Ecopetrol - Q3 2022

Transcript

Operator (participant)

Good morning. My name is Juan, and I'll be your operator for today. Welcome to Ecopetrol's Earnings Conference Call, in which we will discuss the main financial and operational results for the third quarter of 2022. All lines have been muted. There will be a question and answer session at the end of the presentation. Before we begin, it is important to mention that the comments in this call by Ecopetrol's senior management include projections of the company's future performance. These projections do not constitute any commitment as to future results, nor do they take into account risk or uncertainties that could materialize. As a result, Ecopetrol assumes no responsibility in the event that future results are different from the projections shared on this conference call. This call will be led by Mr.

Felipe Bayón, CEO of Ecopetrol, Yeimy Báez, VP of Low Emission Solutions, Alberto Consuegra, COO, and Jaime Caballero, CFO. Thank you for your attention. Mr. Bayón, you may begin your conference.

Felipe Bayón (CEO)

Good morning, and welcome to the third quarter 2022 earnings conference call. The Ecopetrol Group continues to deliver solid operating and strategic results that are joined up by a successful commercial strategy and a disciplined financial management in a year in which we have delivered historical results. Firstly, I want to thank the more than 18,000 direct employees of Ecopetrol and as well as our allies and contractors and partners who jointly look to make the impossible possible for the benefit of millions of Colombians and those in the areas in which we operate. In the first nine months of the year, we achieved a net income of COP 26.6 trillion and an EBITDA of COP 59.2 trillion, which equates to an EBITDA margin of 50%.

The net income for these nine months is 59% higher than the whole 2021 net income and 150% higher than the one observed for the same period in the last year. From this quarter results, I would like to highlight the following milestones. The gas discoveries in the Caribbean, in the Gorgon-2, in which we partnered with Shell, and Shell is the operator, and the Uchuva-1 well with Petrobras, the operator, both exploratory wells, and the announcement by our subsidiary, Hocol, the successful drilling of the Coralino-1 well, proving the presence of gas in a structure close to the Arrecife discovery in the Department of Córdoba. All this to reiterate Colombia's potential for gas, the hydrocarbon of the energy transition. The growth path in our production levels in accordance with the strategy outlined and announced at the beginning of the year.

The average production in 3Q was 720,000 barrels of oil equivalent per day. So far this year, we have an average of 706,000 barrels of oil equivalent per day due to the increase of our execution capacity, which has improved the performance of the fields in Colombia and our growing unconventional operations in the US in the Permian. The increase in the capacity of more than 50,000 barrels per day at the Cartagena Refinery, thanks to the successful start-up of the interconnection of crude oil plants, IPCC project, taking a firm step to guarantee the supply of fuels and Colombia's energy sovereignty. Completion of the pilot test for the production of green hydrogen at the Cartagena Refinery.

This project is part of Ecopetrol's strategic hydrogen plan within the framework of its low carbon emissions business portfolio, which we expect will contribute to our operations' decarbonization goals, as well as those of Colombia. Let's please turn to the next slide to address issues in line with our TESG strategy. During the first nine months of the year, we have made significant achievements in our TESG strategy. On the environmental front, I would like to highlight our progress in decarbonization, circular economy, and natural climate solutions reflected in the following. An 87% fulfillment of the annual emissions reduction goal, accumulating a reduction of 229,317 tons of CO₂ equivalent so far in the year.

The result of our energy efficiency program, which as of Q3 2022, has led to a savings of COP 97 billion and avoided the emission of 98,000 tons of CO₂ equivalent. The inauguration, jointly with El Dorado Airport in Bogotá, of the first road segment in Colombia, paved with asphalt and recycled plastic, low-density polyethylene, in favor of the protection of the environment and waste reuse. On the social front, we continue to work for the sustainable development of the communities in the territories in which we operate. The ceremony where we awarded scholarships for university or higher education to 65 high schoolers through the Bachilleres Ecopetrol program. Thanks to which we have now benefited more than 1,600 young Colombians from 32 departments in the country over the initial 36 years of the program's existence.

The contracting of goods and services for COP 17.6 trillion during 2022 by the Ecopetrol Group, contributing to the economic and social development in different regions. The results achieved in the ranking of the most diverse and inclusive companies of the Centro Nacional de Consultoría, where we obtained 3rd place. On the corporate governance front, Ecopetrol was awarded with the Andesco Sustainability Award for having best practices in corporate governance 2022 environment. Additionally, I would like to highlight the balance of our second extraordinary general shareholders meeting, in which we had 305 institutional and 85 retail shareholders. We reached 1,096 connections in our live transmission, and our shareholders elected the board of directors, which now is formed by 2 women and 7 men, and 7 independent and 2 non-independent members.

In strict compliance with the company's bylaws, the board is composed of one member nominated by the representatives of the minority shareholders, who was reelected, three elected members who continue in office, one board member nominated by the hydrocarbon producing departments in which Ecopetrol has a presence and was elected, and four new board members. The members of the board of directors of Ecopetrol have extensive experience and broad technical, financial, and business knowledge, which supports their role as strategic advisor to the Ecopetrol Group. Finally, on the science, technology, and innovation front, as of 3Q 2022, we have been able to capture benefits for $136 million, mainly due to the results obtained by the business technologies and digital solutions implemented in Ecopetrol and Cenit, among others.

We advanced the first awarding phase of the Innóvate 2022 contest, a program that allocated COP 720 million to promote the energy transition and innovation in the country. We signed a joint declaration with the representation of the State of Bayern of Germany in South America to strengthen our bilateral cooperation focused on intensifying the bilateral exchange of knowledge, innovation, and technology for sustainable development and the energy transition. I wanna now pass the floor to Yeimy Báez, who will talk to you about the main advances in the business segment of low emission solutions.

Yeimy Báez (VP of Low Emission Solutions)

Thanks, Felipe. During this quarter, we reached important milestones in the portfolio of low carbon solutions. On the natural gas side, a pilot project was started for the importation of liquefied natural gas on a small scale to the district of Buenaventura in order to test an alternative gas source to guarantee a reliable supply of this fuel to the city. Additionally, the Candeo project was ratified with 12 companies from the gas and financial sector. This project aims to finance the purchase of approximately 4,000 heavy load vehicles powered by natural gas. Ecopetrol will join with an investment close to COP 60 billion. It is expected that this project will spur demand for natural gas vehicles while eliminating more than 220,000 tons of CO₂ per year.

We reaffirm our social commitment with the agreement signed by Hocol and Gases de La Guajira to provide funding to connect 308 low socioeconomic households to the natural gas service by 2023. Additionally to what Felipe mentioned about the proof of concept to produce green hydrogen at the Cartagena refinery, we continue working on the decarbonization of the public and cargo transportation industry with the introduction of fuel cell vehicles. In this line of work, we made progress on the pilot for sustainable mobility in Bogotá, where infrastructure will be created to recharge vehicles with hydrogen fuel cells, promoting use of low carbon solutions within the integrated public transportation system of Bogotá, SITP in Spanish. The system will be live for approximately 8 years, with the possibility of an extension for up to 10 years.

