Last Friday I bought a bunch of shares of Ecopetrol (ticker: EC), the Colombian state oil company (at $9.60 per share)

I sat down with Calvin here in Boquete, Panama, who is quite prolific on Twitter and who runs a premium subscription service focusing on commodities, trade, shipping, energy, and industry (Marhelm – use coupon WANDER for a 20% discount).

I had been looking at Ecopetrol for a while but was worried about the new socialist president Petro who held strong anti-hydrocarbons views.

A package of tax reforms was passed by the legislature, and it turns out the tax reforms are a lot milder than expected.

In this video, Calvin elaborated on his thesis for Ecopetrol. He made it his largest position.

or read the full transcript below

To be extremely clear, this video is absolutely not investment advice. Investing in oil equities is risky and volalile, and in South American ones even more so. This is not an investment that I can just buy and forget about. I’ll need to be monitoring it on a regular basis, especially as I took a large position.

I am spending most of the year in Latin America looking for investment and immigration opportunities

After spending a few months in Mexico, I explored the market in Costa Rica and am now in Panama for a few weeks.

To a World of Opportunities,

The Wandering Investor

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Full transcript of “Stock analysis of Ecopetrol”

LADISLAS MAURICE: Hello, everyone. Ladislas Maurice from thewanderinginvestor.com. So today, I’m in beautiful Boquete, in northern Panama, with Calvin Froedge from Twitter. How are you, Calvin?

CALVIN FROEDGE: Good.

Current mainstream narrative on investing in Ecopetrol stock

LADISLAS MAURICE: Cool. So I’m staying in Calvin’s lodge here, for a few days, in Boquete. So today, we’ll be discussing Ecopetrol, which is the State-owned oil company in Colombia. So the government owns approximately 80% of the company, the rest is available to investors. It’s possible to buy it on the New York Stock Exchange. And why I wanted us to discuss Ecopetrol is because I’ve been monitoring Colombia for quite a while from a real estate point of view. The yields in places like Medellín are extremely high. It’s a market that I’ve been considering entering. But I wanted to see how things would develop with the new President, Petro, who is a former Marxist guerrilla. So that’s, obviously, never a positive thing. He was going on and on about banning exploration and putting all these like massive taxes on oil and gas companies. So none of that was very bullish for either real estate or Colombia in general, or, more specifically, oil and gas in Colombia.

So that’s kind of the narrative and the stock, again, none of this is investment advice, is priced this way. However, what we see is that the tax reform package was passed in Colombia, and the impact doesn’t seem to be as big as what people thought it would be. So I follow Calvin’s substack. I pay for it. It’s really good. And he wrote a whole analysis on Ecopetrol, which was really good, because it’s both simple and it has numbers. There’s not too much– sometimes, you follow these analysts, and it’s just numbers, numbers, numbers, and they forget the bigger picture, or, sometimes, people are just all narrative and there’s no numbers. So you strike a good balance between the two. And I, essentially, yesterday, I initiated a position in Ecopetrol. So can you elaborate on your thesis?

The reality of investing in Ecopetrol Stock

CALVIN FROEDGE: Yeah. So I started following the company because they have a refinery in Cartagena that exports a lot of diesel, they were doing some capacity upgrades to that refinery. Anyone who follows the tanker markets or the refined fuels markets, which is a market that I have followed very closely, I have invested a lot in tanker companies, refining companies, oil companies, oil infrastructure, fuel infrastructure. I just got back from a fuels conference in Miami, where a lot of these companies had employees, including Ecopetrol. But anyway, I started looking at it because I knew that the world was going to be really short diesel. And I knew that it was going to be especially bad in the Atlantic basin in Latin America.

Ecopetrol is one of the only companies in South America that is exporting significant amounts of crude oil and refined fuels. Colombia actually exports more than they consume domestically. I believe it’s the best kind of trade balance for any of the State-owned companies in South America. So at the time that I started following them, I want to say they were trading at around $15 a share. This was before they elected Petro as President. And I think I bought 100 shares or something, just to kind of keep an eye on it. And then the election happened. And basically, Petro got elected. There was still some hope that Hernandez was going to win. Hernandez was more the pro-business guy. He was a construction magnate. And anyway, after Petro won, you can see basically, well, between the kind of highs when I think they paid their last dividend, the stock basically did a beeline from like $20 to under $10.

