. This negative impact on prices was partially offset by higher middle distillate yields due to the implementation of operational and process improvements, which increased refinery conversion. The throughput of the Barrancabermeja Refinery during the third quarter 2016 increased by 5,200 barrels per day compared to the third quarter 2015, due to the scheduled maintenance turnaround of our crude unit in 2015.

Now I turn the presentation over to María Fernanda Suárez who will comment on the financial results for the period.

María Fernanda Suárez

Thank you, Tomas. Good morning, everyone. Ecopetrol’s quick reaction to the low price environment, there is also the transformation plans, and a strict capital discipline allows to report outstanding financial and operating results in the third quarter of this year.

In this quarter, the Group reported an EBITDA of COP$4.9 trillion, which in turn results in a negative margin of 40%, the highest in the past five quarters. The Upstream and the Midstream segments remained the company’s main cash generators, contributing our 90% of the Group’s EBITDA during the quarter. These results reflect an effective reduction in cost and expenses, as well as higher oil production levels.

Please turn to the next slide for a summary of the Group’s income statement. With a stable Brent price, third quarter operating income totaled COP$12.2 trillion, up 4% increase over the second quarter of 2016, largely due to a 2.8% increase in sales volumes. The spreads versus Brent remained at $9 per barrel, thanks to the strategy of exporting to high value markets as the U.S.

Cost of sales totaled COP$8.7 trillion, down COP$324 billion from the third quarter of 2015. This net decrease is explained by: first, lower cost due to the results in our 50,000 barrels per day volumes of imported fuel giving the commissioning of the Cartagena Refinery; less frequent use of tanker trucks and cost reductions achieved through the company’s austerity and structural savings plans.

Second, depreciation charges totaling COP$2 trillion, 25% more than third quarter 2015. The increase derived from the incorporation of additional production from the Rubiales and Cusiana fields, the commissioning of the Cartagena Refinery unit and the capitalization of major maintenance expenses at the Barrancabermeja Refinery.

Third, other costs assumed as a result of the reversion of the Rubiales fields. Operating expenses totaled COP$905 billion, 17% less than in the third quarter 2015, primarily due to lower seismic activity and a smaller number of dry wells versus the same quarter of 2015. Gradually we see the seasonal trend in cost and expenses that we had anticipated increase this quarter. During the quarter, the company reported the highest operating profits of the entire year, COP$2.5 trillion.

Moving on to net financial income, the company posted expenses of COP$857 billion. Of that amount, losses due to exchange rate fluctuations totaled COP$170 billion, as a result of the impact of the peso appreciation on the net position in dollar. The third quarter provision for income tax was COP$1.2 trillion, equivalent to an effective income tax rate for the quarter of 73%. This percentage is a one-time adjustment derived from updating the tax rate estimated for the year-end close and required by International Accounting Standards 34.

The third quarter tax recognizes the retroactive effects of the year to yield represented annual income taxes, reflecting the improved performance of international oil price.

Finally, net profit attributable to shareholders for the third quarter of 2016 totaled COP$229 billion, 65% lower from the COP$654 billion result of the same period of 2015, due to the adjustment in the effective income tax rate on higher depreciation expenses, both of them non-monetary items that do not affect cash flow generation.

Ecopetrol was one of the few companies amongst the oil and gas industry that reported positive results year-to-date with a cumulative net income of COP$1.4 trillion and an EBITDA of COP$13.6 trillion.

Please turn to the next slide for the description of the Group’s cash flow. Cash generation in the third quarter continued to improve, thanks to solid operating results and tax reform from the Colombian tax authorities, totaling COP$2.7 trillion, COP$350 billion of these reforms were offset by withholding tax payments and the reminder received in tax securities.

The Group generated cash from operations totaling COP$6.5 trillion before taxes, 41% more than in the third quarter of 2015, and 57% more than in the second quarter of this year. Capital investments this quarter totaled COP$1.1 trillion.

Financing activities generated cash outlay of COP$1.9 trillion. As a result of such payments offshore interim financing obligation, financial interest and the payment of dividends by our companies in the midstream sectors to the minority shareholders.

