18th May 2016
In February, GCA reported on the state of Argentina as its new president settled in (see No Need to Cry for Thee, Argentina). The article concluded that the issues to be addressed are not about the rocks (which specifically holds true for the excellent Vaca Muerta shale) but about the cost of operating.
Current State of Affairs
President Macri has brought the country back to the global financial markets through a number of meaningful actions, including ending a 15-year sovereign debt default, eliminating convertibility restrictions, expanding financing opportunities for companies, raising most energy prices (power generation by 200%; domestic gas price by 300%), increasing public transportation tariffs (by 100%), lifting capital controls, eliminating dividend repatriation restrictions, and scrapping trade restrictions. As can be expected these have an impact on other variables including devaluation of the peso, increasing inflation and unemployment, which inevitably leads to questioning of the government’s decisions by those most affected.
With respect to the oil and gas industry, there has also been changes at YPF. The role of President and CEO of YPF has been split into two positions, with Miguel Gonzalez (former president of Telefonica Argentina) being brought in as YPF’s new President. As of the date of this article YPF’s new CEO is still to be named. In 2016 YPF has also expanded its activities in the Vaca Muerta with a three-year, US$500 million JV agreement with American Energy Partners (AEP).
Do current prices and costs support meaningful investment?
This article will look at the Vaca Muerta as a leading indicator of new investment. Argentina continues to have the highest internal oil and gas well head prices in the world, with Medanito oil set at US$67.50 per barrel and Escalante oil at US$54.90 per barrel. Additionally, for a six-month period, any Escalante oil that is exported (at Brent price minus US$10 per barrel) will get an export subsidy of US$7.50 per barrel, which is intended to maintain production that goes to export from the Golfo San Jorge basin to address the differential between international and domestic prices. The government is renegotiating existing gas price contracts to set a common internal gas price of US$5.50 per MMBtu. This initiative is in line with the price that Argentina is paying for the gas imported from Bolivia, about US$4 per MMBtu, and the LNG gas that after regasification costs US$7 per MMBtu.
For Vaca Muerta and other unconventional plays, the government has indicated that in order to attract investment it is maintaining, at least for the near term, the US$7.50 per MMBtu price established for the gas currently produced from these plays.
Thus, while the revenue stream from Vaca Muerta production will be attractive, it is the profitability that matters. To achieve margins whereby investments in the Vaca Muerta can compete with other shale basin opportunities that companies have access to, such as those in North America, there are cost and related issues that need to be addressed. These can be put into two broad categories.
- Well related costs: While well costs have fallen as rapidly as those in US shale basins, these are still not competitive in absolute terms. Some of this just reflects the relative immaturity of Vaca Muerta operations, and more operators drilling more wells will bring about efficiencies. In part this will come from optimizing manning, but more service companies are needed along with improvements in the supply chain and logistics. Other forms of cost reduction will come from the leading operators finding new ways to drill that suit the Vaca Muerta. For example, as well as looking at longer laterals, is the Vaca Muerta a candidate for multi-lateral drilling?
- Infrastructure related costs: Although the Neuquen Basin has been a hydrocarbon producing basin for over 100 years, and thus has extensive infrastructure related to the legacy conventional production, more will be required for the Vaca Muerta production. For example, trunk line capacity is available but new in-basin pipelines will be needed as the Vaca Muerta pilot projects move into full scale production. This will require material capex, and who will go first (or how the industry could collaborate on this) is still an open question. However, the ability to hold large 35 year licenses gives an underpinning security to these types of investment.
On the Horizon
With its huge shale resources, the Vaca Muerta has the potential to address and potentially satisfy the growing Argentinian gas deficit, currently running at 35 MMm3/day. What is required is investment; not just from major industry players, but also from new entrant small and mid-size junior players to move the resource from one that is being understood to one that is in development. While the Vaca Muerta covers more than 5 million acres, only about 610 wells have been drilled and today it is producing an equivalent of 50,000 boe/d from a little over 500 wells. Of those wells, 35% have been drilled in the black oil window, 54% in the volatile oil window and 10% in the gas (dry gas, wet gas, and gas-condensate) window. Additionally, only 15% of the wells drilled are horizontal.
Figure 1 shows the Vaca Muerta unconventional play in the Neuquen basin and the different hydrocarbon windows of the formation: Green area: Black oil window, mainly vertical wells have been drilled, Yellow area: Volatile oil, and Red area: gas window, the latter including dry/wet gas and gas condensate.