So it’s not just like a little pullback, it’s been a significant sell-off, a significant amount of market capitalization wiped away, I think $20 billion or something. So it’s been a huge drop. And so after the drop, I started getting a lot more interested and building a pretty significant position. And in the company, I think my average is around $10.50 a share or so, which I think they closed Friday at around $10 a share. So I’m a little underwater on it, but I’m used to kind of waiting for things to play out. I think that, with Ecopetrol, you have a situation where the rhetoric was awful. Petro was saying, yeah, he hates oil and gas, he’s going to kill this stuff, he’s going to get rid of it.

LADISLAS MAURICE: He sounds like Biden.

Impact of new tax regime on Ecopetrol profitability and stock

CALVIN FROEDGE: Really, he said a lot of the exact same things that Biden said. So he got into office, and then the actual reforms that were passed as law, it was nothing like the original plans, for example, for an export tax, where they would just put a stiff tax on all exports. The taxes were changed to basically be on net profits. So coal, and basically, all hydrocarbons-related industries have this additional tax now. So that’s sort of the form that it took, rather than the more aggressive export base tax that they had planned for initially. It’s basically like an additional 5% to 15%, based on the 10-year rolling average of the price of the particular commodity. So for Ecopetrol, it’s oil.

If you dig in and you look at what kind of impact that’s actually going to have on their business, since it is a 10-year sort of rolling average, it doesn’t all come into effect at once. There are some, like inflation adjustments. I really haven’t dug in to figure out exactly how the inflation is calculated. But if you just look at the 10-year average, it’s like $70 a barrel. And so that is the, basically, additional 5% bracket. They also changed some of the accounting regime. For example, a lot of the oil wells there, basically, it was a project that was done by multiple parties involved, and maybe one party gets a royalty payment.

Previously, under the previous accounting regime, the royalty payments were deductible. So basically, it came off the income statement as an expense. Now, those are no longer deductible. So those are considered after tax. Ecopetrol announced that, well, they put in their last earnings call that they thought that that was going to be a very marginal impact, so two to five points at the most. So your kind of worst case scenario, you’re looking at maybe Ecopetrol, in three, four years, assuming oil prices stay where they are, is trading with like a 50% effective tax rate versus the effective tax rate today is 35%, right? So–

LADISLAS MAURICE: That doesn’t justify a drop of 50%.

CALVIN FROEDGE: So yeah, so you basically have a 50% drop for the asset because of a theoretical tax hit of 15%. And by the way, that 15% is only in an environment where the price of oil is really high. If the 10-year average, let’s say, oil crashed and stayed below $50 a barrel, well, Ecopetrol wouldn’t have to pay any additional income taxes, because that 10-year calculation, you’re basically under $67 a barrel, they don’t have to pay anything additional. So in that kind of environment, they also have very low break-evens.

So it would actually be, I think, a preferred investment, if you were looking at the oil and gas sector, and you wanted to hedge your downside risk from falling price of oil, they’re trading where they were when oil went under $30 a barrel for months in 2016. It was in the 30s, 40s, for a lot of that time period, they’re trading close to where they were during COVID, when WTI briefly went negative, when people didn’t know if there would ever be fuel demand the same again, oil demand the same again.

LADISLAS MAURICE: So essentially, what you’re saying is people who kind of missed the run-up in oil stocks, in oil producers, this is a good one to, potentially, I mean, not financial advice but–

CALVIN FROEDGE: Because they’re, essentially, still priced at the lows and in an environment where, in reality, they’re making more now than they ever have as a company. And if you look at their balance sheet quality, their debt ratios, EBITDA to debt, you look at their cash to debt, I mean, they’re basically in the same category as the US majors. So you’re getting the same kind of balance sheet for a fraction of the price. I mean, I think they’re trading at about two times, like, let’s say, 2.2x 2.3x free cash flow. So the pricing of the stock in this kind of commodity environment, is making the assumption that the company won’t even last until the end of Petro’s term. Petro can only be, without amending the constitution, which requires the approval of both the courts and the legislature–

LADISLAS MAURICE: Which he doesn’t have the control of.

