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POSITIVE RESULTS IN THE PRODUCTION ACTIVITY

Neither at the beginning of the sixties when the field was discovered, nor at the end of the twentieth century when the price per barrel was at the level of US$10 would the thick and viscous mass of high sulphur content would be appreciated in the market. There were several reasons for the commercial rejection: the high cost of transportation of heavy crude, the environmental limitations and the low price that the market was willing to pay for it.
But, since a couple of years ago, when the international outlook for oil started experiencing drastic changes, the reserves of heavy crude laying underneath the Llanos subsoil nearby Castilla (Meta) turned out highly attractive, to such extent that Castilla has turned into one of the main work fronts of Ecopetrol S.A.
The results of this work are now apparent: production in Castilla has doubled in a matter of four years. As a matter of fact, back in year 2000 when Ecopetrol received the field, production was at 22,000 barrels per day. Today, production has reached a peak of 40,000 barrels per day.
This is part of work that technicians undertook not only in Castilla, but in other directly operated fields as well. As a result, the curve of production of those fields –which showed a steep declination – has now been reverted.

BARREL PER BARREL

By August 2002, the actual production of Ecopetrol’s fields was 113,361 barrels per day. By January this year, the same fields showed production of 118,184 barrels per day and it has continued to increase until reaching 129,411 barrels per day in August 2004.
The above amounts to an ongoing increase of 4.3% for the period analyzed (January 2003, January 2004) and 14.32% when comparing August 23, 2003 with August 23, 2004.
Even though the increment between August 23, 2003 and August 23, 2004 is of 16,212 barrels, it is a fact that such volume is significant in times of scarcity, where every barrel adds to the pot, especially now that the price per barrel is quoted at such a high level.
But good results are not only shown in additional barrels.
There have also been important achievements in the lifting cost, of about US$2.57 per barrel in those fields of direct operation. Among those fields stand out Castilla, Apiay and Ariari, where the lifting cost is US$1 per barrel, a figure way below world standards (US$2.50), turning them into the lower lifting cost fields among production projects in Colombia. The new strategy of Ecopetrol points towards optimization of production in the fields –most of them rated as mature fields. There is still, however, an important percentage of original oil left which could be converted into reserves to be produced, through the application of new technologies allowing for increase of the recovery factor in such fields.
Every barrel economically extractable will be brought to surface in Ecopetrol’s oilfields. For this purpose, a series of projects have been outlined, and some of them are already underway.

CASTILLA, THE KING

Castilla is the star in this process, not only because it has doubled production, but it has quadrupled reserves, as well.
By year 2000, reserves for production were estimated at 80 to 100 millions of barrels with a recovery factor of 7%, as against original reserves of 2,700 million barrels of heavy crude (13.4º API). Currently, the heavy crude project intends to carry the recovery factor in Castilla to 21%. This way, a total of 559 million barrels could be recovered by year 2034 which would place Castilla in the list of giant discoveries made in Colombia For the time being, the goal for 2005 is to reach production of 60,000 barrels per day in this field, thereby increasing production by 50% through drilling of twelve development wells.
Since the campaign started from year 2000 up to now, nine wells have been drilled and two more will be drilled before the end of the year. Other activities include well reconditioning, installation of electro submergible pumping and extension of the capacity for handling of fluids in order to manage greater production volumes.
Investments for next year amount to US$198 million, and it is estimated that within the next ten years additional investments will be in the order of US$395 million.
Our journey through the fields directly operated by Ecopetrol in the Llanos, takes us to Apiay, Suria, Libertad, Reforma, Rancho Hermoso y Valdivia-Almagro, which productions contribute to the crude basket of Ecopetrol with an average 30,000 barrels per day.
After extensive drilling campaigns, reconditioning works and improvement of recovery, these fields have contributed to add reserves in the portfolio of Ecopetrol in the amount of 340 million barrels.

THE HEART OF THE MAGDALENA

Yariguí – Cantagallo are two small fields buried deep in the heart of one of the banks of the Magdalena river, where nature created two small islands.
The landscape of those little islands exhibit a series of rocker arms painted with the colours of the national flag which place the petroleum industry amidst an exuberant and rich cattle region.
There, Ecopetrol initiated a series of activities such as reinterpretation of the field, drilling of eight wells and gun perforating of 28 more wells, between 2003 and 2004.
Since January 2003, when there was a daily production of 4,885 barrels until mid October 2004 when there were registered productions of about 8,613 barrels per day, the increase was of 77%, as a result of the actions undertaken by the technicians of Ecopetrol.
The projection of production until December is intended to reach 9.949 barrels per day, which would mean an increase of 106%, thereby doubling extraction of oil in these fields. Investments will amount to Col.$31,408 million in 2004.