Finally, I would like to highlight that the Ecopetrol Group continues with the implementation of various low carbon technologies to generate energy from non-conventional renewable sources such as solar, wind, biomass, geothermal, among others, in the areas of the country where the group operates. The operations that already have this renewable energy system have created cost savings close to COP 19 billion and reductions of over 27,000 tons of CO₂ per year. I will now give the floor to Alberto Consuegra, who will talk about the main operational milestones.

Alberto Consuegra (COO)

Thank you, Yeimy. During this third quarter, we drilled 4 exploratory wells for a total of 13 wells drilled and 6 confirmed exploratory successes, 2 offshore and 4 onshore so far this year. By the end of the year, we expect to drill 24 exploratory wells in line with the plan. The presence of gas has been confirmed in deep waters in the southern Colombian Caribbean in the Gorgon-2 well operated by Shell, in which Ecopetrol has a 50% interest, confirming the extension of the discovery made back in 2017 with the Gorgon-1 well, and confirming the existence of an offshore gas province, where the Cronos and Purple Angel discoveries were also found in 2015 and 2017 respectively.

This outcome will allow us to proceed with the evaluation of the findings, which if developed, would increase Colombia's gas reserves. Additionally, during October, the Coralino-1 well, located in the Department of Córdoba and operated 100% by our subsidiary, Ecopetrol, revealed the presence of gas in the Ciénaga de Oro formation, which is undergoing initial tests to determine its technical and commercial feasibility. Moving forward with incorporation of reserves, the El Niño-Two discovery, located in the Department of Cundinamarca, progressed from its exploratory stage to the development and production stage. Ecopetrol has 50% interest, Perenco 30% as operator, and CNOOC 20%. Currently, the Ecopetrol Group has a robust and competitive exploration portfolio that drives the country's sovereignty. Gas opportunities offer an estimated potential of 17 TCF of gas identified in 46 prospects and eight discoveries under evaluation. Let's continue to the next slide, please.

As Felipe mentioned, production continues to grow, reaching 720,400 barrels of oil equivalent per day by 3Q 2022, the highest on record since 2Q 2020, and placing us at the high end of the target range set for 2022. As compared to second quarter, production increased by 15,800 barrels of oil equivalent per day. We highlight the incremental production of our operations in the Permian and the Rubiales and Caño Sur fields. Likewise, production recovered in the La Cira, Caño Limón, and Caricare fields after community events. Also, the contribution of production from the exploratory wells should be highlighted. It is important to note the increase in our execution capacity.

So far this year, we have drilled and completed 407 development wells, 42% more than in the same period of last year, with an average use of 29 active rigs and 373 workovers. Finally, we highlight the entry into operation of the first facilities trained in Caño Sur, which will increase the production of the field by year-end between 7,000 and 10,000 barrels of oil per day. Let's move on to the next slide, please. In the Permian Basin, our activities during this quarter reached an average production of 43,800 oil equivalent barrels net Ecopetrol per day before royalties. 79.2% more than in the same period of 2021, with a record production of 50,200 barrels of oil equivalent per day in September. Gas production contributed about 16% to total production.

We also highlight our solid financial results. So far this year, we have generated an EBITDA of $454.5 billion with an EBITDA margin of 88%. In line with our TESG strategy, we highlight the low emissions intensity of our Permian operations as a result of the zero routine flaring initiative and the use of fugitive emissions monitoring systems in the facilities. Likewise, as part of Ecopetrol S.A. alliance with Accenture and AWS to develop a digital solution for water management, a pilot project is currently being conducted in our Permian assets. By year-end, we expect an average annual production between 36,000-38,000 barrels of oil equivalent per day net for Ecopetrol before royalties, with approximately 93 wells drilled and 95 wells completed. Let's continue to the next slide, please.

In the midstream segment, transported volume increased by 63,000 barrels per day versus third quarter of 2021, mainly due to the higher production of crude and local demand for refined products. It's worth noting that in the third quarter of this year, we reached an all-time high for product pipeline transport, exceeding 300,000 barrels per day. In order to strengthen the company's operation and contribute to the hydrocarbon transport business, two new tanks, each with a storage capacity of 100,000 barrels, came into operation at the Sebastopol station of the Mid-Magdalena trunk line, increasing the storage capacity of this strategic asset of the pipeline system by 26%.

Within the framework of our TESG strategy, we highlight the inauguration of the photovoltaic solar system in Tumaco, Nariño, together with the Pacific Technical Development Corporation, CORTEPAZ, which will supply the energy required for the cocoa drying process. This project will benefit 293 families and positively impact 90% of women in the region, promoting the closing of gender gaps in the cocoa activity. Let's go to the next slide, please. In the downstream segment, operational integrity was maintained and exceptional financial results were achieved. We highlight quarterly historical throughput levels recorded in both refineries, as well as an increase in value because of higher diesel and jet fuel production. During the third quarter, the segment registered a combined refining gross margin of $20.3 per barrel and an EBITDA of COP 2.2 trillion.

The Cartagena Refinery accounted for 36% of the segment's EBITDA during the quarter and 41% so far this year. These results were leveraged by an efficient plant shutdown execution strategy, ensuring the operational availability and reliability of the assets as well as cost control. On September fifteenth, the Cartagena Refinery increased its throughput capacity to 200,000 barrels per day, an amount that exceeds the previous operating capacity by 50,000 barrels, thanks to the successful start of the original crude unit systems. This project involved the effort of more than 1,500 people, with 93% of labor originated from Cartagena. No injuries, process safety events, and environmental incidents were reported.

This expansion established the role of the Cartagena Refinery as a strategic asset to guarantee Colombia's energy autonomy, and will allow us to produce a greater volume of fuels that meet the highest international quality standards. On the other hand, the Barrancabermeja Refinery was recognized as the best in Latin America by the World Refining Association during the Latin American Refining Technology Conference. This award highlights the refinery's lead position in efficiency, energy transition, profitability, and implementation of new technologies. In line with our commitment to TESG at the Cartagena Refinery, a renewable diesel industrial trial will take place during this quarter in order to gain information for the business case and continue our progress in the energy transition process. During the fourth quarter, we expect to complete the refinery plant shutdown cycle as scheduled. In Esenttia, progress continues in the expansion of one of the plant's capacity.

