Argentina is no doubt a risky place for foreign oil investors. Frequent political swings from the neoliberal right to the populist left, weak enforcement of contracts and property rights, endemic corruption and a volatile macroeconomic environment; in a region that has witnessed multiple waves of resource nationalism, Argentina stands out as a serial violator of debt and other obligations.
And yet, over the past few years, foreign investors have been willing to overlook these red flags and invest in Argentina’s oil and natural gas sector. Investment commitments in Vaca Muerta – the colossal oil and gas shale reserves in northern Patagonia – increased from $3 billion in 2013 to $7.5 billion in 2019. Production of shale gas there has reached 36.5 million cubic meters and oil extraction is at 87 thousand barrels per day, significantly increasing the country’s total production of natural gas and more than compensating for a decline in conventional oil production. In fact, shale now represents 44% of total natural gas production in Argentina.
This development was partly a result of the 2015 election of Argentina’s pro-business President Mauricio Macri. But factors much deeper than politics also drove a rebound in investment: namely, Vaca Muerta’s bountiful geology, which is more favorable to production than even the most lucrative shale plays in the United States.
This is good news for President-elect Alberto Fernández’s plan to rely on the hydrocarbon sector as an engine to boost growth. But shale and conventional production are two very different beasts and, should Fernández repeat some of his predecessors’ policies of expropriation or squeezing energy companies’ assets, the results could be bad for both investors and for Argentina.
It took more than six years for former presidents Néstor Kirchner and Cristina Fernández de Kirchner (2003-15) to face the consequences of having killed Argentina’s conventional hydrocarbons golden goose through expropriation and other interventions. But if Alberto Fernández meddles with Argentina’s shale potential, the country will begin to feel the pain much more quickly.
Different times
In theory, unconventional shale is a much less attractive target for expropriation than conventional oil and gas production. Unlike conventional extraction, shale – using horizontal drilling and hydraulic fracturing – has very short production cycles and lower sunken investments. Conventional wells can produce prolifically for a decade or longer, with little investment required once the well is connected to a gathering system. By contrast, a shale well’s production peaks in the first few weeks and then undergoes a rapid decline, reaching minimal levels within two years.
To keep output stable, shale producers must maintain a constant rate of well-drilling – resembling more a manufacturing process than a traditional oil play. If the drilling is interrupted, shale production collapses. Moreover, shale investors begin to recover their capital relatively quickly, sometimes after just one well has been completed. If the well is profitable, investors can bet again on another one, and so on.
All these characteristics serve as an insurance policy against expropriation – one that is unavailable for conventional oil and gas. If Argentina or any government were to expropriate shale investments, or otherwise impose terms that render them unattractive, shale drilling would stop. Given the steep decline rates that characterize shale wells, production would soon collapse. And the government would quickly find itself with little production or cash flow to move forward with the expropriation.
Shale also needs recurring investments to sustain production, reducing the incentives for obstruction that the actors involved – the national government, provincial governments, unions, service companies and others – are likely to face.
The temptation for expropriation of conventional oil operations is much higher. Once production has begun, there is little in the way of technical expertise or investment needed to keep productive wells in operation. In fact, investors would have incentives to continue operating even if they do not recoup their sunken capital, as long as they recover comparatively small operational costs. They will not fall for the trap of investing again, but production decline may take years.
One caveat to the above deals with Vaca Muerta’s prodigious shale gas reserves, the second largest in the world. In some ways, shale gas is more exposed to political risk than shale oil. Marketing of natural gas requires more in the way of bulky sunk investments, due to the complexity and costs of gas infrastructure from pipelines to petrochemical plants. Expropriators could target this massive infrastructure. Also, Argentina relies on gas for the generation of electricity, manufacturing, home heating and transportation, and historically governments have intervened to create artificially low prices.
As president, Fernández may be tempted to intervene in the energy sector, trying to maintain low domestic energy prices or increase the government take on profits. Yet under the new realities of shale oil and gas, he would swiftly suffer the consequences. Even a shortsighted government – and Argentine governments, especially those of Peronists like Fernández, have been generally myopic in the energy space – will have to reckon with this new reality. Policies that adversely affect energy companies’ operations and profits, or their ability to send earnings abroad, would make hydrocarbon production dramatically decline within a year.
In a world of perfectly enforced contractual rights, Vaca Muerta’s geology could generate a boom equivalent to the one seen with shale in the United States. However, given Argentina’s record and current political environment, Patagonia will not become Texas anytime soon. Still, major investments will continue to be deployed and, if Fernández understands the new shale reality, the government will face significantly lower incentives to implement the misguided policies of the past.
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Jones, Krane and Monaldi are Fellows at the Center for Energy Studies at Rice University’s Baker Institute for Public Policy.