Current structure and dynamics of Colombian politics

CALVIN FROEDGE: Well, he doesn’t have the control of that there are friendly parties, but it’s difficult to get a coalition, especially a coalition to keep him in power, right? In order for this to become a situation where the company is permanently impaired, okay, these people need to have control. If you look at the actual reforms that were put into place, and then some of the other things that went on as well, the during the Iván Duque regime, who he was the previous president, the shares of Ecopetrol, they traded teens, twenties, high teens, twenties. And during Duque, except in the COVID crash, Duque was using something called the fuel stabilization fund in Colombia to essentially support his popularity. And similar to what Bolsonaro is doing in Brazil, right, with trying to get the state oil company to subsidize domestic fuel pricing to help his popularity so that he could get reelected.

So basically, the company has run up a balance that is owed to it by the government for contributions to these fuel subsidies of $3 billion to $4 billion. I think it was like 20 trillion Colombian pesos in the end of September. I think, by the end of the year, it’s supposed to be like 29. I think that’s around, you know, exchange rate in the head, I think that’s like 4 billion USD. So it’s essentially already earmarked for, or maybe it’s a little bit more than that, but the Congress has already earmarked about 4 billion USD next year, this is approved law. So it’s basically the balance will increase to the end of the year to about 29 trillion COP. And then, next year, the government has already committed, already put into law, already budgeted paying that down by like 20 trillion.

So it’s sort of a give-and-take where they’re going to pay some additional taxes, but the government is also going to pay a significant amount of money that is owed to the company by the public, right?

LADISLAS MAURICE: So what we see here, essentially, is a massive discrepancy between perceived risk and actual risk.

CALVIN FROEDGE: Yeah. I think that people think that because Colombia elected its first ever leftist president. I mean, let’s be clear here, Colombia, by historical standards, is a very conservative country. Their central bank is perceived as being very independent and very good within South America. It definitely has one of the better reputations among Latin American central banks. They just recently raised interest rates, I think, two weeks ago in opposition to Petro’s wishes. So the central bank is doing what it wants, regardless of what Petro wants.

The courts have, you know, other presidents in the past in Colombia have tried to amend the Constitution to basically have more than one term available to them. Colombia has a one-term presidential limit. So, and in that way, there’s less political risk than in the US. So in the past, there have been attempts to modify this that the Constitutional Court has blocked. There was a previous successful attempt to change the Constitution to allow for more terms, and then it went back to the one-term limit with the next president. Wikipedia will tell you all about that.

But anyway, they have to get the law changed, and then the Constitutional Court has to approve that change. So it’s not like, they didn’t elect an all-powerful dictator. Colombia is a constitutional republic like the United States. Their systems of government are fairly similar. They’ve got an executive branch, the legislative branch, and a judicial branch. And you can’t control everything that happens in the country without controlling every branch of government. So there are very strong checks and balances in Colombia, and the people who occupy the current positions of power in the court system, they were all appointments made by conservative presidents, because Colombia has never elected a leftist president until now.

So am I saying that there’s like, no risk, that nothing bad can happen? Of course not. I mean, could Petro stay in power? Could the Colombian people move farther to the left? Could they vote for more subsidies, go out in the street and protest fuel prices? Absolutely, they could. But people can do that anywhere.

LADISLAS MAURICE: Yeah.

CALVIN FROEDGE: So if you’re going to invest in oil and gas companies, I mean, to me, it makes sense to invest in what’s cheap and what has a history of paying out big dividends. I mean–

Dividend expectations for Ecopetrol stock

LADISLAS MAURICE: Talk about dividends, what are you expecting?

CALVIN FROEDGE: Well, I can tell you what– I don’t know what to expect in the future but I can tell you what has been the historical case. So over the past year, they paid two dollars and something in dividends, the shares are $10 today. So if the current pricing environment and their behavior, as far as declaring dividends were to continue, then I think you would be looking at 20% to 30% yield on the dividends. Since 2008, the furthest dividend history that I could get, that is going back to 2008, and since then they’ve paid like $22 a share in dividends versus a stock today that’s at $9.95 or something.