Maintain the operational stability and availability of all our business units. Let's move on to the next slide, please. The domestic and international macroeconomic situation has generated commercial, inflationary, and logistical challenges for the Group. As of September, there has been a significant increase in prices, mainly of raw materials and power, which has impacted the cost structure, representing a weighted increase of 13% versus the previous year. Within the Ecopetrol Group, we have been developing comprehensive strategies to mitigate the inflationary impact and protect our ability to execute the business plan. So far this year, we have captured efficiencies of approximately COP 1.8 trillion, of which COP 0.6 trillion have helped contain inflationary pressure and costs. In the absence of these efficiencies, we would have had a 16% cost increase.

In addition to this efficiency program, we have worked to ensure the availability of inventories of materials required to operate by developing joint procurement strategies with our suppliers. The total unit cost for 3Q 2022 had a year-on-year increase of approximately $13 per barrel, primarily due to higher prices of purchases and imports of crude oil and products. The lifting cost increased by 9% versus the third quarter of 2021, from $8.45 to $9.17 per barrel, mainly as a result of greater operational levels and the influence of inflationary pressure on the cost structure. Regarding the refining cash costs, we had a 16% reduction with respect to 3Q 2021, thanks to the higher throughput volume at the refineries. Finally, the cost per barrel transported also decreased due to the higher volume of crude oil and products transported.

I now give the floor to Jaime Caballero, who will present the key financial results of the Ecopetrol Group.

Jaime Caballero Uribe (CFO)

Thanks, Alberto. During the third quarter of the year, the group continued to deliver exceptional financial results, supported by strong operating and commercial performance that has allowed distinctive capture of positive market conditions. EBITDA per barrel of the hydrocarbons business, which does not include ISA's contribution, increased $27.1 per barrel compared to the first nine months of 2021, reaching $67.3 per barrel, explained by higher realization prices of the basket of crudes and products, incorporation of ISA, and the increase in sales volumes. Net income breakeven was $20.3 per barrel, decreasing $14.5 per barrel as compared to the first nine months of 2021, mainly as a result of higher sales volumes and improved crude and product spreads.

In the energy transmission and toll roads business, ISA's EBITDA margin, excluding the construction business, closed at 83.6%, mainly explained by the positive effect of macroeconomic variables in Colombia, Chile, and Peru, and the entry into operation of new projects since 4Q 2021 in all of the company's geographies. ISA's ROE for the nine months of 2022 was 13.2%, in line with the strategy of generating sustainable value. In terms of the Ecopetrol Group's consolidated results, the following stand out. EBITDA margin stood at 49.5%, driven by higher realization prices of the crude and product basket, the incorporation of ISA, and the strong performance of the Permian asset and the Cartagena Refinery.

ROCE continued to increase and stood at 19.1% during the first nine months of the year, compared to 10.8% in the same period of 2021, explained by higher operating income in line with the previously mentioned factors. It is important to highlight the increase in EBITDA in all of the group's segments, particularly in the downstream, which tripled its contribution compared to the previous year due to its operating stability. Likewise, the energy transmission and road segment contributed stability to the group's revenues and operating cash flow. The gross debt to EBITDA ratio was 1.5 times, below June's level, explained by a better EBITDA result.

It is important to highlight that the increase in the debt balance observed in the quarter is explained by the foreign exchange restatement, which is mainly recognized in equity due to the use of hedge accounting, and not by an increase in debt operations. In line with what was discussed in previous calls, the Ecopetrol Group continues to manage debt maturities for the third quarter of 2023, seeking to ensure the most competitive conditions in this volatile market environment. Please, let's go to the next slide. Regarding CapEx performance, during the first nine months of the year, $5.5 billion were executed, 74% more than in the same period of 2021, out of which $4.8 billion correspond to the hydrocarbon business. With this, the Ecopetrol Group returned to the investment execution levels recorded prior to the pandemic.

On the other hand, investments executed by ISA amounted to $0.7 billion, mainly focused on the transmission business. With the above, we maintain the investment target in the initial range of the plan. This quarter marks the one-year anniversary of the consolidation of ISA within the group's results, so I would like to highlight some relevant milestones regarding the investment made in this company. Regarding the financing of the acquisition, during 2021 and 2022, we carried out two liability management operations for a total of $3.2 billion, which allowed us to improve the maturity profile and reduce expiries in 2023. Thus, the balance of the international loan taken for the acquisition of ISA amounts to $472 million, which will be refinanced over the coming months.

In terms of the contribution to the group's results, ISA has exceeded expectations in terms of revenue, EBITDA, and net income generation when compared against original budgets. As of September, revenues were 16% higher than the budget estimate, profit generation was 50% higher, and EBITDA generation was 30% higher. This continues to confirm the added value from ISA to the Ecopetrol Group through the generation of stable cash flows without reducing our exposure to Brent as a group. Please, let's go to the next slide.

At the end of the third quarter of 2022, the Ecopetrol Group recorded a cash position of COP 15.9 trillion, where the following items stand out. An operating cash flow generation of COP 14.9 trillion, mainly associated to the good performance of the business segments, the favorable price environment, and the collection during the months of July and August of COP 6.5 trillion from the Fuel Price Stabilization Fund, FEPC, for its Spanish acronym. The account receivable from the fund amounts to COP 20.4 trillion as of end September, corresponding to the accumulated amount since April.

Regarding FEPC, it is important to note that the general budget of the Colombian nation for 2023 included an explicit item of COP 19 trillion to partially pay off the accumulated balances since April to date, in addition to empowering the ministry to offset such payments against eventual dividends decreed in its favor and/or use uncommitted budget surpluses for additional payments to the fund. Also, it is important to highlight that the new government initiated a gasoline price adjustment path, which is critical to slow down the speed of such accumulation and to close the gap of local versus international reference prices.

The resources generated by the operation were used for organic capital investment for COP 5.5 trillion, as well as for the outflow of COP 7.3 trillion in cash flow, of which COP 2.1 trillion correspond to debt service and COP 5.2 trillion to dividends paid to the company shareholders and to the minority shareholders of the subsidiaries in the transportation segment. I now turn the floor over to Felipe for his closing remarks.

Felipe Bayón (CEO)

Thank you, Jaime. In the context of the long-term strategy, Energy that Transforms, presented at the beginning of the year, we set different goals, not only in terms of our operations and financial indicators, but also around the steps required to move decisively and responsibly towards the energy transition. Several short, medium, and long-term commitments on the environment, social, and governance fronts are part of the roadmap for our various efforts in the areas of water reuse, continued reduction of greenhouse gas emissions, reduction of fugitive emissions, increasing the installed capacity of renewable energies, sustainability in terms of transfers to the nation, impact generation through social environment investment, the constant search of the highest safety standards in our operations.

