Argentina enjoys natural endowments like few other nations, with fertile farmland, vast mineral deposits and countless natural harbors. This constellation of riches has gained a new star with the recent discovery of one of the world’s largest shale oil and gas basins. But it remains to be seen whether the Peronist government of President Cristina Fernández de Kirchner will exploit or squander this new treasure. Argentina’s recent energy policies are not encouraging.
For several years the combination of price controls, import barriers on equipment and unpredictable policy shifts by Buenos Aires has discouraged investment and caused production to decline. Once a gas exporter to neighboring countries, Argentina has run up increasingly costly gas import bills.
Then in May 2011, Repsol YPF, the country’s largest producer, announced a find that promised to transform Argentina’s energy fortunes. In an arid expanse of western Patagonia called Vaca Muerta, or Dead Cow, the company had found an extensive shale oil and gas deposit. The discovery seemed to prove the oft-repeated local saying “God repairs by night the mess that we Argentineans make by day.”
Divine intervention didn’t reckon on Argentina’s tradition of economic mismanagement, though. The government’s debt default in 2001 made the country a pariah in international markets and unleashed turmoil that brought the Peronists to power in 2003 under Fernández’s late husband, Néstor Kirchner. He and his wife, Fernández, who won election as his successor in 2007, have made a series of high-handed interventions in the economy that have hindered growth and investment. The government’s actions on Vaca Muerta aren’t winning it any new friends among investors.
Less than a year after the shale discovery, the government expropriated Repsol’s Argentinean subsidiary, YPF, without payment and nationalized the unit. The government then struck a $1.24 billion deal with U.S. oil giant Chevron Corp. to develop part of Vaca Muerta, setting off a bitter and costly legal dispute.
“Chevron’s actions are preposterous,” says Kristian Rix, a spokesman at Repsol’s Madrid headquarters. “I can’t think of a similar case anywhere. Oil majors don’t encroach on each other’s assets — especially those under litigation.” Repsol is suing the Argentinean government in Spanish and U.S. courts, demanding $10.5 billion in compensation. The Spanish company also is suing Chevron in Spain and the U.S. to abandon its joint venture with YPF. And Repsol has asked the World Bank’s arbitration body to order Argentina to halt development of Vaca Muerta.
Chevron insists it did nothing wrong. “We really don’t believe there is any legitimate claim against us,” vice chairman George Kirkland told analysts in August, during the company’s second-quarter earnings call. Furthermore, the company sees the possible rewards from Vaca Muerta as too large to pass up. “Opportunities are there when they are available, and this one was available,” Kirkland said.
Argentina rejects Repsol’s demand for compensation, arguing that the company failed to invest enough in its conventional Patagonian wells, causing production to drop. The government has offered Repsol a 47 percent stake in a separate joint venture in Vaca Muerta that the state values at $3.5 billion, as well as $1.5 billion toward the project’s development, according to a company regulatory filing in Spain. YPF would hold a 51 percent stake in the venture, while Petróleos Mexicanos (Pemex), Mexico’s state-owned oil company, would own 2 percent. Repsol has rejected the offer as inadequate.
“Argentina’s energy deficit is unquestionably linked to Repsol’s policies,” Deputy Economy Minister Axel Kicillof told the nation’s Congress in April 2012 upon announcing the expropriation that would be carried out the following month. Never mind that most hydrocarbon companies operating in Argentina showed output declines in the previous three years — and that, according to the government’s own statistics, the worst offender was Chevron.
The escalating dispute threatens to delay or derail efforts to exploit Argentina’s shale oil and gas reserves, with negative consequences for both the economy and the country’s energy security. “They are ensuring that our energy import bill will continue to grow for the foreseeable future,” predicts Daniel Montamat, ex-president (1987–’09) of YPF, former Energy secretary (1999–2000) and now head of his own energy consulting firm in Buenos Aires.
What’s not in dispute is the tantalizing potential of Vaca Muerta. The U.S. Energy Information Administration (EIA) estimates that Argentina has 802 trillion cubic feet of recoverable shale gas reserves, third in the world behind the U.S. and China, and 27 billion barrels of shale oil, trailing only Russia, the U.S. and China. Repsol owned licenses covering 12,000 of the field’s 30,000 square kilometers. The Chevron deal covers 400 square kilometers and calls for the company and YPF to drill 120 wells initially. If those prove productive, the companies would drill an additional 1,500 wells by 2017.