The balance of cash and cash equivalent at the close of third quarter was COP$7.7 trillion. This solid cash position allowed the company to prepay an entire bilateral loan with Bancolombia for COP$990 billion. Ecopetrol’s resilience and ability to react quickly have allowed us to navigate the complex price environment and uncertainties of the financial markets, closing out the third quarter with better prospective.

We remain committed to seeking a structural efficiency. Our strong cash position reflects a solid financial capacity to carry out our investment strategies.

I will now turn this meeting over to the CEO, who will close our presentation with prospects for the close of 2016.

Juan Carlos Echeverry

Thank you, María Fernanda. In the first week of October, we updated the market on our 2020 business plan. We are firming our commitment to efficiency, cost reductions and capital discipline.

Having overcome the challenging crude price environment in the first half of the year, we are focused on the third pillar of the plan namely operational excellence and profitable business growth. Projected average production for the year remains stable at 715,000 barrels of oil equivalent per day.

In the fourth quarter, we expect completed drilling of the Warrior, Payero and Boranda exploratory wells. A solid and more efficient company has successfully navigated the oil price crisis. Our commitment to profitable growth and the creation of shareholder value remains firm.

With this, we will open the Q&A session. And thank you very much in participating in today’s conference.

Question-and-Answer Session


Thank you. [Operator Instructions]. And our first question comes from the line of Frank McGann with Bank of America Merrill Lynch.

Frank McGann

Okay. Good day. Thank you for the call. Just a big picture question. The world is in a difficult situation right now, oil prices have been quite volatile and uncertain. The company of course has a done an aggressive job in cutting costs to try to deal with that situation. I’m just wondering how you are thinking right now in terms of priorities when you’re looking at, say, perhaps paying down a little bit more debt, or investing in longer term projects that will use cash and may take some time to pay out in an uncertain return scenario, how do you evaluate the decision whether to essentially take on a little bit of more risk with the new projects, or to reduce the company’s risk profile and pay down debt?

Juan Carlos Echeverry

Frank, good morning. Thank you for the question. You asked quite philosophical question and these are philosophical times because if you go to see how we go to any meeting of oil and gas industry people, they are basically in a sole searching mode, I mean, nowadays this year especially has been a year in which we all have been asking how much money can we make, where are we really profitable, whereas I think we shouldn’t do, and then asking ourselves what are the things we should do.

The way I’d put it is the first half of the year was we were all in hell because the price went to $27 and the situation was really uncertain. After July and August, we like the passed the phase of the crisis, the price crisis situation, and we went back to a stability and growth mode. We produced 2017-2020 plan, financial plan. We presented it to the market with a quite conservative price view, flat $50 per barrel, so that we can weather any difficult situation in price, namely the one which I believe two weeks ago or last week oil prices went to $42.

With this type of plan which is robust to price fluctuations, so to speak, although we all know that some prices could be too challenging but let's say, $50 flat in terms of 2020, we focused on the things we think are have been weaker for us. I think that you have mentioned especially adding reserves to our reserve base, improving our portfolio of exploration, improving our operational capacity in production and focusing on E&P instead of the focus on the mid and the downstream, which has been very strong in the last 10 years.

We already have finished most of our transportation and pipeline projects. In 2016, we will basically finalize all of them. We’re basically finishing this year, Reficar, which is our big refinery project, and Bioenergy, our big ethanol project. We can then participate next - from next year onwards we will be focusing on finding more reserves, adding continue reserves and giving a stronger portfolio to our production people considering new core areas for Ecopetrol.

So it’s definitely in the vein of your question is we are - we have, for example, jobs presently paid where one of our loans of almost COP$1 trillion, that’s more or less $330 million, we just paid in one month ago to Bancolombia showing that if we have the cash, one of our priorities is to improve our debt ratios. The other priority is to stabilize production. Our drilling campaign was in stalemate in the first half of this year. Nowadays we reinitiated our drilling campaigns in Castilla and Rubiales. We’re drilling exploratory wells, five of them currently. We will be aggressively drilling in the offshore in Colombia next year et cetera.

So we are - we will have that much appetite for very risky projects unless those which are have a very high profit namely those in the offshore Colombia. So we are balancing, as everybody is in this industry right now, we’re balancing our act between stability, profitability and some higher certainty in our results vis-à-vis knowing that we operate in a risky industry in which you have to bet on risky projects, like for example - risky yet promising projects, like for example the offshore Colombia.