Figure 1: Vaca Muerta Formation Extension with Different Hydrocarbon Windows
Source: GIGA SA.
Note: The red color includes dry/wet gas and gas condensate window.
Figure 2 shows a cross section of the Neuquen basin, where the Vaca Muerta varies from 150 ft. to 2,700 ft., with an average thickness of 1,500 ft. at an average depth of 9,000 ft.
Figure 2: Cross Section of the Neuquen Basin inlcuding the Vaca Muerta Formation
Thus although volumetrically the resource is world scale with high predictability in GOR and oil API, it is also heterogeneous both in thickness and reservoir properties. Key for producers is to identify the best landing point in the thicker benches, ideally with higher pressures (>8,000 psi), porosity (>6%) and TOC (>2%), and lower Sw and clay content.
The differentiators will then be the ability to cost-effectively drill extended reach laterals (2,000+ m) and engineer completions to maximize EUR, whilst keeping control of costs. Indicatively, GCA sees in the near term good potential in the gas condensate and volatile oil windows. Today, there are horizontal wells that have an initial oil production of more than 800 BOPD in the oil window and close to 10 MMSCFD of gas production in the gas window. The question remains as to what would be a reasonable EUR for these wells. There is not yet enough production history from these wells to provide an answer.
Today the cost of drilling a horizontal well can be managed at a range of US$ 13 to 15 MM. This will be optimized with time and hopefully reduced down to the range of US$ 10 to 12 MM. Opex today can be estimated in the range of US$ 5 to 7/BOE.
More drilling and pilot programs including costs reductions are needed for operators to move to a second stage of full development.
While the Vaca Muerta is a focus for new investment it can also be a catalyst for companies looking at a broader opportunity set.
Figure 3: Argentinean Offshore Basins
Offshore exploration, Figure 3, presents the different Argentinean offshore basins that extend about 4,000 km from the Buenos Aires province to Tierra del Fuego, being more than 400 km wide with water depths that reach a maximum of 400 m. These basins have experienced little activity. Fewer than 75 wells have been drilled offshore and today the only producing basin is the Austral basin, where Total Argentina has a large field producing gas. Geographically the Argentinean offshore is an extension of the Brazilian offshore development and, to the south, Total Argentina has its big gas development in the Austral Basin (offshore Tierra del Fuego). Recently, the Minister of Energy has indicated that a licensing round is being considered for the second half of the government’s current term (2018-2019).
Figure 4: Twenty-Four Argentinean Sedimentary Basins
Source: YPF S.A.
Although Argentina has many mature basins that have been developed over the last 60 years, there are many basins that have little or no exploration. As shown in Figure 4, there are 24 sedimentary basins in Argentina, and of those, only 6 are producing.
The most important basin from a reserves and cumulative production in Argentina is the Neuquen Basin. Now, additionally, the basin has a new future from the Vaca Muerta unconventional formation.
The question now facing investors becomes “Is now the time to invest in Argentina and, especially, the Vaca Muerta?”
Argentina today is moving in the right direction. The objective for Macri’s government is to generate a friendly environment for potential investors in Argentina, and for the development of the Vaca Muerta in the province of Neuquen. In this context there is evidence that the national and provincial governments are working to show investors, both those already there and those thinking of coming, that legal and financial stability exist in the new Argentina. As with all change, Argentina’s recovery will not be accomplished in a single step: it will require a commitment to long-term policies. It is clear that the opportunities are there, albeit with risk, ready for the taking. But delay too long – when today’s problems are solved (or are on their way to being solved), and opportunities are less risky – and “the taking” may come at a higher price. There is going to be more competition and fewer opportunities.
GCA has been working actively in Argentina for the last 27 years, has a well-known presence in Buenos Aires with professionals respected in the industry, and knows the country and the environment. Based on this experience GCA would argue that today Argentina has to be worth a deeper look and, indeed, in the current environment could be one of the best places around the world to invest. Looking forward, GCA is planning to prepare a new update to these series of papers which will concentrate on the economics of Vaca Muerta. At this point, there are sufficient indications that Vaca Muerta can be viable and that the economics of the potential development projects could be reasonably competitive with US basins in the coming 2-4 years provided the proposed pilots are executed and the overall costs continue to fall.
If you decide Argentina may be right for you, please let us know and we will be happy to assist.
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