In line with the performance evidenced in these and other fronts in our key ESG strategy, we will continue to disclose in a transparent and timely manner such information to our different stakeholders. Highlighting the following. In 3Q 2022, we presented our second specialized report on climate change management from the perspectives of governance, strategy, risk, targets and metrics for 2021. Following the recommendations of the task force on climate-related financial disclosures, TCFD, and international best practices. We obtained 77 points in the Dow Jones Sustainability Index measurement, where more than 10,000 companies worldwide participate in such evaluation, and as such, is one of the most recognized international benchmarks for good corporate practices. Let's now go on to the next slide.

Far this year, the Ecopetrol Group has been delivering solid financial and operating results that have been accompanied by milestones in each of the pillars of our 2040 strategy, Energy that Transforms. This has allowed us to move forward in an organized manner towards the energy transition, strengthening our commitment to the country and the energy security. The new board of directors has expressed its support for the continuity of the 2040 strategy, which seeks to promote renewable and low-emission energies while continuing with the exploration and exploitation of oil and gas. The new challenges we face as an industry demand activating levers that allow us to adapt promptly and to continue to work on generating value for our stakeholders, taking advantage of the opportunities that align with our 2040 strategy and within the framework of the decarbonization objectives.

Let's now go to the next slide for our closing remarks. To conclude, we continue to deliver solid results to our shareholders and stakeholders, even above the goals we set for ourselves in the year. We have made concrete progress in each of the pillars of our strategy. Particularly noteworthy are the results that allow us to ensure supply and guarantee of the energy sovereignty for Colombia. We remain committed to creating value for our shareholders while working with the government to contribute proactively to the design of the country's energy policy and to define different commitments within the frame of a gradual, responsible, and just energy transition. Once again, thanks to all of you who are participating today in this earnings call. Thanks for your time. Thanks for your interest in Ecopetrol, and I will now open the floor for questions and answers.

Operator (participant)

Thank you. We will now begin the question and answer session. If you have a question, please press zero one on your touchtone phone. If you wish to be removed from the queue, please press zero two. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press zero one on your touchtone phone. At the moment, we have a question from Bruno Montanari from, Morgan Stanley. Please, Bruno, go ahead.

Bruno Montanari (Executive Director of Equity Research)

Good afternoon, everyone. Thanks for taking my questions. I have a question about production and a question about the taxes. On production, even if we look at the top end of the guidance, it means that in the fourth quarter, there will be a decline, right? Can you walk us through what would be the drivers of production now through the end of the year, and if there could be a possibility that you actually surpass the top end of the guidance in 2022? On the tax rate, if I understood correctly from the Spanish call, the company sounded less concerned, it seemed, about the amount of new incremental taxes that would flow through.

I mean, on our numbers, looking at the potential 15% extra points on tax, it's a meaningful impact over cash flow. I was wondering if that interpretation is correct. Finally, still on the taxes, can you give us an idea of the impact of the non-deductibility of royalties part and perhaps walk us through how that would be measured? It seems a little bit complex, involving what is in-kind royalties in cash, being cost-based, among other items. Any visibility on that specific point would be greatly appreciated. Thank you very much.

Felipe Bayón (CEO)

Thank you, Bruno. Good morning, and thanks for being here today. I'm going to ask Alberto to take us through a bit more detail on production for 4Q and next year. I'm gonna ask Yeimy to talk about tax reform and the impact. Alberto, you can go ahead.

Alberto Consuegra (COO)

Bruno, good morning, and thanks for your question. With regards to production in 4Q, as you mentioned, there will be a decline. Because of the planned maintenance of the Cusiana gas plant, which was executed during the month of October. What we are seeing is in October, with weak production because of that, with an average of about a little bit under 700,000 barrels oil equivalent. But then we expect a strong comeback in November and December, so that at the end of the year, we should be in the higher side of the range that we provided to you, between 700 and 705 thousand barrels. That's 2022.

With regards to 2023, we expect to have to maintain, you know, a higher production in the range of 720-725 thousand barrels of oil per day. Mostly this will be the if we look at what are the sources for the upside, it will be a strong production coming from our mature fields, Rubiales, Chichimene, and Castilla. New production coming from Caño Sur, and then also the additional production that we are seeing coming from Permian. 2022, as I mentioned, very much in line with what we told you before. Yeimy?

Jaime Caballero Uribe (CFO)

Hi, Bruno. Hope you're doing well. With regards to the tax reform, we basically see that we're fundamentally talking about two effects. The first one, and probably the most meaningful, is the surcharge on corporate tax that's gonna be linked to the price environment. Basically, the way that the reform has been proposed, it triggers three levels of incremental surcharge associated to historical price averages in the oil sector. We've been looking at it in a lot of detail, and we actually believe that the methodology that has been proposed in the reform is robust, and it's one that acknowledges the realities of the price environment in the sector.

To that extent, we believe that this 5%, 10% or 15% surcharge that is linked to prices is gonna be kind of closely related to the incremental cash flow that the companies are gonna have. You know, to the extent that those prices materialize, we're gonna have a significant effect or not, right? In lower price environments, the impact is minimal. In higher price environments, there is gonna be a cash effect, but you need to consider that versus the incremental cash flows that the companies are gonna receive anyway associated to the increased earnings associated to that price environment. That's the way we look at it. The other effect, which is royalties, we think it's relatively marginal.

Effectively, what is gonna occur is that cost of production, which are currently being deducted from the tax baseline, you know, from the earnings baseline, are no longer gonna be able to be deducted, right? It's not the commercial cost that is associated to these volumes. It's certainly not the total earnings that the government gets from it, as in earlier versions of the reform. It's only the cost of production. We believe that probably it's not gonna be as material as initially estimated. I'm gonna go ahead and give you some estimates that I shared in the previous call that we did in Spanish, for the benefit of the audience and to make sure that everybody has the same information.

Ultimately, when you take this to a tax effective rate, the way that we're looking at it is that currently, in the Ecopetrol Group, we have a tax effective rate that it's at around 33%. It could, you know, if we think in terms of ranges, you can think about a nominal tax rate of 35%, right? When you think about a world in, under this tax reform, in a high price environment, we're gonna have a surcharge of up to 15%. That's gonna take that 33%-35% to 48%-50%, on the basis of the surcharge. On top of that, we think that the change in the methodology around royalties may add somewhere between 2%-5% of additional points to that tax effective rate.

That's how we think about it, and that's how we're modeling it at this stage. I do wanna emphasize again that this is closely related to what price environment you are believing, right? You know, what price environment you are believing. Clearly, in the near term, when we think about 2023, we continue to see a robust price environment for our commodities. When you think about it in the long term, you know, in midterm and long term, we don't believe that. Therefore, we don't believe that this tax reform fundamentally changes our valuation of long-term projects. I hope, you know, this addresses kind of the broader angle around your questions. Thank you.

Alberto Consuegra (COO)

Thank you. Our next question comes from Barbara Halberstadt from J.P. Morgan. Please go ahead.