CASABE IS DELIVERING RESULTS

River up, and right in front of Barrancabermeja, well into Antioquian territory, is located Casabe, another field that Ecopetrol works in alliance with Schlumberger since last August, and which contributes with an additional volume of 18 millions barrels of oil.
There, the barrels produced through the application of new technologies are just beginning to add, going from a production of 5,979 barrels per day by January 2003 to 6,416 barrels at the beginning of October 2004. They are projected to increase production up to 7,176 barrels at the end of the current year, which represents an increase of 20%, with an investment of Col $18,885 million during 2004.
The plan is to drill a total of 19 wells and to recondition 100 more during the remaining of 2004 and 2005.
The activity continuous incessant after leaving the river banks, this time at the very heart of the Magdalena Medio, where the drilling rigs were raised for the first time in Colombia.
A series of gun perforation of 16 wells and drilling of six more in the areas of Llanito, Gala and Lisama raised production of the superintendence of De Mares, going from 10,683 barrels per day in January 2003 to 11,976 barrels per day in August 2004. Expectations within the portfolio of products look to close the current year with a production of 12,200 barrels per day, for an increase of 14%.
Investments at the end of the current fiscal year will reach Col. $4,351 million.

WAY DOWN SOUTH

Nearby the Tatacoa dessert - one of the heavenly places at the department of Huila - sharply contrasting with the lush greenness of the Magdalena Medio, are located the fields of the old Dina concession.
There too, Ecopetrol’s technicians try to increase production of these fields which started pouring oil at the beginning of the sixties. Production was increased from 10,247 barrels per day which were extracted by January 2003, to 11,119 barrels per day in August 2004.
Going further down south and after crossing the Colombian massif to land in the heavy jungles of the Putumayo, we find the oilfields corresponding to the old south administrative division of Ecopetrol, which were discovered by Texas Petroleum Company back in 1961. In this place terrorist actions prevent the work of the technicians who amidst a critical public order situation try to maintain production of these fields above 9,000 barrels per day.
This way, going from north to south and west to east of the uneven and diverse Colombian geography, work is taking place for retrieving every barrel of oil lying under the subsoil in a ceaseless endeavour to keep a production level that may keep them viable, while the exploratory activity contributes with new reserves to be added to the business portfolio.

WHAT HAPPENED TO THE BACKWARDATION?

In discussing the current extended price rally, it is useful to examine earlier periods of very high prices. A prime example is the invasion of Kuwait in the summer of 1990. That summer, the market was actually in deep contango before the invasion, as Kuwaiti overproduction was swamping the market, and some players were already expecting some Iraqi response.
After Iraq's military action, prompt WTI soared by nearly $9.00/bbl from July to August and the price structure swung to steep backwardation, as the contract for twelve months forward rose less than $4/bbl. As prices rose toward their peak in October, this forward price hardly moved from its August level, thereby widening the backwardation to nearly $10/bbl (see chart). This steep backwardation signaled the market's overall confidence in producers being able to meet demand once hostilities were finished. Similarly during the war in Iraq last spring, prices surged to their peak of $35.75/bbl in February, while the backwardation grew over $8.50/bbl. Again, the market largely discounted the immediate cause of high prices (loss of Iraqi and Venezuelan production), in the expectation that the market would return to equilibrium in the future.
What is striking about the current price rally is that the entire forward curve has moved with the prompt month's surge. The discount for crude a year forward has remained roughly near $4.00/bbl, even as the prompt month price has risen to historic levels over $40/bbl. This upward shift of the curve even in the outer months suggests that deeper changes may be emerging in the oil market. Of greatest concern is that the market may have lost some faith in the ability of Saudi Arabia to play the role of swing producer. Our estimates of current OPEC spare capacity certainly suggest that the traditional safety margin has narrowed. We believe OPEC spare capacity has fallen to levels near 2.56 million b/d, which would represent their lowest level in over 10 years.
Another useful way of looking at this shift is to compare the value companies are assigning to crude reserves still in the ground. Historically in-ground crude reserves were priced at levels roughly near $5/bbl when firms acquired additional assets.
However in recent years, the industry has seen this crude valuation measure rise. Some of the recent deals in the North Sea and the U.S. Gulf of Mexico have witnessed valuations in the range of $7.00/bbl or even $8.50/bbl. These higher prices seem to be an indicator that some industry players are expecting a higher price environment moving forward. To be clear, we remain convinced that WTI is currently overvalued, and will fall from current highs in the coming months. However, we highlight these two factors to suggest that the price may not collapse as far as feared earlier. WTI may in fact have shifted to a higher trading range of $30 to $40/bbl from its recent pattern between $25/bbl and $35/bbl.