Exploiting Argentina’s potential won’t be easy. Companies need to drill huge numbers of wells to expand production at shale sites. At Eagle Ford, a southern Texas formation that is one of the largest shale gas deposits in the U.S., companies have drilled some 6,500 wells at a cost of some $65 billion, or roughly $10 million per well. “It would be hard to imagine Vaca Muerta coming up with that large an investment,” says Laura Atkins, director of upstream petroleum research at Hart Energy, a Houston-based energy research firm. “The obstacles are so numerous.”
Those barriers are largely man-made. For the better part of the past decade, the government has fixed a price of $2 per million BTUs for gas sold to the national grid, a level that is unprofitable for conventional deposits of gas, much less shale formations. The current spot price for U.S. natural gas is about $3.60 per million BTUs.
Argentina has offered a few pricing alternatives, but they tend not to last long. In 2008 the government introduced a “gas plus” program under which production companies could negotiate contracts with industrial customers at prices as high as $5 per million BTUs, but it pulled the plug on that program after expropriating ?YPF.
The authorities then developed a scheme in which companies could sell their gas to the grid at the regulated price, with the government promising to pay them additional money to raise the ultimate price to $5 per million BTUs. And in July the government issued a decree allowing companies that invest at least $1 billion in the country to export 20 percent of their production after a five-year period without paying export taxes or keeping most of the profits in Argentina, as current laws require. “The problem is, the government has zero credibility,” says David Mares, a University of California, San Diego, politics and energy professor who recently wrote a working paper on Latin American shale prospects for the Inter-American Dialogue, a Washington-based think tank. “It makes promises about prices, contracts, tax rebates, and without batting an eye, it goes back on those promises.”
The gas price caps have dampened exploration and production by both domestic and foreign companies. Gas output fell by 10 percent between 2006 and 2011, according to the EIA. Meanwhile, the government encouraged demand by providing energy subsidies that total $10 billion a year. The result? Once a net exporter, Argentina ran up a $4.5 billion gas import bill last year. It spent an additional $5 billion to import oil and refined products.
Regulations extend beyond prices. In a bid to support domestic makers of oil and gas drilling and production equipment, the government imposes tight restrictions on equipment imports. But Argentina-made equipment is often lacking or of inferior quality.? At the Argentina Oil & Gas Congress held in Buenos Aires in early October, Alejandro Bulgheroni, head of Bridas Corp., a leading private Argentinean energy company, warned that for Vaca Muerta to be successful, “it will be necessary to import the latest, most advanced equipment.”
Persistently high inflation poses yet another obstacle. Most Argentinean economists privately estimate that the inflation rate has been running at more than 20 percent for several years, but the precise level is unclear. Official figures put inflation at about 10 percent; the government has threatened stiff fines or even jail sentences for economists who report higher figures, earning Buenos Aires a censure from the International Monetary Fund. The cost of drilling a new well, optimistically budgeted at $10 million, could reach more than $12 million within a year. As a result, many industry analysts are skeptical that Chevron can drill 120 wells in Vaca Muerta with its $1.24 billion investment.
The expropriation of YPF is only the latest in a series of interventionist moves by Buenos Aires that have slowed the economy and virtually cut Argentina off from foreign capital. Consider beef, an agricultural staple that practically defines the country. Fernández’s populist, Peronist government decreed limits on beef exports in 2006 in an attempt to ensure affordable quantities of steak for the domestic market. But high inflation caused by the government’s loose economic policies has reduced meat purchases. Argentina no longer leads the world in per capita consumption of beef, ceding that distinction to Uruguay. It has fallen behind Brazil, Paraguay and Uruguay as a beef exporter.
The oil and gas industry has long stirred nationalist passions in Latin America, and Argentina, despite having smaller reserves than Mexico or Brazil, is no exception. In 1922, Argentina became the first nation after the Soviet Union to create a state-owned oil enterprise, ?Yacimientos Petrolíferos Fiscales (Petroleum Fields of the Treasury), or YPF. But unlike Mexico, which nationalized all oil and gas production under Pemex in 1938, Argentina permitted foreign companies to compete with its state-owned enterprise in production and distribution. And in 1993 president Carlos Menem privatized YPF after it had run up multibillion-dollar debts, making Argentina the first major Latin American country to do so.
Over the next six years, YPF expanded its reserves by 50 percent and doubled its annual oil output, to a record 190 million barrels, or nearly two thirds of the country’s overall production of 308 million barrels. Domestic oil and gas production largely met Argentina’s consumption needs.
