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Supply Chain Management of EMPRESA COLOMBIANA DE PETROLEOS - December 30th, 2010

Ecopetrol (BVC: ECOPETROL / NYSE: EC / TSX: ECP), formerly known as Empresa Colombiana de Petróleos S.A. (English: Colombian Petroleum Company) [Colombian Enterprise of Petroleums], is the largest and primary petroleum company in Colombia. Because of its size, Ecopetrol belongs to a group of the 35 largest petroleum companies in the world and it is one of the four principal petroleum companies in Latin America.[1]

The reversion of "The Mares Concession" to the Colombian State on August 25, 1951 gave way to the Empresa Colombiana de Petróleos, which had been created in 1948 by means of Law 165 of that same year. The growing company assumed the reverted assets of the Tropical Oil Company that began oil activities in 1921 in Colombia with the implementation of the Cira-Infantas Field in the Middle Magdalena River Valley, located some 300 kilometers northeast of Bogotá. Ecopetrol undertook activities in the oil chain as a State-owned Industrial and Commercial Company in charge of administrating the nation?s hydrocarbon resources, and grew as other concessions reverted and became part of its operation.[2]

In 1961, it assumed the direct management of the Barrancabermeja Refinery. Thirteen years later, it purchased the Cartagena Refinery, built by Intercol in 1956. In 1970, it adopted its first by-laws, which ratified its nature as a State-owned Commercial and Industrial Company, linked to the Ministry of Mines and Energy, fiscally supervised by the General Comptrollership of the Republic of Colombia. In September 1983, the best news for the history of Ecopetrol and some of the best news for Colombia was given: the discovery of the Caño Limón Field in association with OXY, a reservoir with reserves estimated at 1.1 billion barrels (170,000,000 m3). Thanks to this field, the Company began a new era and in the year 1986, Colombia began to export oil again. During the 1990s, Colombia extended its oil self-sufficiency with the discovery of the Cusiana and Cupiagua giants in the Foothills of the Plains region, in association with the British Petroleum Company.

State Owned Company
Incorporated: 1951
Employees: 12,500
Sales: US$950 million

Company History:

Empresa Colombiana de Petróleos, the state oil company of Colombia, is wholly owned by its government and is usually referred to by the abbreviation Ecopetrol. It was founded in 1951 but has its origins in the 1910s. Ecopetrol is the principal oil producing, refining, and transporting company in Colombia. It has a monopoly on natural gas distribution and sales, and participates in the refined oil market in competition with other companies. Although it owes its existence to the nationalization of the country's long-standing major foreign-owned oil company and to continued government political support, it acts in partnership with foreign oil interests in Colombia through special agreements.

Ecopetrol was established on January 9, 1951 by the Colombian government in anticipation of the transference to state ownership of the country's largest oil concession, which was owned by the Tropical Oil Company. Ecopetrol was established as a fully integrated and independent state oil company. Ecopetrol's predecessor, Tropical, was incorporated in 1916 by Mike L. Benedum and J.C. Trees, who went into business together in the United States and abroad, acquiring oil properties in the exploratory or developmental stage for profitable resale. They purchased a concession in central Colombia, held by a French speculator, Roberto de Mares, and established Tropical to work it. Early developments on Tropical's concession date from the end of World War I. Equipment for the company's first wells was carried in large canoes up the shallow Magdelena River in 1917-1918. In 1920, these oil speculators sold the operation to the Standard Oil of New Jersey (Jersey Standard) subsidiaries, the International Petroleum Company (IPC). One of the first three wells drilled had produced oil in quantities which indicated that production could be commercially viable, and was sufficient to justify the investment by IPC. A share exchange was arranged whereby Tropical would become a subsidiary of IPC, although actual control of Tropical was exercised from New York rather than from IPC's head office in Canada.

A contemporary law set a limit of 30 years on the life of Tropical's concession when IPC acquired control, and ownership of the oil fields and installations was set to revert to the nation exactly 30 years later, on August 26, 1951. Tropical's central Colombian concession was geographically very large. The concession ran about 70 miles along the principal river of Colombia, the Magdelena. With an average width of 30 miles, it had a total size of about 2,100 acres. The title was transferred to IPC along with the sale of control, but under the conditions of a new petroleum law Tropical was subject to a number of requirements. In addition to observing the limit on the life of its concession, the company was required to build a refinery within two years, of sufficient capacity to provide for the Colombian market, and was subject to a royalty of 10% on gross oil production.