So thank you for your question. I hope that we have - I have answered some of the issues you raised. Of course as I said, they are quite philosophical. We keep our strive for operational excellence, rigorous engineering project costs in order to finish them in time and in budget and doing that we can cover, let's say, issues that in the past have been vulnerability for Ecopetrol and strive for having success in our exploration and production front.

Frank McGann

Okay. Thank you very much. Very helpful.


[Operator Instructions]. And we ask a courtesy to other analysts to please limit your questions to two. And our next question is from Alexander Burgansky with Deutsche Bank. Please go ahead.

Alexander Burgansky

Yes, good afternoon, and thank you very much for the presentation. I have two questions. First of all, now that you have taken the full ownership and proprietorship over the Rubiales field, I wonder if you can update us on your production plans for that field, specifically how much it is producing now, what do you think the production range will be at the end of this year and in 2017? And my second question refers to your Slide 14. I was quite intrigued to find that you have circled the depreciation amortization item as a non-recurring. So I was wondering what amortization and depreciation you expect going forward given the contribution from Rubiales? Thank you very much.

Juan Carlos Echeverry

Thank you, Alexander. Regarding Rubiales, we will - next year, we’ll have the whole year impacting our production. This year we had only half of the year impacting our production.

The second thing is that the Rubiales drilling campaign was in a stalemate in the first half because the company was operating, of course you have the incentive to drill as much as committed, but we already restarted our drilling campaign. We’re going to drill 35 wells until the end of the year, that’s our target. And for next year, we have already the drill campaign for the whole year.

I will ask Rafael Guzmán to complement on this and then María Fernanda for answering your second question.

Rafael Guzmán

Yes, Alexander, it’s Rafael Guzmán, Technical Vice President. We started drilling in Rubiales in October, we currently have four rigs and we plan to have them for the whole year next year, but if we don’t drill Rubiales of course has a natural decline, but with the drilling campaign that we’re doing, we plan to overcome that natural decline and actually increase production. We expect that for next year, the production for the field will be stable at around 125,000, 130,000 barrels per day. One of the things we’re doing is of course getting efficiencies in the drilling, that is less costly well and reducing also the time.

In the presentation we talk about six days of drilling compared to eight days of drilling in the previous campaign in 2015. In fact, as of yesterday we drilled a record well in Rubiales which took us five days to drill and we’re drilling them under $1 million cost for that well. So those two things together has a great potential that the field has - the field has a very low recovery factor, plus low cost well will allow us to drill many, many wells and maintain production in the fields.

María Fernanda Suárez

Alexander, good morning. Thank you for your question. Well, regarding the depreciation amortizations that we show on our Slide 14, I would like to mention that we what we wanted to highlight is the delta that you were seeing from one Q into another. It’s a delta that you will only be seeing during this quarter due to the entrance of the Cartagena Refinery. The level of depreciation amortizations that you’re seeing currently in this quarter is the level that you can expect to be maintained going forward.

Alexander Burgansky

Thank you very much.


And our next question comes from the line of Madalena Costa with Morgan Stanley.

Madalena Costa

Hi. Thanks for taking my question. Just a quick one from me. If you can quantify how much the startup of the oilfield in U.S. explains the lifting cost increase on a quarterly basis? Thank you.

María Catalina Escobar

Sorry, if I can ask you to please repeat your question. We couldn’t hear correctly.

Madalena Costa

Yes, sure. So if you can quantify how much the startup of the oilfield in U.S. explains the increase in the lifting cost on a quarterly basis? Thanks.

Rafael Guzmán

Madalena, this is Rafael Guzmán. We had several impacts here in our lifting costs going from second to third quarter. One of those is the Gunflint field coming into a production with a very good result in production, but with a slightly higher lifting cost on the average. The impact we had was receiving 100% of the production of Rubiales again with a higher and average lifting cost, and in addition to that, paying royalties of 32% as opposed to 20% that we had previously. Those three effects together with some seasonal effects of the suspending for the second half of the year, explains the increases in lifting costs.

However we don’t guide on specific lifting costs by field, so we will not have the specific number for the increase in the Gunflint field.

Madalena Costa

Thank you.


And our next question is from the line of Fillip Craig [ph] with S&P Global.

