No Need to Cry For Thee, Argentina

No Need to Cry For Thee, Argentina

18th February 2016

With oil priced at US$67.60 per barrel, natural gas at US$7.50 per MMBTU, and a rig count that has been going up over the past five years, it may be tempting to think that you have just stumbled across an old article.  However, this is very much 2016 Argentina, and with a new market-oriented government just installed, you would also be thinking that seats on the flights to EZE would be getting hard to come by!

However, while the oil and gas business in Argentina does appear like a veritable oasis in an otherwise gloomy desert, it is not without its own challenges, which includes turning around the legacy of a dozen years of neo-Peronist policies.  Under the Kirchner administration the industry, along with the rest of the economy, had been subject to the impact of government intervention, constraints on the capital markets, very high inflation, and over-valued currency, and controls on prices, imports and exports, the latter on capital being a particular concern to foreign companies.

As a result of initial changes brought in by the new administration, the petroleum sector has been given at least a short-term shot in the arm.  The peso devaluation will mean a CAPEX and OPEX cost reduction in dollar terms of about 15% for 2016, contributing to the reason why producers have accepted a lower oil price (12%), and refiners have accepted not to increase their prices at the gas pump more than 12% during the first three months of the new administration. 

By negotiating with the oil and gas producer higher prices than the international reference prices, the government is trying to maintain constant the internal O&G activity to keep a similar production level and avoid having layoffs. 

Macri Installed as President

On December 10, 2015, Mauricio Macri took over as president of Argentina.  The challenges he inherited included: 

  • A budget deficit of over 7% of GDP

  • A peso 40% overvalued versus the US Dollar, coupled with highly restrictive convertibility

  • Highly distorted domestic prices

  • Inflation on the order of 30% a year

And all this while being cut-off from external capital markets because of the sovereign debt default.

These challenges are summed up in the charts showing the regional (Brazil, Chile, Peru and Bolivia) comparisons of GDP, Inflation and Foreign Investments, along with the official and black market exchange rates in Argentina.

Figure 1: Macroeconomic Indicators of the Region

Source: GCA Analysis

Figure 2: Exchange Rates in Argentina

Source: GCA Analysis

While Argentine GDP growth was comparable or even better than that of its neighbors in 2010-2011, this changed dramatically with the imposition of exchange controls.  Inflation rates have been very high compared with the rest of the region, and foreign investment very low relative to the size of the economy.

While Macri’s electioneering suggested he might immediately move to free the economy, his popular majority was not that liberating.  Thus, while the new government is understandably moving as quickly as it can to develop more market-oriented policies, it is having to do so at a much more measured pace.

The main decisions that have already been taken and will have an impact on the economic and social outcome of the country for the next four years at least (his elected term) include:

  • Eliminate restriction on buying dollars in the official open market (CEPO in Spanish) and allow the dollar exchange rate to fluctuate freely.  This has resulted in a devaluation of some 40% against the US Dollar;

  • Eliminate export duties (with exception of soy beans);

  • Negotiate with external banks to make available a US$15/25 Billion line of credit;

  • Initiate negotiations with the “Holdouts” (the financial institutions that have so far refused the Government’s propositions for debt restructuring/write down of the defaulted sovereign debt); and

  • Authorize international companies to repatriate dividends.

But the oil business is great!!!…

Perhaps not fully appreciated outside of Argentina, while the rest of the world’s oil and gas sector appears to be in a freefall/bloodbath that looks like it could still get worse before it gets better, the failed policies of the last 12 years of Kirchner have ironically created a (at least very temporary) oasis.  During 2015, the Kirchner administration negotiated an internal reference price for the Medanito crude of US$77 per barrel, and US$63 per barrel for the Escalante (the two reference oils produced in the country).

As a result, while having languished in the halcyon days of US activity, the effect has been essentially to stabilize activity while all others about have been losing their heads. 