Barbara Halberstadt (Senior Credit Analyst)

Hi. Good morning. Thank you for the opportunity of the question. I wanted to also follow up from a comment made earlier on the Spanish call in terms of the refinancing options for 2023. Definitely, where bonds are trading currently would be a much higher cost of debt for the company. If I understood correctly, currently the main source of funding could be bank lines. If that's the case, just wanted to confirm if you're looking more into local sources or local plus international, and to confirm if that's the case as well. And also in terms of the FEPC balance, I think we had an expectation that it could end the year around COP 27 trillion.

Just wanted to have an update if you continue to think that's more or less where you end the year in terms of the outstanding balance for the FEPC, and if you already have an estimate for 2023, considering the modest increases in the domestic prices have been applied for gasoline at least. That would be for me. Thank you.

Felipe Bayón (CEO)

Thanks, Barbara. This is Felipe. Good to have you here. I'm gonna ask Yeimy to give us more details on both refining and status of Reficar as we see it at the year-end and next year. Yeimy.

Jaime Caballero Uribe (CFO)

Hi, Barbara. Effectively what we were sharing in the call in Spanish is that I think there's three key messages. The first one is that the ISA acquisition loan has been refinanced to a very large degree. Out of the COP 3.7 billion of the ISA acquisition, basically COP 3.2 billion have already been refinanced at a cost of debt that is very comparable to the initial acquisition credit. We have remaining balances for the fourth quarter of next year or September, October of next year of about COP 3.5 billion or so of credits that we need to refinance. We're actively working on those. Our bias is towards bank loans on this.

We are looking at all sources, both local and international. To the extent that there is a remaining balance that we don't think it's cost competitive to deal through loans, we will be looking at other options. I think those are things that are gonna sort themselves over time. At this stage, we have a very high degree of confidence that we can refinance this in the short term through the mechanisms available. With regards to your second question around the FEPC and, you know, the stabilization fund balance. As we mentioned in our report, our balance at 3Q closing was of COP 20.4 trillion. That will continue to accrue over the next few months.

We believe that the year-end balance is gonna be somewhere between COP 29 trillion and COP 32 trillion. I cannot give you a certain number because it depends on how international prices evolve. It also depends on how the exchange rate evolves. With regards to 2023, we have been working on some internal projections, and we are sharing those with the Ministry of Mines and with the Ministry of Finance to inform their decision-making around adjustments at a local level. What we've seen so far is that the Ministry of Finance has a clear interest in accelerating those adjustments over the coming year, with a view to reduce the differential that we have between the international price and the local price.

I think it's too early to give you a view around projections for next year since they're gonna be heavily dependent on the pace in which the ministry makes those adjustments and how international prices and exchange rate evolves. Thank you.

Felipe Bayón (CEO)

Thanks, Yeimy. Thanks, Barbara.

Operator (participant)

Thank you. Our next question comes from Luis Carvalho from UBS. Please go ahead.

Luiz Carvalho (Senior Equity Analyst)

Thanks for taking the questions. I have basically two questions here. The first one is trying to come back on the connection between the FEPC and the tax reform. I think that we discussed this in a call, you know, a couple of weeks ago. But just trying to understand, I mean, we think that had some impact in mining and oil. There were some impacts, you know, increasing royalties with ANH. Also, if you could comment on the free zones, particularly on Reficar, and how, you know, also the tax reform is correlated to the, I don't know, to the FEPC situation, right. The second question is about some contract renewals or reactivation.

There is some talks about potentially reactivating some, I know, some contracts in some exploratory areas. Just trying to understand how this can, you know, bring some, you know, impact either the CapEx or production to the company looking forward. Thank you.

Jaime Caballero Uribe (CFO)

Hi, Luis. Good to hear you and hope you're doing well. I'm gonna take the first question, and Berto is gonna take your second question around the contracts outlook and, you know, basically what you're asking is how has the tax reform evolved. I think we need to recognize that this latest version that was approved by the chambers of Congress last week, it is a very different version from the ones that were previously discussed. I think directionally you can almost speak about. This is version 3.0, and there was a kind of version 1.0 and a version 2.0. Version 1.0 spoke about things like export taxes and export levies and things like that.

Version 2.0 spoke about a very aggressive, if you will, taxation or treatment to royalties, right? All of that has gone away. What we have now that is relevant to the oil and gas sector is fundamentally three fundamental effects, you know. The first one is this surcharge that is linked to prices. There's some bands, and basically, if you are below 60, I don't have the exact numbers here with me, but it's, I think it's $63 or so, there is no, you have the same corporate tax that everybody else has. Above 63 and going from 63 to 72, and I'm gonna give you the exact numbers in a moment, you basically have a 5%.

From 72 to 83, you have a 10%, and 83 and above, we have 15%. When you look at those tax bands, they actually quite reflect our understanding of the international price environment, you know. We can agree if you think about our blend prices, they do reflect when you are in a positive price environment, when you are in an exceptional price environment. I think that's in the discretion of the tax authority.

What this reform is doing is essentially taking a stand where this cost of production is no longer gonna be tax deductible. In the context of the overall reform, the impact of that is not that significant. We believe it represents somewhere between two to five points of incremental taxation for the industry. In the end of the day, we don't believe that's a deal breaker in terms of the economics of a given project. The third big topic of conversation throughout this whole tax reform debate was around the continuity of duty-free zones, right? You know, version 1.0 and version 2.0, again, had a very strong stance around the continuity of them. They were gonna go away in some shape or form.

Basically, the project that is in place right now and that was already approved by the chambers, it basically maintains the tax status of the existing duty-free zones that the Ecopetrol Group has in place. There is not gonna be any negative impact associated to that. That's kinda where we are on this, Luis. Over to Alberto.

Alberto Consuegra (COO)

Hi, Luis. Good morning. What are we hearing from the government? First, both the Minister of Mines and the Minister of Finance have been very vocal in stating that contracts already signed will be honored. The Minister of Mines also has said that together with ANH and UPME are evaluating the need of signing new contracts. We received this news with a positive messages, and this reduce certainly the uncertainty that we have in the future. With regards to reactivation of suspended contracts, I have to tell you that some of them have been suspended for social unrest, force majeure issues. Others will need to have agreement in terms in commercial and technical terms.

If those causes for suspension are resolved, these options will have to compete with other options that we have in our portfolio. If they are competitive enough, then they will have to go through the maturation process. At the end, probably will mean that we will have exploratory options, exploratory drilling associated with these assets.

Jaime Caballero Uribe (CFO)

Thanks, Alberto. Thanks, Luis.

Operator (participant)

Thank you. Our next question comes from Andrew McCarthy from Credicorp. Please go ahead.

