Argentina's currency crash hits shale development

When Argentina’s currency plummeted by 50% this year, the oil sector started to worry about a slowdown in the development of Vaca Muerta, the country’s biggest shale play.

The peso’s crash led the central bank to hike the benchmark interest rate to 40% from 27.25%, pushing up corporate borrowing rates to as much as 70%.

The result? The 2,000 small and midsize services companies in Vaca Muerta are facing hard times.

“There are not many companies that can handle such a high financing cost,” said Federico Mac Dougall, a director at First Corporate Finance Advisors.

The currency crisis, fueled largely by capital flight from emerging markets after a hike in US interest rates in April, comes as field operators seek to ramp up the development of Vaca Muerta. Argentina’s Pampa Energia recently said it will lead a $520 million, five-year pilot project in the play with ExxonMobil and Total.

“There are a ton of opportunities for services companies because the operators are demanding more and more all the time,” Mac Dougall said. “But the service companies don’t have the capital and they are worried about losing their current contracts and those that are to come.”

Many of these companies borrowed in 2016 as conditions improved in Argentina. The right-of-center administration of President Mauricio Macri removed the capital, currency and trade controls of its populist predecessors of 2003 to 2015. Interest rates fell, funding became abundant and the economy revived.

Now many of these companies must refinance their debts at higher rates after running down their working capital. Some may be able to access capital at 29% from state banks, but most will have to pay 50%, some even 70%, Mac Dougall said.

This means companies will be resistant to cut fees because financing costs have “tripled,” he said.

CUTTING COSTS

On the other hand, operators have been trimming their well costs. YPF, the busiest player in Vaca Muerta, has slashed its development costs per horizontal well to below $12 million from nearly $30 million in 2015.

Most of the operators are large locals or multinationals with easier access to capital, meaning that, despite the financial problems, they can still borrow in the single digits.

With the hike in financing costs for services suppliers, however, the progress in bringing down overall costs to a target of US levels may take longer.

How long? The government has suggested the first signs of economic recovery will be seen in the fourth quarter, but Mac Dougall said it could stretch well into 2019, a presidential election year when investment traditionally is put on hold.

CUT BACK IN PUBLIC WORKS

Another concern is a reduction in public spending on infrastructure for Vaca Muerta.

During the peso’s plunge, the government asked the International Monetary Fund for help and got a $50 billion credit line. As a condition, it vowed to slash public spending by some 80% over the next three years.

Luciano Fucello, the country manager for Houston-based services company NCS Multistage, said 120,000 people were hired in the first quarter of this year to work in Vaca Muerta, and this is putting strain on the road between Neuquen and Anelo, a town at the heart of the play’s activity.

“We need investments in roads because this is going to make it safer and decrease costs,” he said.

The pressure for expanding infrastructure is only going to grow as activity increases, including for a proposed cargo train to take frac sand and other inputs to Anelo.

To do the railway project in spite of the spending cuts, the government will seek a private developer at an upcoming tender.

Will companies bid?

Diego Solis, senior manager of unconventional reservoirs at Argentinian oil producer Pluspetrol, said the financing problems could slow the railway project, a key for cutting “huge” logistics costs.

FOCUSED ON THE LONG TERM

In the long term, there is more optimism about Vaca Muerta. The Energy Ministry estimates its development could boost the country’s overall oil production to 750,000 b/d in 2030 from 478,000 b/d this year, and take gas to as much as 200 million cu m/d from 125 million cu m/d over the same period.

Vaca Muerta is producing 50,000 b/d oil and 13.5 million cu m/d, according to Fucello.

“The forecast for this year is that production will increase,” he said, noting that projects are coming online like Tecpetrol’s Fortin de Piedra.

Another encouragement is a pricing incentive for gas, which pays out on incremental gains in production, said Solis. If companies don’t meet the growth targets, they don’t get the incentive, which is $7.50/MMBtu this year, gradually falling to $6/MMBtu in 2021 before market pricing takes effect across the industry.