Cristina Fernandez, president of Argentina, is the sort of populist political leader financial markets love to hate. For business interests and the media, she has become an archetypal villain, a symbol of everything that has gone wrong with the country’s economy over the last century.
Extreme political polarisation, serial defaults, devaluations, hyper-inflation and expropriations of foreign property, culminating in the nationalisation of oil company YPF in 2012 and a standoff with the U.S. courts over unpaid foreign debts in 2014 – Argentina’s economic dysfunction is legendary. The country remains frozen out of foreign debt markets while its lawyers argue about how to pay restructured bond holders without also paying investors who refused to participate in the restructuring.
The federal government enforces strict controls on imports as well as the export of capital and earnings to protect Argentina’s meagre foreign exchange reserves. Relations between the government and much of the business community and foreign investors can best be described as confrontational. In the energy sector, oil and gas production has stagnated over the past two decades as consumption has grown, adding to pressure on the balance of payments.
Oil output has been falling, from a peak of more than 900,000 barrels per day in 1998 to a little over 700,000 bpd in 2013, and Argentina became a net petroleum importer in 2012. In the foothills of the Andes, however, the country has world-class shale resources in the Neuquen Basin’s Vaca Muerta (Dead Cow) and Los Molles formations.
The U.S. Energy Information Administration estimates Argentina has the world’s fourth-largest technically recoverable shale oil resources at around 27 billion barrels, putting it behind only Russia, the United States and China. The government recently updated the energy laws to ease exchange controls for investors in the oil and gas sector, harmonize treatment across provinces and provide more favourable fiscal terms. Many observers remain skeptical, however, about whether shale can be successfully developed without a fundamental change in the business climate.
“Flogging a Dead Cow” was the headline of an article that appeared in the Economist magazine in July 2013, typical of the attitude of the international media.
But there is another side to the story, which suggests Argentina could be one of the first large shale plays outside the United States (“Flirting with default, Argentina enjoys drilling boom” July 21).
FOLLOW THE DRILLING
There are more rigs drilling for oil and gas in the country than at any time in the last 30 years, according to oilfield services company Baker Hughes. With over 100 rigs operating in September, the number of rigs has doubled since 2009. (http://link.reuters.com/jew33w) There is more drilling activity in Argentina than anywhere else except the United States, Canada, Russia, China, Saudi Arabia and India.
In 2013, U.S. oil major Chevron signed a deal with YPF on a drilling programme across 5,000 acres in the Neuquen Basin. In total, they drilled 109 wells in 2013, and the drilling plan includes a further 140 wells in 2014, according to Chevron. In a conference call with investors on Aug. 1, the company disclosed it had 19 active rigs in the first half of the year and had already drilled 89 wells.
“Chevron is pleased with our initial results in the Vaca Muerta,” Chevron’s exploration chief told analysts. “Drilling results have identified two sweet spots where we are focusing our activity. In one of these areas we have commenced a horizontal (drilling) programme.”
He continued, “We have seen a production uptick, which gives us confidence that we will deliver the growth we anticipated when we entered this play.”
Other smaller North American exploration and production companies also have active drilling programmes in the Vaca Muerta. Of course, all these exploration and production companies are very bullish about the play’s future. But it would be a mistake to write off their enthusiasm entirely. Vaca Muerta has made faster progress than other shale plays in Poland and China.
WORLD CLASS RESOURCE
The play remains speculative from a regulatory and political perspective. But the geology is favourable (with hundreds of feet of thick organic-rich marine shale). Neuquen has a long history of conventional production as well as existing pipelines to Buenos Aires.
Neuquen was labelled “geologically perhaps the best shale basin outside North America”, by Advanced Resources International, the consultants who conducted the landmark assessment of 137 shale plays around the world on behalf of the U.S. Energy Information Administration (“EIA/ARI World Shale Gas and Shale Oil Resource Assessment,” July 17, 2013).
Vaca Muerta’s potential has already drawn strong interest from investors willing to separate Argentina’s oil potential from its political and economic turbulence. In August 2014, it was disclosed that billionaire hedge fund investor George Soros had more than doubled his stake in YPF to 3.5 percent.
Sceptics in the business community, politics and the media question whether the Vaca Muerta’s potential can ever be realised under the current administration. But Cristina Fernandez’s administration has favoured shale production. In any event, Argentina’s next presidential election is due in October 2015, and she is term-limited from seeking immediate re-election.
With record drilling already underway, good quality shale resources, support from local government and strong interest from outside investors such as Chevron and Soros, it would be foolish to write off Argentina’s potential as one of the first major shale plays outside of North America. Argentina is a high-risk venture and definitely not for the faint-hearted. But big rewards in the oil industry come from taking big risks. There are no low-risk options.
The dangers in Argentina are no worse than alternatives – such as China’s Sichuan basin, Russia’s Bazhenov shale, or drilling in Iraq, Sudan, Arctic waters or off the coast of Africa. Sceptics usually miss new resource plays. The naysayers predicted that Texas’s Barnett shale and North Dakota’s Bakken would soon fizzle out because shale production was not sustainable.
In contrast to Sichuan, Bazhenov or the Arctic, let alone Britain’s onshore shale deposits, hundreds of wells have already been sunk into the Vaca Muerta and are already producing oil. Given its superb geology, Vaca Muerta remains one of the most promising plays around the world for investors willing to look through the extremely polarised commentary to assess the underlying risks and conditions.