The Panamanian question delayed Tropical's development plans in the early 1920s. In 1920 the Andian National Corporation Ltd. (Andian National) sought permission from the government to build a crude oil pipeline to carry Tropical's oil from the De Mares concession to the Caribbean coast for export. Although registered as a separate organization, Andian National was an indirect affiliate of Tropical by virtue of a common parent company, IPC. The United States had supported the secession of Panama from Colombia in 1903. That action remained an open wound between the United States and Colombia for many years, with the latter seeking compensation for its lost territory. However, negotiations over Panama went slowly and Colombia sought advantage by pressuring U.S. business interests in the country. Approval for Tropical's pipeline plans were delayed. Captain Flanagan, head of Andian National and an agent for the president of Standard Oil of New Jersey, worked informally in Washington, D.C., on settling the outstanding issues in the negotiations. In the end, the Colombian government was paid a US$25 million indemnity in equal tranches over five years as compensation. With the treaty concluded in 1921, Tropical was able to assemble land titles and to award contracts for the construction of the pipeline between 1922 and 1925.

Tropical's building proceeded apace, with IPC's new capital support. Soon there were tractors moving earth and building an exploration camp. Hospitals were built in 1924 and preventive medicine was practiced to promote public health. Within one year the incidence of hookworm among workmen fell from 90% to 25%. Much of the improvement was attributed to the encouragement of the wearing of shoes. In addition to fighting tropical diseases the company had to fend off the rapid overgrowth of vegetation.

IPC's investment in Tropical led to a great amount of drilling to define and expand the known petroliferous region, despite limitations imposed by a restrictive petroleum law. Surveying, the building of infrastructure, and organizing for production occupied most of the 1921-1924 period, but some drilling did occur. Rotary and cable percussion tools were used in drilling wells from the 1920s, and Tropical's success rate was extremely high from the outset. In some years nearly every well was productive. Tropical's production was so large that by 1927 it was one of Jersey Standard's most prolific oil producing properties. With the development of its field and opening of the Andian National pipeline, Tropical's operations made Colombia in 1927 the third largest oil producing nation in Latin America after Mexico and Venezuela.

Tropical's production continued to increase until World War II. In the 1930s, the company's production and exports grew steadily, with the main destination North America. The company's activities accounted for the sale of all petroleum products in Colombia. Wartime conditions caused tanker shortages and led to the reorganization of hemispheric oil supply lines to minimize risk for water-borne traffic. Canadian, U.S., and northern South American governments agreed upon an oil-allocation program which included the elimination of Colombian oil exports and their replacement with Venezuelan exports to Canada and the United States. The effect was to minimize the total number of oil tankers at risk to enemy attack during the war.

Throughout World War II, Tropical operations were dedicated to providing for a growing Colombian domestic market, while Venezuelan crude and refined products took the place of Colombian exports. Colombian oil exports revived after the war, but most of Tropical's production went to the increasingly large domestic market.

Refining began in Colombia as a result of government requirements for the transfer of the title and continuance of Tropical's operations. The refinery, which IPC had promised to build when it acquired control of Tropical, was completed, as required, within two years and began operations in 1922. Its initial capacity was about 2,000 barrels per day (b/d), and that figure grew over the years, as did domestic market requirements. Capacity had increased to 23,800 b/d just before the reversion of control to Ecopetrol.

Tropical Oil Company's sales organization evolved from Jersey Standard's marketing operations in South America. Initial marketing of oil imports from Jersey Standard was carried out by its Latin American marketing arm, the West India Oil Company. West India Oil took its products from New York, conducted business in four languages and in a dozen currencies, and sold throughout the continent in countries in which Jersey Standard had no production activities. However, once the less expensive Colombian oil was available for sale through Tropical, West India Oil withdrew from the market place. From then on, Tropical's marketing dominated petroleum sales in Colombia. Tropical organized these activities through local commission sales agents, just as IPC had done in Peru and Chile.

Tropical was able to undercut the cost of traditional fuels, such as wood and coal, especially on the Magdelena River, through promotion of the use of fuel oil. It encouraged conversion from the use of steamers to fuel oil burning engines. The Tracey Brothers agents also sold Tropical's other products: kerosene for illumination and cooking, and gasoline, the sales of which grew with the increasing use of internal combustion engines.

Getting the oil to market, either domestically, or for export, was one of Tropical's principal problems at the outset. The natural impediments to commercial transportation were substantial, but not insurmountable. Mountains and thick tropical jungles made the Magdelena the only means of surface travel between the concession and the outside world. Even then, shifting sandbars were a hazard to large supply boats; only flat-bottomed steamers could be used. In 1926 Tropical dredged the river; the sandbar was removed, permitting freer communication of heavier ocean-going vessels. Portage railways were built to connect the navigable parts of the river, and Tropical built narrow-gauge railways on the concession for more efficient transportation of drilling rigs. Meanwhile IPC organized Andian National to build the pipeline. Its completion validated development of the De Mares concession, as it permitted large-scale crude oil exports. Tankers received the oil delivered by pipeline and then transported it to world markets, but mainly to the Americas. Jersey Standard preferred to obtain most of its North American-bound oil imports from Peru and Colombia as opposed to Argentina. Not only were the two Andean nations closer and therefore had lower transportation costs, but also the operating costs of the two companies were individually lower. Andian National's throughput continued to increase in the late 1940s; it grew from 37,000 b/d in 1946, to 41,000 in 1948, to 58,000 b/d in 1950.

