17 February 2020

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Prior to the newly-elected President Alberto Fernández’ government taking office on 10 December 2019, anticipation and anxiety were high as Argentineans speculated about the uncertain direction of his administration.  Whom would he appoint to what positions? How influential would his vice president Cristina Fernández de Kirchner be?  How friendly would the administration be to foreign investors?  Would it be Peronism as usual, or something different – better or worse?

Fernández acted true to form and played his cards close to the vest until announcing his cabinet.  He appears to have tried to balance moderate Peronists with more progressive Peronists loyal to his vice-president, so-called “Kirchneristas.”  Restructuring sovereign debt is his administration’s first priority.  Reviving the economy is a close second.  In this, one of the principal sectors affected by his policies will likely be oil & gas.  This is evident from his choice of Guillermo Nielsen to head Yacimientos Petrolíferos Fiscales (YPF), the state-owned oil company.  Nielsen was a key economic adviser to Fernández, as well as the most centrist of his economists.  His choice is another sign of Fernández’ pragmatism and reflects the importance of this sector to Argentina’s economic revival.  As finance secretary from 2002 to 2005, Nielsen renegotiated Argentina’s debt with the IMF and private creditors.  He holds a doctorate in economics from Boston University and also served as the country’s ambassador to Germany from 2008 to 2010.

No one knows for certain how Fernández will try to tackle the nation’s severe debt situation.  In January 2020, he made is first overseas trip to begin steps towards renegotiating Argentina’s large IMF debt.  His economic advisors have divergent opinions about how to achieve this.  Exports are one area that could generate much needed hard currency revenues.  Both oil and gas are potential export sources.  Argentina has the world’s fourth-largest shale oil reserves with 2.4 billion barrels and the second-largest shale gas reserves of 350 bcm.  These are concentrated in the Vaca Muerta formation, located in the Neuquén Basin in the northern Patagonia province of Neuquén.  Production year-on-year increased in September 2019, reaching 102,174 b/d according to the Neuquén Department of Energy, Mining and Hydrocarbons.  According to the Argentine Energy Secretariat, the country produced a total of 517,041 b/d in September, up 3.7% over September 2018.  Gas production is also up.  Total gas production in Neuquén rose to 75.5 million cubic meters/day in September, a 10.6% increase year on year, with 45% of the province’s gas production coming from Vaca Muerta.  While gas production has grown over the last years, pipeline bottlenecks and low prices have hindered growth.  Despite this, 44% of Argentina’s total gas production comes from shale.

Vaca Muerta has been producing oil since 2010, but its vast shale reserves remain unexploited.  Many majors have shown interest in the area.  YPF has agreements with companies such as ExxonMobil, Total S.A., Chevron Corporation, Dow Argentina (a subsidiary of Dow Chemical Company), Shell Argentina, PETRONAS (the Malaysian state oil company), Gazprom and China Petroleum & Chemical Corporation (Sinopec).  YPF has described its joint venture with Chevron to develop just the Loma Campana area within Vaca Muerta as the most important unconventional (oil) project in the world outside the United States.

At the recent World Economic Forum in Davos, Switzerland, Nielsen announced that the administration was finalizing a draft regulatory framework for developing Vaca Muerta that it would soon submit to Congress.  Fernández’ government appears to be attempting to downplay the traditional risks of Argentina in order to lure new investment in the massive unconventional play.  Nielsen also suggested that a gas pipeline into southern Brazil could open a strong market for the area’s gas production, since local and Chilean demand has been insufficient to spur production.  Argentine Energy Secretary Sergio Lanziani and Jorge Argüello, the country’s U.S. ambassador designate, have said that they will also seek investments for Vaca Muerta in the United States.

Shale plays offer investors and majors two advantages over traditional oil plays, particularly in Argentina.  Extraction of oil and gas in shale formations requires fracking, a process of vertical and horizontal drilling combined with underground explosions and the injection of fluids to force the hydrocarbons out of the small areas between the rock.  As opposed to traditional oil drilling where once a well is drilled and operational there is little further activity by oil companies, fracking is an ongoing, repetitive process, with shorter production cycles and lower deep investments.  Capital investment in a fracking well is recovered much more quickly.  All this makes shale projects less vulnerable to expropriation, something investors remember and fear, particularly from the Kirschner administrations (2003-2015).  The recurring need for regular investment also makes shale operations less attractive for intervention and meddling by national and local governments, unions and others.  This helps explain the increase in investment in Vaca Muerta from $3 billion in 2013 to $7.5 billion in 2019.

On the other hand, once found natural gas requires much larger investment in above-ground handing and processing.  It is less easily stored and requires significant pipeline infrastructure.  And in order to be exported, it must be liquified.  This will require pipeline investment of US$800 million and a processing plant costing US$5 billion.

Fracking does offer opportunities for smaller and medium-sized players, who helped create the shale boom in the United States.  However, operating costs in Argentina are higher and operators must deal with the unions there.  The Macri government recognized this and in 2017 began a plan of agreements and investment incentives to reduce these hurdles and risks.  However, Argentina relies on gas for most of its domestic energy needs.  Governments have therefore traditionally intervened to maintain artificially low prices.  Fernández could be tempted to do the same.  But the shale market has different dynamics.  Any action E&P operator’s investments or profits, and their expatriation of revenues, could cut production within as little as a year.  The new administration must resist the temptation to resort to traditional taxes on exports as a short-term way to generate revenue.  Indeed, virtually immediately after taking office, the Senate granted him increased authority to negotiate with creditors, raise worker salaries and increase taxes.  However, this was achieved after the government agreed to lower export taxes on oil, gas and mining, as well as tax relief for small farmers.  This indicates that oil & gas will be subject to the same balancing of competing interests that appear to be future of the new government.  No one knows with any certainty whether his vice president was chosen as a running mate merely to obtain votes from the Kirschner base, or whether there is any true synergy between her and Fernández on any policy issues.  So far, things seem to be leaning in a Kirschnerist direction.

Business Analysis

We recommend a continued wait and see approach to investment in the country.  The potential opportunities must be weighed against unknowns and alternatives in other countries or regions that may offer less potential but also lower risk.  It may take several months before the new government’s policies become clearer.

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