Moodys Downgrades Ecopetrol to Junk

Moody’s Ratings (Moody’s) yesterday downgraded Ecopetrol S.A.’s Baseline Credit Assessment (BCA) to b1 from ba3, which reflects its standalone credit strength. At the same time, Moody’s downgraded Ecopetrol’s long term issuer rating and senior unsecured ratings to Ba1 from Baa3 and changed the outlook to stable from negative.

Ratings Rationale

The downgrade of Ecopetrol’s BCA (a measure of the company’s intrinsic credit risk without support considerations) to b1 from ba3 and the ratings downgrade to Ba1 from Baa3 reflect a shift in the company’s financial policy as leverage has risen concurrently with the ongoing distributions of dividends and the coming implementation of an ambitious capital investment strategy spanning the next three years, which could erode the company’s liquidity position or lead to higher indebtedness. The downgrade also reflects the negative free cash flow posted in 2023 and Moody’s expectations that Ecopetrol will continue to register negative free cash flows by 2025.

Ecopetrol has been increasing debt levels in order to finance its expansion, including the acquisition of Interconexion Electrica S.A. E.S.P.’s (ISA, Baa2 stable). However, Moody’s acknowledges that capital investments have not resulted in a similar increase of the company’s EBITDA. Debt increased at a compound annual growth rate (CAGR) of 22% during the 2019-2023 period, while EBITDA has only grown at an 11% CAGR. Increasing debt has also led to a lower interest coverage of 8.3x in 2023 compared to the 12.6x of 2022. Given that Moody’s expects Ecopetrol to continue funding its ambitious capital spending plan through debt and due to the high interest rates environment, interest coverage will further decline to 7.3x, on average, for 2024 and 2025. Moody’s also recognizes that a number of Ecopetrol’s planned projects, particularly those involving natural gas, carry increased execution risk due to their location in deep-water offshore environments.

The downgrade also takes into account that Ecopetrol has been distributing a higher share of dividends compared to its current policy of 40-60% during the last 3 years, while increasing debt levels, demonstrating a more aggressive financial policy. The cash outflows have been partially compensated by the Government of Colombia’s (Baa2 stable) transfers to reimburse fuel subsidies. However, Moody’s recognizes that instead of reducing debt or strengthening the company’s liquidity position, available cash has been used for dividends.

Ecopetrol’s Ba1 ratings continue to reflect the company’s status as Colombia’s leading oil and gas producer, accounting for over 60% of the country’s production and close to 100% of the supply of oil products, as well its large power transmission business in Colombia and other countries in Latin America. Furthermore, Moody’s assumes high probability of support from the Government of Colombia and a moderate default dependence between the two entities; this assessment results in a three-notch uplift of Ecopetrol’s rating to Ba1 from its b1 BCA.

Ecopetrol’s liquidity position is adequate. During 2023, Ecopetrol registered a negative free cash flow position of $3.4 billion funded through a $3.8 billion increase of debt given its record capex investments. The company’s cash position as of December 2023 equaled $3.6 billion. Moody’s expects that in 2024 the company’s cash generation along with the Government of Colombia’s transfer to compensate fuel subsidies will be enough to cover mandatory cash obligations plus annual capital expenditures of about $6 billion, as per management’s guidance, and dividends. However, Moody’s expects that liquidity will be tight during the next two years per Moody’s expectation that capex will remain around $6 billion, and if dividend distributions continues to outpace the policy range.  The rating action takes into account that while the company took an extended time to refinance 2023 and 2024 maturities, it has already refinanced 2025’s. The next significant debt maturity is in 2026 when $2.8 billion will become due.

Moody’s expects Ecopetrol’s financial obligations will continue to be supported by access to global and Colombian capital markets, and government support. Ecopetrol’s Ba1 ratings also take into consideration the solid and relatively stable cash flow from its power transmission company, Interconexion Electrica S.A. E.S.P. (ISA) and its midstream subsidiary, Cenit SAS, which includes Oleoducto Central S.A.

The stable outlook on Ecopetrol’s ratings reflects Moody’s view that its credit profile will remain mostly unchanged over the next 12-18 months. The stable outlook also reflects the stable outlook on the Government of Colombia’s sovereign rating.

Factors that could lead to a ratings change

An upgrade on Ecopetrol’s Ba1 ratings is unlikely over the next 12-18 months because Moody’s expects the company’s credit metrics to remain relatively stable. However, if the company manages to strengthen its financial policies and simultaneously demonstrates ability to register recurrent positive free cash flow, reduce financial leverage while growing production and keeping proved reserve life at least stable, its ratings could be upgraded. Specifically, its rating could be upgraded if the company’s Leverage Full Cycle Ratio remains at 1.5 times, which would indicate stable finding and development costs, and retained cash flow/net debt would have to be over 40% on a sustained basis.

A ratings downgrade could occur if there is a deterioration in Ecopetrol’s operating performance, including a significant decline of its reserve life on a sustained basis, or increasing liquidity risk or debt leverage from the current levels; or if retained cash flow/net debt declines to around 20%. In addition, because Ecopetrol’s ratings benefit from implicit support from the Government of Colombia, a negative action on the government’s rating or a change in Moody’s assumptions about government support could lead to a negative action on Ecopetrol’s ratings.

Profile

Ecopetrol, 88.5% owned by the Government of Colombia, is the largest integrated oil and gas company in the country. The company has three business segments, namely hydrocarbons, low-emission solutions and transmission and toll roads. Its gross production averaged close to 730 mboed and total assets amounted $65 billion on December 31, 2023.

ISA, headquartered in Medellin, Colombia, is an operating holding company with businesses in the electricity transmission, toll roads, telecommunications, and systems management sectors. The company holds direct and indirect ownership stakes in a portfolio of subsidiaries located in Colombia, Brazil, Peru, and Chile.