With Menem continuing to pursue liberal economic policies, the government in 1999 sold YPF to Repsol for $15 billion. To demonstrate its commitment to Argentina, the Spanish company erected the Repsol-YPF Tower, a 44-story glass headquarters, designed by César Pelli, that overlooks the River Plate. When the government nationalized YPF in 2012, it lit up the renamed? YPF Tower in the blue and white colors of the Argentinean flag.
The move continued the Peronist government’s long record of economic intervention. In 2007 the government had pressured Repsol YPF to sell a 15 percent stake in the company to Petersen Group, an Argentinean family firm headed by Enrique Eskenazi, who had strong political and financial ties to Kirchner and Fernández. Petersen Group acquired an additional 10 percent in 2011. “The government wanted more of an Argentinean presence in the shareholding, which we thought was fair enough,” Rix says.
But as her government’s spending increased and the budget deficit widened, President Fernández expanded state control over portions of the economy. In 2008, shortly after taking office, Fernández nationalized the private pension fund system, claiming its $30 billion in assets. Later that year Argentina expropriated the country’s leading airline, Aerolíneas Argentinas, which was controlled by Spain’s Grupo Marsans.
Repsol YPF was becoming too tempting a target, especially after the company discovered Vaca Muerta. In October 2011, five months after announcing the find, the company flew analysts and investors to Argentina to brief them on the field’s huge reserves. In subsequent months, however, the government mounted a campaign asserting that Repsol YPF was failing to invest enough money in exploration and production. The company’s gas production had in fact fallen by 16 percent in the three years before the expropriation, and its oil output had declined by 5 percent. But those figures compared favorably with Chevron’s: The U.S. company’s gas output plummeted by 61 percent and its oil production by 35 percent during the same period.
The government’s point man on hydrocarbons is Deputy Economy Minister Kicillof, a 41-year-old left-wing firebrand. He is a close friend of President Fernández’s son, Máximo Kirchner, who is a force in the youth wing of the Justicialist Party, as the Peronists are formally known. Kicillof has parlayed his good looks, charismatic oratorical skills and doctorate in economics from the University of Buenos Aires to become a rising political star.
He electrified nationalists when he addressed Congress on the eve of the 2012 expropriation of YPF and rejected Repsol’s $10.5 billion compensation claim. “We’re not going to pay them what they’re asking,” Kicillof said. “Only retards would think the state is that stupid.”
But having taken possession of YPF and Vaca Muerta, the government faces the dilemma of finding the funds to exploit new reserves. Most foreign investors are steering clear of Argentina because of the government’s 2001 default on $95 billion in foreign debt and a protracted legal battle between the government and holdout bondholders. In August a U.S. appeals court barred Argentina from making payments on its restructured debt unless it also pays the holdouts. The U.S. Supreme Court declined Argentina’s request to hear the case, bringing the country closer to a second default. Standard & Poor’s has cut Argentina’s credit rating to CCC+, seven levels below investment grade.
That’s why the government was negotiating with Chevron even before expropriating Repsol. “Through the deal with Chevron, some access to these capital markets becomes possible,” says former YPF chief Montamat.
Chevron insists it did not hesitate to sign a deal with the renationalized YPF. During the second-quarter earnings presentation in August, vice chairman Kirkland was asked why the company chose to wade into the legal and political morass in Vaca Muerta. “We have been in Argentina for a long time, so we understand, I think, Argentina quite well,” he replied. Indeed, Chevron began operating in Argentina in 1958. Today the company is the country’s third-largest gas producer and sixth-largest oil producer, turning out 21,000 barrels of oil a day and 4 million cubic feet of gas.
Some observers contend that other considerations played a major role in Chevron’s decision. Last year a court in Ecuador found the company liable for $19 billion in damages for environmental harm that its oil operations — undertaken by Texaco before it was acquired by Chevron in 2000 — allegedly caused in that nation’s Amazon jungle. Argentina has close relations with the populist, left-wing Ecuadoran government. In November 2012, at the request of Ecuador, an Argentinean judge, Adrian Elcuj Miranda, ordered 40 percent of Chevron’s Argentinean bank accounts to be held in escrow until the U.S. oil and gas giant agreed to pay the $19 billion award.
At the time, the Argentinean government was already negotiating with Chevron for a joint venture in Vaca Muerta. The two sides reached agreement on July 17 of this year, only weeks after the Argentinean Supreme Court revoked Elcuj Miranda’s ruling. “We can only speculate on what made Chevron join with YPF in Vaca Muerta,” says Montamat. “But we do know that once the Supreme Court dropped proceedings against it, Chevron decided to go ahead with its investment in Vaca Muerta.”