Andrew McCarthy (VP of Equity Research)

Thanks very much. Good morning, everyone. Thank you Felipe, Yeimy, Alberto, and Jaime for the presentation and the opportunity to ask questions. My first question was on fracking in Colombia. You know, just seeing on local media at the moment, quite a lot of news flow on that. Just wondering, is it the case that the formal decision has been taken to desist from, you know, moving forward with the Kalé and Platero projects? And if so, what are the key sort of steps to unwind, you know, all the sort of key contracts behind that that are in place? Would there be any sort of cost or financial cost implications there for the Ecopetrol Group? That's question number one.

Question number two, apologies if this has already been covered in the presentation or in the questions. I couldn't quite hear. Just wondering about whether the door has now been opened, in fact, for the possibility of signing new exploration contracts in Colombia. Any color you could share on that? My third and final question, just if you could provide any update on the Invercolsa divestiture, where that is, if that's indeed still moving ahead. Just generally on any other sort of asset rotation initiatives that you might be looking at to, you know, optimize the portfolio. That's it from me for now. Many thanks.

Felipe Bayón (CEO)

Thanks, Andrew. I'll take the first one, and if there is anything, Alberto, you wanna add on that. On Invercolsa, I'm gonna ask Nicolás Azcuénaga to give us a bit of color on that question. In terms of fracking, and you were mentioning some of the media coverage that we've seen over the last few days, what we've said as a company is, if at the end of the day, the government, and in particular Congress, takes the decision formally that there won't be fracking in Colombia, we won't do fracking in Colombia. I think that's very clear. We've asked ANH formally for a suspension, a 90-day suspension of the contract that we have as operator. We've done this. Remember, there's Kalé and Platero, as you were mentioning.

Remember, we do have a formal environmental license on one of the projects, on Kalé. What we've said is, we're discussing with our partner, with ExxonMobil, on how to go back and undo some of the commercial agreements that we had with them, and then we'll take this forward. Each company will return to the ownership, the original ownership of the areas in case of Kalé and Platero. That's where we are. I would say that we will, as Ecopetrol, remain with the ownership of the acreage, you know, long term. We'll see where that goes. In terms of cost implications, we've spent money on preparing for the environmental submission, the application of a license.

We've done social investment in the area, and we'll manage that accordingly. We don't see an issue with that. Right now, I think in terms of key steps, awaiting a response from ANH, and then taking it from there, and obviously in constant and continuous communication with our partner. The potential of the already signed contracts, and both of them have been very vocal in terms of honoring the existing contracts. I think that's important. We've mentioned that we foresee eventually some 10 years of activity going forward in those areas. We're not only shooting new seismic, drilling wells, we had good success, as you've seen from exploration, but we're also reinterpreting seismic, which has proven to be quite useful.

You know, we can do, as an example, if we do 2,000 square kilometers per year of new seismic surveys we have collected. The recent or the most recent conversations, Andrew, have been around the possibility of looking at additional exploration potential beyond the contracts that have already been signed. That means, I mean, we've been talking to both ministries. We've sat down our technical teams with them, looking at what that would entail, you know, how would that look in terms of what's the potential. What are the options. Just sharing data and information and having open conversations around our view of what the subsurface potential could be. In terms of Invercolsa, Nicolás, if you can help us with where we are in the process. Go ahead.

Andrew McCarthy (VP of Equity Research)

Yes, Felipe. Andrew, thanks for your question. First, in terms of our approach to divestments in general. On that regard, our approach remains unchanged. That is basically to constantly review our portfolio transport, distribution, and commercialization of natural gas in Colombia, where we hold a 51.8% stake. Our decision to divest our equity remains unchanged as announced earlier this year in May.

Alberto Consuegra (COO)

In due course, we will take this decision to review with the new government. As you know, this process of divestment of assets that have a participation of Colombian nation in its equity. It's ruled by Law 226 in Colombia, which includes the revision or the stage at which the government needs to provide a green light to proceed. If and when we obtain this green light, we envision a process that will take around nine months to complete. Thanks again for your question, Andrew.

Jaime Caballero Uribe (CFO)

Thanks, Nicholas. Thanks, Andrew.

Operator (participant)

Next, we have a question from Frank McGann from Bank of America. Please go ahead.

Frank McGann (Managing Director)

Thank you very much. Just a couple of questions, if I could. One, could you just confirm, you mentioned in this, the tax discussion about the ability to deduct production costs. So I just didn't know if you meant total production costs or royalties only. And then in terms of cost inflation, where are you seeing the biggest effects, and are you seeing any, you know, acceleration in cost inflation as you look out over the next 6-12 months? And then, your diluent volume seemed to be, you know, much lower. And I'm just wondering, what are the expectations for diluent usage, as you go forward here and how will that maybe affect your overall cost structure? Thank you.

Jaime Caballero Uribe (CFO)

Hello, Frank. Hope you're doing well. This is Jaime. With regards to your first question, just to clarify, it's the cost of production associated to those specific royalties. That's what currently the tax regime allows you to deduct, and should the reform proceed as it has been approved in the two chambers, that will no longer be a deductible item. With regards to your second question about inflation, I'm gonna make an overarching comment, and then I'm gonna pass it over to Alberto for some of the specifics. Generally, what we're seeing so far is that we have seen an effect of around 12%-13% in our cost base associated to inflation to our.

We have been able to mitigate probably some 4 or 5 points of that, you know, with the existing contract strategy and through demand management and through long-term pricing and the like. As we look into next year's planning and certainly to the next 2- or 3-year horizon, we are seeing an increasing pressure in that regard. Probably that, you know, 12%-13% is gonna become something along the lines of 16%-17%, simply due to the fact of indexes kicking in. Now, of course, we are not, we're not staying, you know, we're not standing still. We are looking again at, you know, value chain opportunities and contract opportunities and the like. Directionally, we are seeing an increased pressure.

I'm gonna pass it over to Alberto so that he can give you some further color.

Alberto Consuegra (COO)

Hi, Frank. Thanks, Jaime. When you look at our refining and transportation costs are very much in line with the plan. This is because we have in the case of transportation actually transported more volumes. We keep you know the indicator under control. Where we are seeing an impact is in terms of lifting costs jumping about 15% compared to the second quarter of this year. Right now, we have it in the lines of $9.15 per barrel. When you look at what are those areas in which we need to focus, I would say energy cost. That's number one. The second one has to be with the cost of raw materials, particularly steel.

The third one is about the cost of well services. This is subsurface well services intervention. Well intervention costs are going higher, particularly because of what Jaime mentioned. This is about introducing the indexes in line with the inflation that we are seeing for these areas.

Frank McGann (Managing Director)

Thanks, Alberto. Thanks, Jaime.

Operator (participant)

Thank you. Our next question comes from Hernán Goicochea from LatinFinance. Please go ahead.

Hernán Goicochea (Peruvian-American Finance Journalist and Reporter)

Hello? Can you hear? Hello?