Figure 3: Wells Drilled, Rig Count, and Oil and Gas Production 

Source: GCA Analysis

The Kirchner agreement expired on 31 December 2015.  To keep the hydrocarbon industry insulated from the harsh realities of the current global energy markets, the new administration negotiated lower but, in a current market context, still substantial reference values with the producers and the refiners:

  • Beginning 1 January 2016, the new reference price for Medanito crude (WTI referenced) that it is being produced in the Neuquén basin will be US$67.50 per barrel and the price for Escalante crude (Brent referenced) that it is being produced at the Golfo San Jorge basin (Chubut and Santa Cruz) will be US$54.90 per barrel.  These prices will be maintained throughout 2016 and thereafter until global prices recover when they will follow the WTI and Brent prices.

  • Gasoline and diesel prices were increased by 6% (in pesos, as a consequence of the devaluation) and will increase a similar amount in March 2016.  The plan is to increase the prices by 20% during 2016, in line with expected inflation rate for the year.  The equivalent price of gasoline in Argentina today is close to US$1.10/liter or US$4.24/gallon.  So while the industry has been protected from price collapse, this has not been shared with the rest of the economy.

  • For natural gas, the pricing scenario is slightly less clear.  The message presented by the new administration is that they will try to get to an average internal natural gas price of US$5.30 per MMBTU, though it is understood that unconventional gas will receive premium pricing, in the order of US$7.50/MMBTU. 

  • In April 2016, the YPF Shareholders will have their annual meeting where they will make a decision regarding the continuation of Miguel Galuccio as President and CEO of the company.  Although the new administration has not yet taken a position, according to the Energy Minister, they are evaluating the alternative to appointing Galuccio as the CEO of the company reporting to a new President. 

Vaca Muerta

It is well known that Argentina has very large unconventional resources in several basins around the country, with the best-known being the Vaca Muerta formation.  It is also, perhaps, Argentina’s biggest prize as well as its biggest disappointment (to date, at least). 

YPF and its partners have proved the reservoir quality of this formation and the production capacity of vertical and horizontal wells.  The goal today should be to acquire acreage in these basins and perform exploration and pilot projects to define the best development plan for implementation under an improved price environment.  However, despite several years of evaluation, the commercial viability of the Vaca Muerta shale play is still not yet clearly established and near-term activity is likely to be limited to existing undertakings.  These include contracts signed between YPF and Chevron, Dow Chemical, Petronas, Sinopec, and recently with American Energy Partners.  Additionally, companies such as ExxonMobil, Shell, Wintershall, Pluspetrol, Tecpetrol, and many others are carrying out exploration in unconventional prospects.

Other Oil & Gas Opportunities

Although at this point it is impossible to predict for how long this internal oil and gas prices scenario will be maintained in Argentina, it is clear that there are many opportunities available for E&P companies willing to invest time and money in a country with more than 100 years of hydrocarbon history, and with many basins that are still under-explored or under-developed:

Mature fields: the average recovery factor for the mature fields in Argentina is around 18%.  There are opportunities to improve the recovery factor of existing developments by improvement or implementing water flooding projects and IOR projects, with every 1% of increase in recovery factor representing 500 million barrels.

Tight gas:  there are many tight gas reservoirs that companies have been developing with good results.  Gas prices in Argentina are higher than international prices and this situation is expected to continue for at least the next decade.

Heavy oil: there are several heavy oil play concepts that have to be proved and tested including searching for the adequate technology to be implemented.

Near-field exploration: deep oil and gas in unexplored formations, and shallow oil and gas as a consequence of new geological models and new prospects.

Offshore exploration (shallow and deep water): very little has been done in offshore exploration in Argentina.  Only 54 total wells have been drilled in shallow water and 13 wells in deep water.

Frontier exploration: there are 18 basins in Argentina that have had very little or no exploration.

Summary

For Argentina it has never been about the rocks, but about the political overlay.  This has changed again sharply for the better, and the business case for Argentina is once more on the front foot. 

Authors

No Need to Cry For Thee, Argentina

Cesar Guzzetti

Principal Advisor: Latin America General Manager - cesar.guzzetti@gaffney-cline.com

Signup to receive our latest articles

We're here to help