Industry analysts aren’t thrilled with Chevron’s deal. “The investment in Vaca Muerta seems like a distraction for a company that is not particularly short of resources and is spending at very high levels,” says Paul Sankey, a New York–based oil and gas analyst for Deutsche Bank.
In Argentina the government has had to defend its deal with Chevron, which is seen by nationalists — many of them government supporters — as merely substituting a U.S. oil giant for Repsol. “In terms of politics, it doesn’t make much sense,” Montamat says. “It was ‘Out with the Spaniards,’ and now it’s ‘Bring in the Yanks.’”
But Kicillof insists Chevron will be only one of several foreign companies involved in the exploitation of Vaca Muerta, with state-owned YPF holding the whip hand. “Chevron brings us the know-how we need,” he said on a government television broadcast a few days after the joint venture was announced.
According to Kicillof, the government has been negotiating with the Chinese to help develop Vaca Muerta. YPF says it is close to signing an agreement with China National Offshore Oil Corp. (Cnooc) and Argentinean company Bridas, in which the Chinese company owns a 40 percent stake. But Cnooc has neither raised its low production levels nor increased investment in Argentina, suggesting that the Chinese are as wary of the political and economic environment as other foreign energy companies.
In September, Argentina announced two small deals by foreign companies in Vaca Muerta: German oil and gas producer Wintershall Holding, a wholly owned subsidiary of BASF, said it would invest $150 million; and Dow Argentina, a wholly owned subsidiary of Dow Chemical Co., agreed to invest $120 million. Apache Corp., a U.S.-Canadian oil and gas company, has drilled three exploratory wells in the region.
Pressure is mounting on YPF to arrange deals before foreign investors gravitate to other Latin American oil and gas producers. This month the Brazilian government plans to auction off 130 shale gas and oil blocks spread over 3,800 square kilometers in northeastern Brazil to foreign companies and Petróleo Brasileiro.
More relevant for Argentina and YPF is Mexican President Enrique Peña Nieto’s proposal to open up his country’s energy sector to private investment. Under the proposal, which faces a bitter fight from left-wing opponents, state-owned Pemex will offer profit-sharing contracts to private companies to help exploit Mexico’s estimated 115 billion barrels of oil-equivalent reserves, which are roughly equal to Kuwait’s. More than half of Mexico’s estimated reserves are in shale gas and oil deposits.
The largest of these shale deposits are believed to be in the Burgos basin, an extension of the Eagle Ford field across the border in Texas, where Chevron has a large operation. Chevron has already voiced enthusiasm over the prospect of investment in Mexican shale and offshore fields.
Given the need for Argentina to boost energy output and cut imports, a number of analysts believe YPF and Repsol will eventually reach a deal. “YPF has to negotiate because the dispute with Repsol is a serious obstacle to gaining access to other oil and gas partners and the huge investments needed to develop the full potential of Vaca Muerta,” says Montamat.
Repsol insists it would rather negotiate than litigate. “We are trying to do what our shareholders would want us to do, which is to reach a negotiated solution,” says spokesman Rix.
Daniel González, YPF’s chief financial officer, told analysts much the same in August at his company’s second-quarter earnings conference. “We would definitely like to see a negotiated settlement,” he said. “I think it would benefit all parties.”
Trouble is, Repsol is demanding money up front, and Argentina doesn’t have it. “But maybe there is enough room to negotiate with Repsol over future production from Vaca Muerta,” says Montamat.
Others believe that any negotiated solution will have to await a new president. After her candidates lost in congressional primaries in August, President Fernández appears unlikely to win enough support in her party to change the constitution and run for a third term in October 2015. Her health is also fragile: She is now recuperating from brain surgery to relieve bleeding caused by an unspecified head injury. Her successor will almost certainly be another Peronist, though perhaps a more pragmatic one. The current favorite, observers say, is her former cabinet chief, Sergio Massa, who heads a dissident Peronist faction.
A new government might mean new rules of the game and a better business environment. In the meantime, says UC San Diego professor Mares, “you can expect Chevron and any other company that goes into Vaca Muerta to put up minimal capital — just enough to keep a finger in there — because this is a great resource that will someday be developed and bring huge returns.” • •
Read more about Argentina oil shale in a companion piece, “Latin America at Forefront of Oil Shale Shake-up”.