Unidentified Analyst

Yes. Good morning. Thank you for taking my call or my questions. I have a question about your current divestment plan and specifically the sale of ESENTTIA. Do you still see that taking place or making any progress toward the end of the year, or can you give an update on the current state of the sale of ESENTTIA?

María Fernanda Suárez

Fillip [ph], thank you for the question. Well, the process that we have right now for selling Propilco is that we already went to the Council of Ministers and it has already been approved. However there is an additional thing that needs to be done. It’s a decree issued by the Minister of Finance and the Minister of Mines & Energy, and we expect that to happen during the - before the end of the year. If that happens before the end of the year, we will be able to do the first round that is going to [indiscernible] for two months at the beginning of 2017, and then selling all our stake to a strategic buyer during 2017.

Unidentified Analyst

Okay. Thank you.


And our next question is from the line of Pavel Molchanov with Raymond James.

Pavel Molchanov

Thank you for taking the question. Interest expense has increased quite sharply over the past year, no more than US$200 million in the third quarter. Is that a function of just higher rates on your borrowings, or is there something else that work?

María Fernanda Suárez

Pavel, thank you for the question. Regarding interest expense, you see in this quarter also the effect of Reficar, on how Reficar - since Reficar has an important level of debt in its balance sheet, those interest rates - interest expenses were capitalized before the third quarter. So now that we have all the units operating, we will see that as an expense. So it doesn’t have nothing to do with borrowing costs.

Pavel Molchanov

Okay, understood. More broadly on the political front, earlier this week, of course there was a new peace agreement negotiated with FARC. As you think about the security landscape in the country, are there any particular areas where security remains a problem and is preventing normal operations for Ecopetrol?

Juan Carlos Echeverry

Pavel, thank you. We have seen a substantial reduction in attacks since July 20, 2015 when FARC instituted a ceasefire. So since then we had two months last year, which was May and July which we had like 20 attacks, and it was really difficult to handle the situation in the pipeline. Since then, ELN which is the other guerilla group in Colombia, which also is now entering a peace process. ELN has been attacking us this year. They have made close to 30 attacks on our pipeline. So we went from like 55 attacks last year 2015 to 34 this year in total so far until now.

However ELN now since like two or three weeks ago started negotiations with the government which take place in Ecuador, and we hope that these negotiations will soon lead to a ceasefire. We don’t have a ceasefire yet. As a matter of fact, ELN hit our pipeline last week and we have had - these are the things that as awkward as it sounds are normal for us. I mean, we know we are very efficient in repairing the pipeline, we’re probably the best company in the world repairing pipelines because of this we have experienced years and years of doing this. We used to have years of 170 attacks.

So we expect to - with these attacks we just received from ELN, I think that we’re solving in 48 hours basically. So it doesn’t affect really our production in Caño Limón or our production in Putumayo. We have big capacity to accumulate those crudes produced in the field, and then once the pipeline is working, we basically evacuate all that oil. But yes, the things we’re seeing in the peace process with FARC are in the negotiations, the ELN are very positive events for Ecopetrol.

They open for exploration, for instance, they open new areas like Caquetá which has been closed for decades for Ecopetrol. We just run a seismic on Caquetá in the last four months. Those are communities that are new to oil so we have to do a lot of work on ground with the people with the community socializing our work, but those are positive events that if you look at it in the long-term, they open up a provinces for Ecopetrol in exploration.

In our production areas, we basically know how to do what, how to handle this type of threats and this type of challenges, so we’re not entirely worried on the other hand. On the contrary, we are hopeful about these negotiations.

Pavel Molchanov

Thank you very much.


[Operator Instructions]. And our next question is from the line of David Gamboa with TPH.

David Gamboa

Hi. Good morning. Just a couple of questions please. When you think about your gas production, fields in Guajira are declining and the gas discoveries offshore are out of the business plan that you’ve laid out. So when you think about the 760,000 barrel a day target for 2020, how much of that is oil and gas, just to think about the evolution of the portfolio mix for the following years to come? And then the second one, as you’ve mentioned, one of the benefits of a ceasefire is the opening up of exploration area. So when thinking about organic growth through exploration, I heard you just said you are processing some seismic in the Caguán-Putumayo Basin. So I was just wondering how to think about that province in particular. Any timing around it, if you have any plans in drilling there perhaps next year, or if that's a bit more towards the future? And just if I can squeeze a last one. Just a clarification, if you could please comment around when Reficar might be a plateau? I know you are ongoing some debottleneckings and starting up in stabilization, but just guidance for us to model the performance of this refinery. Thank you.

