Huge potential, big hurdles for Argentina's Vaca Muerta

Buenos Aires — Vaca Muerta, the biggest shale play in Argentina, is poised for growth in oil and natural gas production and exports as proposed legislation is expected to improve investment conditions, but analysts and executives warn that economic and political uncertainty could slow the pace.

On April 15, Energy Secretary Darío Martínez said a long-promised bill for promoting the development of the large shale resources — as well as conventional and tight plays — is nearly ready.

The bill, if made law, will create "clear and stable conditions" for benefits, exchange rates, export rules, taxes and regulations to provide the "predictability" and "confidence" that companies need to step up investment, Martínez said in a presentation to the Oil Club, an industry group.

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"It is a priority," he said. "We are always thinking of increasing production by an important amount. We want to increase the quantity and quality of exports."

To do this, the key is to increase drilling in Vaca Muerta, a play so large that it can supply all the country's oil and gas needs for decades to come and also export increasing amounts — and soon. Argentina supplies all of its 500,000 b/d of internal oil demand and most of its 140 million cu m/d of gas demand, and exports have been on the rise over the past few years, including exports of light sweet Medanito crude from Vaca Muerta.

Gas may have even more potential to meet rising global demand for the energy transition to net-zero emissions.

Uneven development

The trouble is that Vaca Muerta's development has been uneven since its first output in 2012-13. This is partly because of the learning curve, but also the ups and downs of Argentina's economy and politics. Investment shot up in 2016-18 after a conservative government improved conditions, such as by removing capital, currency and price controls, only to slow after a financial crisis hit in 2018.

The crisis brought a temporary cap on prices of diesel and gasoline from August 2019, depressing the local price of oil and hampering investment in Vaca Muerta as the profit potential slimmed.

Argentina's current left-leaning president, Alberto Fernández, hopes to change this. His administration has allowed pump prices to rise again, rolled out gas pricing incentives, loosened capital controls on the use of export proceeds and is now finalizing the promotion bill.

But concerns remain regarding his energy and economic policy, and this is limiting investment even as Brent crude prices have rebounded to more than $60/b in April.

The price recovery has pushed the rig count in Vaca Muerta to 22-23 units, almost in line with the pre-August 2019 level of 28-30 units and a vast improvement on the zero fracking activity at the start of the March-November lockdown for the COVID-19 pandemic.

But that is less than the potential of the play, an executive at an international oil company with operations in Vaca Muerta said on the condition of anonymity.

"There could be a lot more rigs working in the fields," the source said. "The play can produce a lot more."

In December, Eric Dunning, managing director of Chevron in Latin America, said that with better policies, Vaca Muerta could lead a doubling of the country's oil production — now at about 492,000 b/d — in a few years, making it possible to export 500,000 b/d.

But while it is possible to increase oil exports by 360,000 b/d from Vaca Muerta with little investment in pipelines in the near term, gas needs around $20 billion in infrastructure for exporting LNG, according to some estimates.

Currency concerns

In order to raise that amount, companies must turn to the international markets for long-term financing, said Rodrigo Terre, manager of capital markets at First Capital Markets, a financial advisory in Buenos Aires.

But this too comes with risk. The central bank over the past year has imposed capital controls and ordered companies to refinance their foreign currency debts to protect its own foreign reserves after they fell to dangerously low levels.

"If there is no access to foreign currencies, it will be hard for companies to come to make big investments in Vaca Muerta," the oil executive said.

Another setback is pricing controls. The government wants to keep down energy prices at a time of high poverty and inflation, which limits the profitability of projects and makes it hard to recoup investments, the executive added.

José Luis Sureda, an oil industry veteran and former secretary of hydrocarbons, said another concern is political uncertainty. Fernandez may be the president, but his vice president, the former two-time president Cristina Fernandez de Kirchner, is running a shadow administration that appears to be calling more of the shots, he said. At the same time, a fragmented opposition is posing little challenge as an alternative.

"The velocity of Vaca Muerta's development depends on two factors: politics and the economy," he said. "There is not going to be order in the economy if there is not order in politics first."

The economy is poised to rebound this year with 6.7% growth from a 10% contraction in 2020, but inflation is also accelerating, expected to reach 46% at the end of the year, up from 36% at then end of 2020, according to a survey of economists by the central bank.

Amid inflation fears, companies are only investing what is needed to sustain production and are wary of a rise in social tension. Indeed, a protest by health workers and truckers for higher salaries has been blocking access to Vaca Muerta since April 7, threatening shortages over the next few weeks.

Oil companies can handle pricing and supply uncertainty, but not political uncertainty, and so "they only invest the money that they can rapidly recover," Sureda said.

Sense of urgency

There is a growing sense of urgency to quicken the pace of developing Vaca Muerta because of a potential decline in fossil fuel demand during the transition to cleaner energy, such as with growing use of electric vehicles.

"We don't know what is going to happen with energy in 50, 60 or 70 years, when it is very likely that fossil fuels are going to have a much smaller participation in the world energy matrix," Horacio Turri, executive director of exploration and production at Pampa Energía, the country's fifth-biggest gas producer, said. "Everything that we don't produce from Vaca Muerta today will probably lose value. Every year of delay in developing Vaca Muerta is an additional risk that we won't be able to develop it."