Oil prices and FDI
February 9, 2018
This article started – as many do – in response to a question from a subscriber: “Can you relate oil prices to Colombian petroleum investment?” It was easy to think of an answer at first, but we did not expect the result to be so definitive. We did a graph showing hydrocarbons-related Foreign Direct Investment (FDI) as reported by Colombia’s Central Bank for the past 11 years compared to the price of Brent. Because they would be on different scales (FDI in US$ millions, Brent in US$ per barrel) we indexed them both to the base year, 2007. Mathematically, this not only removes the scale but focuses more on changes than absolute values (because any index minus 1.0 is the percentage growth from the base year).
The two are startlingly similar, especially from 2011 onward, especially as prices started to fall in from 2012. The conclusion from this analysis is somewhat obvious; that companies invest more when Brent is going up and less when Brent is going down. Nothing really surprising there. The surprise is the statistical correlation – 85%. That says that 85% of the variation in FDI is explained by the variation in Brent. Such high correlations are rarely seen in economic time series like these. Getting a correlation above 50% is considered fantastic. Often, correlations are in the low 30% because other factors are also important and moderate the direct effect.
There may be some of our readers who were taught the maxim that correlation is not causation and their professors were right. Except that none of the main reasons that the relationship between correlation and causation breaks down seem relevant here. The causation does not flow the other way: Colombian investment does not cause Brent. The correlation is not illogical like many of the spurious causations that Internet conspiracy theorists often spout and newspaper editors love to find to fill in blank spaces in newspapers. The only way to conclude that Brent does not cause Colombian FDI is to assume that there is a third, hidden factor that causes both. Here we would point out that such a factor has to be global and not Brent or we are back to the absurd position that a decidedly mid-tier oil producer is somewhat determining the price of Brent.
The statistics say that if Brent holds at about its current price, US$70, then FDI will be 10% higher in 2018 than it was in 2017. Since Ecopetrol (NYSE:EC) says it will spend at least 30% more and many other companies have given guidance that their CAPEX (CAPital EXpenditures) will be more than 10% higher, this 10% higher forecast seems like a pretty good bet, even conservative. But the main conclusion from this analysis – for us at least – is that Brent is (almost) the only thing that matters when it comes to investment decisions. Sure, other factors must be accounting for the remaining 15%, but values would have to be pretty extreme to affect FDI more than Brent.
That means, that for all we complain about ‘surface factors’ like government indifference, social conflict, conflict with the ELN guerrilla group and delays in obtaining environmental licensing, at the end of the day, the industry invests if Brent is going up and reduces spending if Brent is going down. Even in the case that the correlation we see here is, in fact, the result of some hidden third factor determining both, that third factor is not Colombian but universal. Maybe Brent is not the driver but whatever the factor is, it has nothing to do with government indifference, social conflict, the guerrilla or the environmental licensing. True, this analysis applies to companies that are already in Colombia.
Non-price factors would almost certainly affect a board’s decision to enter the country for the first time, or even to exit the country despite existing production. But most FDI, at least in the past five years, was determined by players who are already here and deeply committed to Colombia. These may complain and threaten to reduce spending, but they still invest more when Brent is going up and invest less when Brent is going down. It is (almost) the only thing that matters.
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