A seldom mentioned emerging market country is nurturing a future oil giant.

Few are aware that Colombia is a growing and dynamic economy. Many people think of Colombia as a violent and lawless place dominated by drug cartels, or perhaps even confuse it with socialist Venezuela. But, the truth is Colombia has come a long way. [Read: Forget BRIC: Buy These Emerging Economies Instead]

After nearly 30 years of drug-related violence, a new pro-business government and a U.S.-supported crackdown have vastly improved conditions in the past decade. Since 2002, terrorist acts are down -84%, kidnappings have dropped -88% and the homicide rate is the lowest in 22 years. Colombia’s crime rate is now lower than that of many U.S. cities.

As a result, Colombia is attracting more investors and domestic spending is on the rise. In fact, GDP has grown +5% in the first half of 2010 (compared to +1.6% in the second quarter in the U.S.) and the market has reacted. The Colombian exchange-traded fund (ETF) Global X/InterBolsa FTSE Colombia 20 ETF (NYSE: GXG), has soared +48% so far in 2010 and was the No. 1 performing country specific ETF for the year as of July 30th.

Colombia is rich in natural resources, including one of the largest deposits of oil and gas in Latin America. There are just two Colombian ADRs trading on the New York Stock Exchange, but luckily, one of them has been on fire…

Ecopetrol (NYSE: EC) is Colombia’s largest integrated oil company, and is also the fourth largest oil major in Latin America. The company focuses on exploration and production, but is also involved in refining and transportation. About 90% of the firm is owned by the state.

Ecopetrol explores for oil and gas across Colombia and is expanding internationally through exploration partnerships in Brazil, Peru, and the United States (Gulf of Mexico). As of the end of the first quarter, Ecopetrol had reserves of 1.9 billion barrels of oil equivalent (BOE), 71% of which is oil and 29% gas. The company’s production for the quarter was 83% oil and 17% gas.

The company, like the country, is looking to the future.

Ecopetrol has hyper-aggressive plans to expand and become a major international oil giant. It plans to invest a whopping $80 billion on expansion in the next 10 years and forecasts dramatic production and reserve gains in a relatively short period of time. The company is targeting daily production growth of +27% in 2011 (from Spring 2010 levels) and reserve growth of +68% by 2015 and more than +200% by 2020.

The market apparently likes the growth of the company, as well as the Colombian growth story: Ecopetrol’s stock has returned more than +70% so far this year. This is no small feat considering Morningstar’s Independent Oil and Gas category has returned a paltry +2% year-to-date.

The company should be able to afford the grand $80 billion expansion plans. Most of it (62% to 67%) will be financed with cash generated from earnings, and the rest from debt and new issuances. The company had virtually no debt and about $2 billion in cash and short term investments at the end of the first quarter.

However, this company is extremely vulnerable to the price and demand for oil and gas. In 2009, net income fell -43% from 2008 as energy demand and prices plummeted amidst the financial crisis and recession. But, as world economies have recovered, so have Ecopetrol’s earnings. Profits in the second quarter of 2010 rocketed an amazing +137% compared to the year ago quarter, and first half profits increased +64% compared to a year ago.

Ecopetrol also pays a solid dividend. There are usually several payments every year, and dividends during the past 12 months have totaled $1.36, translating to a solid 3.5% yield even after the run up in the stock’s price. Dividends are paid in Colombian Pesos and converted to dollars for American investors, so there is some currency risk. However, the superior economic growth in Colombia bodes well for the Colombian Peso, which has already soared +16% against the dollar in 2010.

Despite its expansion plans and the emergence of the Colombian economy, Ecopetrol’s performance will be tied to energy prices. The long term growth in worldwide demand for oil and gas as well as oil’s increasing scarcity portend well for the longer term. However, a slowdown in world economies and falling energy prices could hurt Ecopetrol’s performance and stock price just like any major oil company.

Action to Take –> At this point, Ecopetrol encompasses several likely trends going forward. It is an aggressive way to play growing demand and higher prices for energy. It is also a hedge against inflation and a falling dollar that provides exposure to a fast growing emerging market.

The stock is selling at a relatively high 28 times 2010 forecasted earnings.  However, the possibility of significantly higher energy prices in the future combined with rapid expansion of production add to the possibility of explosive earnings growth and make the stock worth it.

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