So, if this is a company that you’re willing to hold for 10 years, and oil pricing kind of sticks around, I think you’re going to get paid just in dividends. I mean, what you need to look for, as an investor, is you need to say, “If nobody else buys this, if I can’t convince anybody else that this is a good investment, am I still going to make money?” And the only ways that that is possible, the three scenarios, and I’ve invested through all three of these scenarios.

One, the company is worth more to some private enterprise than it is to whoever owns it at the time. So Ecopetrol essentially owns Colombia, they own all these oil and gas leases, we should talk about the exploration as well. They own all these oil and gas leases, they own the ground, they own pipelines, they own roads, they own utilities, they own refineries. I mean, it’s billions and billions and billions in assets. And I don’t think that Colombia is going to sell that. But the question is, would it be worth more to Exxon Mobil, for example, than it’s trading for today? I think it’d be worth a lot more. So that’s one way, a buyout. Okay. It’s a little big for a buyout, obviously, right?

The other way is, if other people aren’t going to buy the stock, the company can buy back stock. So what’s the probability that the company buys back stock? Probably also pretty low. But at the same time, YPF in Argentina recently– I mean, Argentina is much worse, as far as their governance quality. I think, in Colombia, the institutions are much weaker. They went way down the rabbit hole into Peronism, Eva Perón, and socialism. And they are buying back shares for their national energy company. YPF was actually a big win that I had this year. I bought a lot of calls when the stock was trading in the twos. Just this past week, I finished selling. And I sold the last of my calls with the stock trading about $8.

LADISLAS MAURICE: Well done.

CALVIN FROEDGE: So that was a huge, huge win for me. So if even YPF would buy back shares in the open market, I mean, maybe it’s not unfeasible that Colombia, or Brazil would do so, you never know who the next guy for President is going to be, right?

LADISLAS MAURICE: Mm-hmm (affirmative).

CALVIN FROEDGE: But anyway, let’s say those first two are fairly unprobable. And then the third way, obviously, is dividends. So Petrobras is another name that I have pounded the table on, because it just got so ridiculously cheap because, first, it was Bolsonaro put a general in charge of the company. And this is literally a company that was started by the Brazilian military. So I’m like, why are you guys worried that a Brazilian General is running the company, a company that was started by the military? Are there still competent technical people, competent executives involved? Then who cares who the CEO is, right?

So that was a name I pounded the table, about $7 a share, that the shares have fluctuated. I think the highs have been $16, $17. But in the meantime, I think they’ve paid, since that kind of post-COVID when the shares crashed, I mean, they’ve paid, I think, close to $5 a share in dividends.

LADISLAS MAURICE: It’s been a good ride with Petrobras. Very well.

CALVIN FROEDGE: Yeah, the returns from the dividends have just been incredible. So in this kind of hydrocarbon pricing environment, and there are other reasons why I think Ecopetrol is incentivized to pay dividends, it’s part of the basically that FEPC balance, the fuel fund, it can get reduced back to zero in two ways. And also the Petro government wants to stop subsidizing fossil fuels. At least that’s another goal that they’ve stated.

So Duque was subsidizing domestic consumption. Petro has stated that he wants to stop subsidizing domestic consumption. So were they to do so, that would basically be another tailwind for the company, because they don’t need to sell fuel into the domestic market cheaper and run up that accounts receivable balance for the fuel stabilization fund. So the government has definitely made it clear that they want to bring that balance down, that they want to pay that to zero, and then dividends, which would be paid to the government as cash, will instead, in lieu, reduce the balance of that fuel stabilization fund. So the government is definitely, I think, double dipping with changing the tax regime, but it’s also been a give and take, right? The give has been higher taxes, which also affects Colombia’s many private producers, right, I mean, of coal, of other hydrocarbons.

So let’s remember that this is just, they’re not the only fossil fuels company in Colombia. The entire sector is affected by these changes. But in exchange for these changes, the country is doing things that are better for the company than were being done under the pro-business, pro-fossil fuels, I believe he was a shareholder in EC, previous conservative guy, right? So, I just think that people tend to run on these headlines, where Colombia is the next Venezuela, and they don’t stop and ask, okay, well, what’s actually happening in reality? Is this actually Marxism, or is it just kind of a slight, maybe temporary change in the political landscape, in the tax regime? How long is it going to take for these changes to actually impact the company? How much is it actually going to take out?