In the 1930s the pipeline was looped by laying parallel pipes to increase its carrying capacity. Andian National was able to escape reversion of its assets to the government along with Tropical's concession, because the pipeline company was not owned by Tropical, to whom it only provided a service. Andian National's president Flanagan represented his company as being completely separate from Tropical and made no reference to IPC's common ownership of the two companies. Furthermore, Andian National established its head office in Canada and Flanagan represented himself as a British citizen and president of a Canadian company to avoid anti-American antagonism.

Although Ecopetrol was created through takeover of foreign oil assets, it maintained friendly links with the private sector. The handover of the oil fields, pipeline, and refinery was the first peaceful transfer of oil assets to government in Latin America. In 1948, a few years before the intended reversion of Tropical's concession, the Colombian government offered Jersey Standard a minority residual stake in the property, but it refused. Instead it agreed to sell technical assistance to Ecopetrol, and the government oil company continued producing oil from the moment of takeover in 1951. Standard Oil's expertise was obtained through a service contract; it agreed to train Ecopetrol employees over a ten-year period. More assistance came in the early 1950s, in the form of a loan of US$10 million from Jersey Standard. With the new financing, Ecopetrol expanded the capacity of the old Tropical refinery to 78,200 b/d in 1960. Colombia, more than any other South American nation, retained close relations with Jersey Standard.

Since its inception, Ecopetrol has been adding to its refining capacity. After the expansion financed by Jersey Standard's loan, the capacity rose from about 78,000 b/d in 1960 to about 110,000 b/d in 1975. In that year, Ecopetrol acquired a 50,000 b/d refinery in Cartagena from Jersey Standard. Through that move, Ecopetrol acquired control of all but 10,000 b/d of Colombian refinery capacity. In 1990, the Colombian refining sector was still dominated by the two Ecopetrol plants. The Cartagena refinery's capacity had grown from 50,000 to 70,000 b/d while the Barrancabermeja plant had grown from 110,000 to 150,000 b/d.

With all the expansion in demand and in refining capacity, crude reserves were becoming depleted. From the late 1960s Ecopetrol became involved in a wide-ranging exploration program, concentrating on the Llanos region, to offset declining production. In the meantime, the company did its best to prolong and maximize production from the old oil fields along the Magdelena. It sought an extra 200 million barrels from the main La Circa-Infantas field by flooding the oil bearing structure with water. By the mid-1970s Ecopetrol was one of the four most active exploration companies in Colombia. Most of Ecopetrol's oil was still coming from its old fields, and at the rate of only about 20,000 b/d. Fortunately, oil was discovered in the Llanos field in the late 1970s and with rising output, production from this field alone was expected to reach 45,000 b/d once a pipeline was completed.

The pipeline to the Llanos basin field took about two years to complete, and was very expensive, since parts of the pipeline had to cross the Andean mountains at extremely high elevations, causing engineering problems. The Caño Limon field was part of a $1.8 billion deal sponsored by Ecopetrol in consortium with Occidental Petroleum and Shell of Colombia to develop the basin, build a pipeline, and export crude oil. In this and other projects Ecopetrol enjoyed remarkable success in exploration between 1978 and 1988, finding 24 commercial oil fields which increased its reserves from 600 million to 2 billion barrels or enough to supply the nation's domestic needs from 1988 to 1993.

Ecopetrol's drilling activity from 1988 to 1990 accounted for one in five of all exploratory wells, while in 1990 it planned to drill 30 of the 80 expected wells. The expansion of the oil industry in Colombia in the last few years has placed it third among Latin American oil producing countries, just after Mexico and Venezuela. In the 1940s and 1950s it had fallen to fourth and fifth place, and never really recovered its position until the late 1980s. Ecopetrol's 1988 production amounted to about 210,000 b/d, accounting for about half of the country's production, while the Cravo Norte field--which includes Caño Limon--is said to account for half of the nation's oil reserves.

Ecopetrol's efforts to promote foreign investment dated from the late 1960s. In 1966 the International Development Bank (IDB) lent US$5 million to Colombia for a polyethylene plant. The IDB took an equity interest of nearly 50%, with Dow Chemical and Ecopetrol taking up nearly 13% each.