Felipe Bayón

David, Felipe Bayón, Executive Vice President. Thanks for the question. As we see our production going forward from now until 2020, we believe that the split between oil and gas should remain basically constant. So in that sense, some of the production that - and volume that we’re losing from Guajira as its natural decline, we may be able to compensate, or we will be able to compensate with some other sources of gas. So the split of around 15%, 20% of gas versus oil shall remain roughly in that same order.

And just what I’d like to stress that we continued to look aggressively for other sources of onshore gas that as you well explained can help us create the bridge now and when those big discoveries in the offshore will come on line. So very active and aggressively looking at trying to maintain that split between oil and gas.

Juan Carlos Echeverry

In regards to the ceasefire opening opportunities for exploration areas, as we have said, basically the Colombian onshore we have opportunities, Ecuador or south of our border, Ecuador for 500,000 barrels per day. North of our border, we produce as a country 40,000 barrels per day. And this is same reservoirs, right. So we can increase - according to our geologists and our engineers, we could increase as a country, and we as a company we could increase, by two or three-fold the production in Putumayo and in Caguán but for that we needed these, we need time, we need time for running the seismic. We need time for doing our exploratory wells, et cetera, et cetera.

So I’m not saying that in the next two or three years, we’re going to produce a substantial increase but what we’re saying is that are both there and in the border with Venezuela in Aragua, in North Santander, in Catatumbo region, we have very interesting opportunities of exploratory endeavors.

In regarding with the timing opportunities in Caguán and Putumayo, we are now basically focusing on exploratory wells in Meta in the foothills in Casanare and we’re drilling from - before year-end we’re drilling Boranda, Chimu [ph], Pegaso, all of them in the Meta region and in the Janos [ph] region and we’re also drilling Warrior, Bullerengue we drilled this year. All of these exploratory wells of 2016. So maybe Max Torres can elaborate on that, which is our focus on the real well right now like Meta, regions are promising like Caquetá, Putumayo and Aragua and other exploratory areas that we are touching right now like our Offshore Colombia and Offshore and of course Gulf of Mexico. Max?

Max Torres

Good morning, David. Thank you for your questions. Yes, as Juan Carlos Echeverry was mentioning, we have sort of an increase in our activity next year. We are planning to drill about 15 wells in exploration. Right now we are currently drilling three wells. We have planned two more wells this year, so probably end up the year with five wells. So we’re going to jump from five to 15 next year.

Out of the 15, five wells are in the offshore Caribbean in Colombia. And as you know, the Caribbean frontier basin is attracting a lot of attention. So that is very important for us in our plans.

Regarding to the onshore, we are targeting our heavy oil province in the Meta in Llanos. We are targeting the middle Magdalena Valley as well, and we are targeting the lower Magdalena Valley with some gas activity there with our subsidiary, Hocol. So essentially next year, we’re going to have focus on those areas. And as the peace process moves ahead, we are planning to target these more challenging areas like Caguán-Putumayo and the northern parts of Aragua. We think there is potential there. We need to - we should seismic those studies. That’s longer term, but we think we have opportunities in Northern Aragua, Caguán-Putumayo and that is the future. The present is, as I said, heavy oil and in the middle Magdalena Valley.

And then of course the offshore. I think our big bet or big promise is offshore, and we’re going to be drilling in a matter of weeks. We’re going to be drilling the appraisal well in Purple Angel, which is the Kronos discovery appraisal. Next year we’re going to be drilling Brama [ph] which is a sort of an appraisal of our discovery in Aragua and two new prospects like Molusco and Siluro. So, as you see, aggressive activity and big promises for the future.