I mean, to me, it looks like, over the next couple of years, unless you continue to see a really robust hydrocarbon pricing regime, it’s more or less going to be awash between what they’re paying the company back, that they ran up during Duque for the fuel stabilization fund, and the additional that they’re going to pay in taxes. I was thinking that, just take the net income and next year take 8% of it out, right, 8%, 10%, that’s probably going to be the hit, it’s on net income. They’re not robbing the company, they’re not selling the assets to do like social programs or something.

Exploration program of Ecopetrol

LADISLAS MAURICE: And they’re still exploring as well.

CALVIN FROEDGE: Yeah. So that’s another interesting thing. This is really what’s caught on in Colombia media. And I think this is more because of people playing Colombian politics than of doing actual sort of objective analysis of the reality. The government suspended new exploration licenses, and they suspended fracking, okay? But the thing is that, one, Ecopetrol’s production isn’t changing, okay? Like, they’ve actually maintained and increased their production. Colombian production is down a little bit, but they own assets outside of Colombia. They own a lot of assets in the United States, they own a lot of Permian assets. Their Permian assets, I believe, are producing 50,000, 60,000 barrels a day of energy right now, which is 12%, 13% of their total production.

So it’s a significant amount that’s being produced outside of Colombia as well. Within Colombia, I think, there’s 210, maybe, active exploration licenses. All of those existing exploration licenses are being honored, they aren’t stopping anything that’s already been approved, okay? And then, of those two hundred something that have been approved, only about half of those have active work taking place on them. So, there’s essentially an inventory of approved but unutilized exploration licenses that can also be used to maintain production. So again–

LADISLAS MAURICE: Until the next government who might just kind of–

CALVIN FROEDGE: Until the next government, and then they come in and do new exploration licenses. I mean, maybe the next government will also be anti-oil exploration in Colombia, but there’s definitely there’s a buffer there till the end of the Petro presidency for them to keep pursuing new stuff. They’ve also been doing all these joint ventures with Shell, with Petrobras, with other big companies for offshore, right? So you’ve got another thing there.

Remember, is you’ve got conventional production, you’ve got unconventional fracking, you’ve got offshore production, you’ve got all the stuff that they own outside of Colombia, which is significant. So, you can’t really just simplify all of it down to they elected a Marxist who hates oil, and the company won’t exist in two years. It’s just that’s the assumption that’s being made by the way that the company is priced right now in this oil and gas environment. I mean look at the stock for Exxon Mobil, look at XLE, right? I mean, these things are back at all-time highs. The Colombian national oil company is close to an all-time low.

LADISLAS MAURICE: I mean I put a small car into it, so.

CALVIN FROEDGE: Well, I have several cars into it. Not small.

LADISLAS MAURICE: [laughs] Way bigger than me.

CALVIN FROEDGE: But, I mean, it would definitely be a loss for me if it didn’t work out. If–

LADISLAS MAURICE: It’s your single biggest position.

CALVIN FROEDGE: Yeah. EC, right now, is my biggest position.

LADISLAS MAURICE: Okay, cool. Fantastic. So if you want to follow Calvin, he’s on Twitter. There’s the handle below. There’s also his substack. So what I like about your substack is that you choose random stocks that you analyze, and then you also talk about life in Panama, which I enjoy reading about. So it’s quite insightful. So I encourage people to sign up to Calvin’s substack. I’m a subscriber myself. And then Calvin also has a premium newsletter specifically for oil, shipping, commodities, etc., where he really follows up on a weekly basis, etc. So it’s quite popular.

CALVIN FROEDGE: Yeah.

LADISLAS MAURICE: It’s doing really well. The results are fantastic. We’ll do another video on that whole topic. And there’s also the link below. So, Calvin?

CALVIN FROEDGE: Yeah?

LADISLAS MAURICE: Thank you very much.

CALVIN FROEDGE: Yeah, right on.

LADISLAS MAURICE: I really appreciate it.

CALVIN FROEDGE: Yeah.