Jaime Caballero Uribe (CFO)

Yes, we can hear you, Hernán.

Hernán Goicochea (Peruvian-American Finance Journalist and Reporter)

Yes. Okay, great. I just wanted to make sure. Thank you so much for taking my question. I wanted to follow up a little bit on the financing options that is related to the refinancing of the loan that was used for the ISA acquisition. You mentioned that they will be looking at other options. I remember earlier this year that there was a mention that it was a possible sustainable bond sale either later this year or at the end of this year. Is there still the possibility of going to the international markets as an option to finance to pay off the loan?

Jaime Caballero Uribe (CFO)

Hi, Ivan. How are you? This is Jaime. Yes. You know, with regards to refinancing, I think there's two different buckets to speak about. The first one is the ISA acquisition loan in and by itself, and then there's, like, everything else, which is basically some maturities that we have at the back end of 2023. With regards to the ISA acquisition loan, which was a loan of about $3.7 billion, $3.2 billion of that has already been refinanced through on one hand, a bond that we issued late last year. More recently, we used a committed line that we had for $1.2 billion.

That has already been refinanced, and there's a balance, if you will, a remaining balance of $470 million to go, which we're working on. With regards to 2023 maturities, when you add this, you know, the balance of ISA, the $470 million plus other maturities that we had at the back end of next year, we have a total balance of about $3.5 billion. We are working, you know, with the financial system on different avenues to refinance that. Our preference at this stage is through bank loans, which we are working on.

These are, you know, bank loans with a variety of time horizons. We believe that they actually give us some pretty competitive cost of debt associated to them, with some very interesting extensions in terms of time horizons, which are linked to our business plan. That is our preference, I'd say. There are other options. Bonds are always an option, right? Ecopetrol has a longstanding presence in the bond market, and we are cognizant of that. We keep that option as a possibility. I think as we monitor the credit markets at this stage and circumstances around Colombia and international macroeconomic factors, we continue to review that.

I would say that's a secondary option at this stage, but it's certainly something that we do not rule out at any moment in time. Thank you.

Hernán Goicochea (Peruvian-American Finance Journalist and Reporter)

Thanks, Jaime.

Operator (participant)

Thank you. Our next question comes from Oriana Covault from Balanz. Please go ahead.

Oriana Covault (Equity and Credit Research Analyst)

Afternoon. Thanks for taking my question. This is Oriana Covault with Balanz. I had, one follow-up with regards to the FEPC receivable. Just I understand that you're in conversations on what would be the necessary adjustments for, next year to prevent the further acceleration. If you have any ballpark estimates or view on where do you see the needed adjustments in gasoline and diesel prices as to prevent an accelerated accumulation of the receivable. That would be the first question. And the second question would be more on the CapEx side. I'm looking at your CapEx figures for the quarter.

If you can further elaborate on the inflationary pressures that account for the increase in USD terms, specifically for the exploration, CapEx, which I noticed that you did the same number of exploration wells, but the figure was substantially above, quarter-over-quarter, and same goes for midstream business. Thank you.

Jaime Caballero Uribe (CFO)

Hello, Oriana. This is Jaime. With regards to your first question around FEPC, basically, you know, the balance of FEPC has been accruing at a rate of around COP 2.5 billion-COP 4 billion per month, depending on the month. There's actually two or three key factors that are associated to that. You have on one end how product differentials internationally evolve. On the other end, you have how the exchange rate evolves. Thirdly, as a major item, of course, you have the interventions that the government is making around domestic prices. I actually would argue that there's a fourth element, which is our some methodological adjustments that go into a lot of detail, but they actually also influence the rate of accrual.

The extent of adjustments that need to be made will vary depending on these other factors. You actually need to look at all the factors in unison in order to close, if you will, the gap, right? To close the gap. I'd say directionally that the adjustments that the government has announced certainly go in the right direction, and if they are maintained and implemented on a monthly basis, we believe that the gap is gonna be narrowed in a significant way by the end of next year. Right? Again, there's always the uncertainty around how these other factors evolve.

With regards to your second question around inflationary pressures in CapEx, I'd firstly say that the CapEx execution that you saw in 3Q is by and large and by a massive amount dictated by activity execution. It is by no means result of inflation. I think the inflation that we have seen in our CapEx outlay so far has been minimum. You know, what you're seeing is basically the result of an increased activity set where we have more rigs, we have more workover units, we have more crews in the ground. And that is actually translating into more production. That's really the headline.

Now, as we look into next year and more longer term, CapEx deployment, inflation, it does become a factor. You know, as we sign new contracts associated to those capital projects, inflation will be a factor. I'd say that depending on the specific commodity subsector or service subsector, those effects can be anywhere between, you know, 10%-20%. You know, anywhere in that range. I think you would have to go into the specifics of each project to see to what extent they are mitigated or not.

I would say as a gross average, I would say that, you know, a CapEx effect next year of between, you know, 13%-15% is a reasonable estimate. I hope this helps, Oriana. Thank you.

Luiz Carvalho (Senior Equity Analyst)

Thanks, Jaime.

Operator (participant)

Thank you. Our next question comes from Badr El Moutawakil from Barclays. Please go ahead.

Badr El Moutawakil (Director and Senior LatAm Corporate Credit Strategist)

Yes. Thank you so much, and congrats on your earnings. Two quick questions from me. First one is, are you expecting to receive any FEPC payments from any excess cash from Hacienda by year-end? I think that we read on the news that Ecopetrol could potentially receive something around COP 7 trillion by year-end in addition to the 19 trillion pesos that, Jaime, you mentioned earlier on the call. Just curious if you have any updates in terms of that. My second question is regarding your gross debt level for 2023. Are you thinking about keeping the gross debt stable around $24 billion?

I'm just asking because, you know, if I look at the company right now in 2022 full year picture, and I just try to do like a quick parallel in 2023, this new government is gonna increase taxes, let's say, you know, by COP 5 trillion on Ecopetrol or so depending on the assumptions. So the increase in terms of taxes, and obviously on the upstream is not based on our model, is not gonna offset the pressure from the FEPC. Even if we increase local prices by, let's call it, you know, 20%, we don't have the FEPC balance and the working capital balance offsetting these taxes.

Just curious if you can give us, you know, some your view in terms of gross debt in 2023, and then potentially with the risk of funding, you know, any dividends or potentially these higher taxes with gross debt, or you don't think so. You think that, you know, you can fund it extensively with cash. Thank you so much.

Jaime Caballero Uribe (CFO)

Hi, Badr. How are you? Let me address your different questions. I'd say firstly, let's start with expectations around FEPC payments. This year. There are no further FEPC payments budgeted in Hacienda in the Ministry of Finance budget for this year. However, there is the legal flexibility to apply excess, you know, budget surpluses to FEPC, right? The extent to which those budget surpluses are gonna occur or not is yet being defined, right? It's yet being defined. In our conversations with the Ministry of Finance, we've discussed that as a possibility, but it is yet an uncertain one.