Juan Carlos Echeverry

David, in regard to Reficar, you asked for some guidance on how to model the performance of the refinery. We currently are dealing with the stabilization of refinery. We started all the 34 plants by July. The first half of the year was a startup process. So this took from October 21 until July. And the next three quarters probably the second half of 2016 and the first quarter at least of 2017, we are stabilizing all of these plants we have had issues. In some of our plants - the good plant has some issue at the beginning, then [indiscernible] has an issue right now, et cetera. But this is normal in terms of the startup process. Tomas Hernández will elaborate in a second.

In terms of guidance for your modeling, the performance or refinery, I would say these, is we’re going to be stabilizing it until the first quarter of next year at least, and then the second half of next year we expect to have the refinery going let's say from 130,000 to 140,000, 150,000 obtaining optimization process of our feedstock. The margins also will stabilize next year. So barely until next - until the first quarter of next year, you’ll have a ramp up and then optimization until the end of 2017.

So the actual results have already stabilized and optimized refinery will be seen really doing 2018. But probably it’s better that Tomas Hernández the Vice President of Refining can take over.

Tomas Hernández

Thank you, David. Good morning. Tomas Hernández. Yes, to expand a little bit on the stabilization process, we define it as a conducting all the unit performance tests. So we started up all the units in July. We ended the stabilization process, which means we had to work with the licensers and get the plants up to design ,so we’re 16 out of 34 plants into the stabilization process, working out all the debottlenecking issues that come up normal to startup. So like President said, we believe that we go into the first quarter in the first semester, we will be passed the acceptance tests for the refinery and in a period where we’re stable.

We look at benchmarks in refining, a very, very typical of grassroots high conversion refineries to go nine to 12 months into a stabilization process, very, very difficult. This is highly complex and we’re working out some issues, but we feel confident that next year we’ll be passed the stabilization process in the second quarter of 2017.

David Gamboa

Thanks everyone.


And ladies and gentlemen, this concludes our questions and answer session. I would like to turn the call to our CEO, Juan Carlos Echeverry for final remarks.

Juan Carlos Echeverry

Thank you to you all for participating in this conference call. As we said, 2016 has been very challenging year. The first half was practically inferno period because we went into prices of $27 per barrel. The second was a real transition. By June, July, August we already as a company and fairly as an industry made a transition from the crisis, the price crisis period towards stability and growth period. We presented recently our financial plan 2017-2020 and we are now finalizing also our phase of week investments in the mid and downstream segment with the end of Reficar, the construction and the stabilization of Reficar, with the end of construction and startup of Bioenergy, our ethanol project, with substantial investment in pipelines. We can now turn the page and go towards much more investment and CapEx devoted to exploration and production.

We will tackle a more aggressive agenda in exploration. We have been improving our portfolio of exploratory wells. We have very good partners in the Gulf of Mexico, very good partners in Offshore Colombia and we have a very comprehensive portfolio for Onshore Colombia as Max Torres explained.

We have undertaken a very deep transformation, a strategy of Group Ecopetrol. We have changed the reduced the cost of dilution, renegotiated more than 4,000 contracts. We have made a transformation of our human capital. We’re still in the process of completing that. It will take at least one or two more years. We’re not yet in - we’re in the middle of our process transformation, but we have demonstrated that we can reduce cost of the much more efficient - in many metrics we can be much more efficient.

Ecopetrol is among the few companies in the oil and gas industry with net profits in the first three quarters of 2016. This is a very nice group to be in the company of Exxon, of Shell, of Repsol and Total, Ecopetrol has during the first three quarters of this year produced positive profit. But especially profits are very volatile in terms of accounting techniques and procedures, we are more proud of what we have achieved in terms of cash generation.

We have been through a process in which cash was king and we have been able to produce enough cash and to improve our debt ratios. We clearly just paid a debt, a loan with Bancolombia of almost COP$1 trillion, close to $330 million, and that shows that we have had the duration of cash internally very satisfactorily.

Finally, the way we have created this cash when at the beginning of this year, 60% from the Midstream, 25% from the Upstream and right now the shares have moved a little bit. We’re almost 60% Upstream, 35% Midstream. This shows that the company had the flexibility and the balance between been an integrated company, the balance to compensate difficult times between all the segments.

So we are glad there is a lot of homework to do. We feel we still have lots to things to improve but we think that we have shown to the market to all of you that we’re doing a satisfactory job. So thank you to you all for participating in this conference call and have a good day.


Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program, and you may all disconnect. Have a wonderful day.

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