As elsewhere, the concession system, whereby oil companies were granted exclusive rights to a property over an extended period of time, had come under criticism in Colombia in the 1960s, since it was felt that governments in general signed away too much control over oil development in this way. In consequence, Colombia established its association contract system in 1974 in place of granting any new concessions. Under the system, Ecopetrol permitted other oil companies to explore on certain lands at their own risk and expense until the exploration company and Ecopetrol both agreed that the oil field was commercially viable. Ecopetrol collected 20% royalties on production for subsequent redistribution to three levels of government: local, state, and federal. Thereafter, the private company and Ecopetrol shared production and expenses equally.

Oil nationalism revived in Colombia just as new oil reserves had been discovered and developed by foreign oil companies under previously more relaxed foreign investment rules. In 1979 Colombia's new president, Julio Cesar Turbay, replaced all existing oil concessions--those granted before 1974--with new agreements, in the form of the recently created association contracts with Ecopetrol. Royalties were to be reduced for inaccessible areas. The idea was to use the so-called a Peruvian Model contract, whereby the state oil company would be able to pay for up to half of its share of the development costs with crude oil. In the early 1980s these association contracts were altered to induce greater foreign investment. The year 1983 verged on being a record year with between 15 and 20 contracts signed with foreign companies.

As the beneficial effects of foreign oil investment took root, the political mood changed. In 1985 there was fear that Colombia's "open door" for petroleum investment might be shut. The nation's president, Belisario Betancourt, had established pro-foreign oil policies, but by 1985 his general policies, and with them his oil policies, had come under leftist attack. The energy minister applied extra taxes and restrictions upon the Colombian oil industry and this led to oil industry fears that management control of all pipelines might be transferred to Ecopetrol. Soon after, Occidental was forced to give up ownership of its Caño Limon-Pacific Coast pipeline to Ecopetrol.

Further inducements to foreign investors were developed in the late 1980s. As a variant on the association contracts, risk participation contracts were created, whereby Ecopetrol would contribute a proportion of the cost of the project at the exploration stage, thereby assuming some risk itself, with a partner taking the balance. The areas chosen generally had very great potential and such contracts awarded Ecopetrol a larger share of production if the field were eventually developed. However, this new variant of the association contract was far less successful, and Ecopetrol signed only a few such "risk participation contracts."

In the late 1970s, a time of high and rising oil prices, Ecopetrol was losing money. It had large debts in 1978, totalling US$342 million, and was expected to lose about US$265 million in 1978 owing to the high cost of importing crude oil and gasoline from the Colombian market. The company was short of oil and was spending increasing amounts to reduce its dependency on imports. It planned to spend US$37.5 million in 1979 and a total of US$86 million before 1982 on exploratory oil wells. The discovery of the Caño Limon oil field, and its development in partnership with Occidental Petroleum, made a great improvement; since 1985, exports of crude and fuel oil from Colombia have been making large contributions to a surplus in the country's balance of payments and Colombia is now the third largest oil exporting nation in Latin America. Exports at the end of 1987 were over 250,000 b/d and are projected to reach 430,000 b/d in 1993. In 1988 Ecopetrol had long-range plans to drill 345 exploratory wells by the year 2000, while private foreign companies were expected to drill double that amount.

Ecopetrol is an important tax gathering agent in the country, distributing revenue to the three levels of government in place of those levels of government establishing and collecting a tax. It is also a substantial investor in other industries. The state oil company collects oil royalties, calculated at the rate of 20% on production, and then distributes them for key government projects at local, regional, and national levels. Ecopetrol's non-oil investments include a 14% stake in a chemical complex and a 49% share in the large government-owned coal mining agency Carbocol. Prominent amongst Ecopetrol's other investments is the company Promigas, established in 1985, which distributes and sells about 250 million cubic feet per day of natural gas along the country's north coast.

Nearly all pipelines in Colombia are owned and operated by Ecopetrol; the remainder are jointly owned and operated with other international oil companies. Since the late 1980s the government has been extending the gas distribution network and Bogota will be connected in about 1995. Gas is to come from the eastern plains, but some additional fields will supply Bogota. The company's Promigas subsidiary is building a 435-mile pipeline from the north coast to Bogota. This offshore field holds most of Colombia's gas reserves and is operated jointly by Texaco and Ecopetrol.

The nation, under Ecopetrol, has big and promising plans for the future. It remains to be seen whether Ecopetrol will be allowed to continue to work with the private sector on developing the nation's energy in a successful partnership.

Principal Subsidiaries: Colombian Petroleum Company, South American Gulf Oil Company; Petrofinas Colombianas (89%); Terpel Manizales (70.7%); Terpel Antioquia (59.3%) ; Carbocol(48.87%); Terpel Bucaramanga (40%); Carboriente (37%); Fertilizantes Colombianos (26%); Petroquimica del Atlantico (23.9%); Colgas (21.3%); Promigas(20.3%); Monomeros Colombo Venezolanos (13.8%).

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