I would say that the base case is no further FEPC payments this year, but there is an upside that that occurs, and that's something that we are actively working with the Ministry of Finance. With regards to your second question around gross debt levels, basically, you know, we close with a healthy gross debt to EBITDA ratio in the third quarter, and that's gonna continue to be reduced over the next few months. The outlook is a positive one for next year. I think the extent to which we're gonna incur incremental debt or not next year is gonna depend on the assessment of the timing in which the FEPC payments are gonna come in, you know, and at the same time, how capital markets evolve.

I think it's gonna be all those factors are gonna have to be considered. You know, all those factors are gonna have to be considered. I think it's still premature to give you a view on that. We're gonna be discussing with the board over the coming weeks what is our view on the investment plan for next year? What is the optionality that we see around that investment plan? You know, what are the trade-offs associated to the investment plan with regards to cash, with regards to a potential dividend payment, and you know, decisions are gonna be made on that basis. What I would say is that we do have a very strong inclination to protect the investment plan.

We have a strong inclination to protect the debt levels that we have at this stage, but we are keeping our flexibility. You know, we are keeping our flexibility because, you know, things are dynamic, you know. What is gonna be the best combination to protect value for the company is something that is yet to be determined. With regards to your third question around working capital balance, you know, and how to offset the pressure of the FEPC. You know, really, I'd say two things. The first thing is that we are approaching this conversation from a healthy place, you know. I mentioned in the call in Spanish that our free cash flow in 3Q is the best free cash flow in the company's history.

The first free cashflow in the company's history ever, you know. It's obviously a combination of multiple factors, but it is accumulating as opposed to a liberating. It's more rather than less, and that helps a lot. Now, to what extent that can fully offset an accumulating FEPC indefinitely, I'd say the answer is no, it can't. No, it cannot. It will not fully offset the FEPC effect, and that's why COP 19 trillion were included in the national budget, and that's why we are in discussions with the government to increase that amount. I think that is something that is gonna evolve over the coming months, and probably in our next call, we can give you a better view of that. That's where we are.

Thank you.

Alberto Consuegra (COO)

Thanks, Jaime.

Operator (participant)

Thank you. Next, coming up next, we have a question from Andrés Cardona from Citibank. Please go ahead.

Andrés Cardona (Director of LatAm Equity Research)

Hi. Good morning, and thanks for the presentation. I have two questions. The first is, guys, you have pointed to $4-5 billion per year incremental cost due to the tax reform. Can you let us know what are the key assumptions you are using there in terms of oil prices? If you can explain that cost between the sobretasa and the non-deductibility of the royalties. The last question is if you can give us an update about how many development wells are you targeting to drill in 2022?

Jaime Caballero Uribe (CFO)

Hello, Andrés. I'm gonna take the first one, you know, or your questions related to tax reform. We haven't given an estimate around what is the tax reform impact for the company, and I can assure you that it's not $4 billion-$5 billion. I think we need to look at the basics. The basics are, we have a tax effective rate of 35% currently, you know, or about 35%, depending on whether you're looking at a group level or at Ecopetrol S.A. separate level. Depending on your price outlook, you need to add either 5, 10, or 15% to that.

In the highest possible case, which is in a scenario where we end up over the $83 or so per barrel kind of threshold that kicks in the 15% surcharge, that tax effective rate is gonna go to about 50%, right? It's 50% on our total net income in pesos. That's the way that you need to calculate it. The split of what is associated to the surcharge or the sobretasa and the royalties is that 90%-95% of the effect is associated to the surcharge, and the marginal amount is associated to royalties. The new treatment of royalties is not a substantial amount as compared to the effect of the surcharge on corporate tax.

I hope this addresses your question. Over to Alberto.

Alberto Consuegra (COO)

Hi, Andrés. What we have said is that for this year will be around 580 wells, and for next year, around 600 wells, development wells. Thanks, Alberto.

Operator (participant)

Thank you. Our next question comes from Andrés Duarte from Corficolombiana.

Andrés Cardona (Director of LatAm Equity Research)

Hello. Thank you. I have one question. Can you please brief us on the carbon shadow prices you're using to price your projects today? Please remind us if the current tax reform includes a carbon tax component. Thank you.

Jaime Caballero Uribe (CFO)

Hi, Andrés. How are you? With regards to carbon taxes, the approach in the company has been around employing what we call a carbon shadow price. Basically what that is it's a theoretical level of a carbon impact that is included in the valuation of a forward economics in projects that we are reviewing. Basically the way that it has been implemented is that we, if you will, we punish the projects that we're evaluating with an incremental cost associated to a ton of carbon that the unitary ton of carbon that a project produces.

Basically, the way that we have been modeling that out is that we use $20 per ton for the next five years, then it goes up to $30 per ton, and eventually it goes up to $40 per ton. It is a theoretical economic impact. This has no cash impact whatsoever. What it does is that it allows us to prioritize projects and to measure projects in terms of their carbon footprint competitiveness. What this actually does is that it actually in a way rewards projects that have a low carbon footprint in that they don't have to reflect that cost burden. It punishes costly projects with a high carbon footprint through an incremental cost. Again, it's theoretical, right? It's not a

These amounts do not go to a purse, they do not go to a fund or anything like that, and they don't have any cash implication as of now. As we look into the future, we are looking at mechanisms to see whether eventually this could actually translate into a real fund, whereby what we accumulate in the fund is used to fund energy transition projects, right? But again, this is something that is still on paper and that we are debating as a best practice in the industry.

With regards to the carbon tax as such, in Colombia, there is an existing carbon tax that it has different mechanisms of the measure, but it ultimately translates into the equivalent of $4 per ton of emitted carbon to the system. What the tax reform does is that it takes that $4 per ton, and it takes it on average to about $20 per ton, right? On average. This depends on the specific product, and it depends on the place in the value chain where you're actually at, right? Within the Ecopetrol Group, Ecopetrol S.A. and Refinería de Cartagena are responsible for this tax. They either pay it directly or indirectly, right? It does have an effect on them.

In the context of the total tax reform numbers that we have been discussing, it is not a material item. Thank you, Andrés.

Felipe Bayón (CEO)

Thanks, Jaime.

Operator (participant)

At this moment, we have no further questions. Mr. Bayón, do you have any final remarks?

Felipe Bayón (CEO)

Well, thanks. I just wanna thank everyone for taking part in today's conference call. Thanks for the interest in Ecopetrol. Thanks for the questions. Hope to see you sometime soon. Please stay safe. Have a great day.

Operator (participant)

Thank you everyone. You may disconnect now.