Last year when Argentina expropriated most of Repsol’s majority stake in YPF, the country’s flagship oil and gas company, the Spanish government and the European Union howled in anger, leading calls to sanction Argentina and restrict trade in retaliation. The high drama in April 2012 culminated in a few months of frosty relations between Spain and Argentina, but an embargo failed to materialize. It did not take even six months before Argentine energy companies returned to Spain to do business with Madrid’s blessing.
Now, Argentina seems to be poised to develop one of the largest unconventional oil and gas plays in the Western Hemisphere. Countering Europe’s whimper that the rule of law would always prevail over nationalism, a steady stream of suitors have been sidling up to the country’s formidable oil and gas resources. These suitors are not just national oil companies from the Middle East and Asia. Instead, they have included ExxonMobil, Apache, Statoil, and now Chevron, which recently signed an $1.5 billion deal to drill up to 1,500 wells that could raise production to 50,000 barrels of oil and 3 million cubic meters of natural gas a day.
Even in the face of a tough political climate and the geological difficulty of shale extraction, investors are lining up.
And they like what they see. The U.S. Energy Information Administration estimates that Argentina has 774 trillion cubic feet of recoverable shale gas, making the country’s reserves the third largest in the world (after China and the United States). A significant amount of petroleum sits alongside the shale gas.
Investors are focusing on the country’s Vaca Muerta shale oil field, and are banking on the potential to double Argentina’s output within a decade. If the Vaca Muerta formation reaches anything close to its full potential, Argentina could also become a regional gas powerhouse, capturing a greater share of exports to Brazil and Chile or filling liquefied natural gas (LNG) ships bound for Europe and Asia. This would reverse Argentina’s need to import. It would also be a major victory for a country that has quickly gone from being a net exporter of LNG to requiring massive LNG imports, imposing a major challenge on fiscal resources and its balance of payments.The domestic demand fundamentals are there too, with robust internal oil and gas consumption and a natural gas distribution network that is the most comprehensive in South America.
The Argentine government, meanwhile, is finally beginning to connect the dots and see the constraints of rickety oil and gas production capacity. Localized gasoline and natural gas shortages have emerged over the past several years. With one of the largest compressed natural gas (CNG) automobile fleets in the world and some of the coldest winters in South America, getting gas to market matters to voters as much as it does to investors.
The dark side of the equation, however, is that the Argentine government controls domestic prices. In 1992, while then-President Carlos Menem was in the process of privatizing YPF, the government passed Statute 24.076, installing a system of gas price caps for residential and industrial consumption. This includes the country’s CNG car fleet as well. Gasoline prices are a bit less sticky, although all price increases have to be approved by the government before consumers see them at the pumps. In the 1990s, these pricing agreements between the government and operators made for cushy private profits. But the same mechanism allowed the government to freeze prices earlier in the decade to assure that cash-strapped post-crisis consumers could afford to heat homes and run cars.
Even with a better economic environment, this is unlikely to change. The government faces considerable political pressure to keep energy prices affordable, given raging inflation in other parts of the economy. But increased supply could solve this problem in much the same way that natural gas prices reached historic lows across North America after U.S. and Canadian shale plays began hitting markets.
One of Argentina’s main goals for the expropriation was to exert more control over YPF’s capital investment plan, which the government long accused Repsol of ignoring at its own peril. This is why even some of President Cristina Fernández de Kirchner’s harshest critics cheered the government’s bold move. With Argentina’s robust economic growth over the past several years and Spain’s precipitous fall, who could believe that capital would flow freely from Repsol?
Only time will tell if foreign oil and gas companies can recover their investments in Latin America—or if local governments can navigate the difficult political waters of foreign exploration. Like many foreign oil majors over the last 100 years, Spain’s Repsol learned the hard way about how political risk can wreck investments.
But this time, with local and regional demand taking off and an Argentine government sensitive to self-sufficiency in energy markets, things might be different. With the country shut out of international credit markets—and an administration hungry to develop a vast natural resource to keep local consumers happy, drive industrial competitiveness and pad the budget—investors are finding that Argentina’s energy sector might be a risk worth taking.
