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Commodities 2021: Argentina's Vaca Muerta has huge potential, but will companies take on the risk?

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Commodities 2021: Argentina's Vaca Muerta has huge potential, but will companies take on the risk?

Highlights

Oil and gas production seen rising in short term

Long-term growth depends on an improvement in conditions

Decline in US shale could speed up Vaca Muerta

Buenos Aires — Argentina is taking steps to rebuild its oil and natural gas production after a year of decline, but if it wants to make Vaca Muerta, one of the world's largest shale plays, a global exporter, Latin America's third-largest economy must create the conditions to attract investment.

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President Alberto Fernández appears to be taking a shot at this. In his first year in office, he suspended the 8% tax on oil exports, temporarily propped up crude prices, and introduced an incentives program for boosting gas output. His energy team is now working on legislation to provide tax stability and loosen restrictions on accessing foreign currencies and moving money in and out of the country.

The goal, his team has said, is to rebuild confidence in the business, which has dimmed since a worsening financial crisis now in its third year deepened capital and price controls from August 2019 and led to tight controls on accessing dollars to finance investments and pay debts.

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Will the measures turn around a slump in production?

José Luis Sureda, an oil industry veteran and former national secretary of hydrocarbon resources, is optimistic that they will in the short term.

The prospects for oil are brightest, he said. While profit margins are expected to be tight if Brent, the international reference price followed in Argentina, remains at around $45/b as is expected, there is pipeline capacity to return output to the pre-pandemic level of 520,000 b/d from 474,000 b/d in October and increase that to 600,000 b/d, Sureda said. With local demand averaging 500,000 b/d, he said that would build a surplus to increase exports to around 100,000 b/d using existing infrastructure.

Argentina's oil production has fallen from roughly 777,000 b/d in 2001, according to S&P Global Platts Analytics, which expects output to remain somewhat flat over the next five years before nearing 900,000 b/d by 2040.

Gas is poised for growth, too. A new 2020-24 gas incentives program should boost output by addressing several impediments to investment, chiefly by allowing producers to skirt tight restrictions on buying dollars — $200 per month for individuals, and little for companies to import or pay foreign debts.

The program also will pay producers a subsidy to increase prices to around $3.50/MMBtu — the breakeven price in Vaca Muerta — from a current market price of $2/MMBtu.

There is a lot of production to recover. A plunge in gas demand during a March to November lockdown of the economy for the COVID-19 pandemic created an oversupply, forcing producers to reduce prices to make sales. The result is that output fell 7.7% to an average of 125.3 million cu m/d in the first nine months of 2020 from 135.7 million a year earlier, according to the Argentina Oil and Gas Institute, an industry group.

Sureda said that while gas output will rise over the next few years, the long-term prospects are uncertain.

"If there are no solid signs about what will come after the four-year gas plan, then investments will fall again in the third year," he said.

Global competition

This uncertainty is holding investment back in Vaca Muerta, leading to calls for better conditions at a time when low oil prices and the transition to cleaner energy are making companies more selective about where they allocate capital, said Guido Cerini, vice chairman of Latin America at Credit Suisse, an investment bank.

"Investment will go into the best countries and the best projects," he said at a Dec. 3 talk hosted by the Institute of the Americas.

For Argentina to compete for capital against Brazil and Guyana, the other large oil resources in the region, Eric Dunning, managing director of Chevron in Latin America, said at the event that Argentina must provide a stable, predictable and transparent regulatory and tax environment, market-based pricing, access to foreign exchange markets, the ability to repatriate cash to pay loans and dividends, and automatic and transparent rules for oil exports.

If it can, production could surge, he said.

"With the right investment climate, we believe Vaca Muerta could double Argentina's crude oil production in a few years and generate crude oil exports of half a million barrels per day," Dunning said.

A focus on efficiency

YPF, the country's state-backed energy company and biggest oil producer, is taking steps to grow production by cutting costs so it can drill and complete 20% more wells with the same investment.

"We are aiming for breakevens of less than $30/b," said Pablo Iuliano, YPF's vice president of unconventional upstream at YPF. This would, he said, allow it to develop Vaca Muerta and export supplies at a profit in a future of prices of around $45/b.

José Luis Manzano, chairman of Integra Capital, an investment fund with interests in Vaca Muerta, said Argentina faces no choice but to improve its investment conditions to bring down financing and operating costs if it wants Vaca Muerta to be developed.

"In a world that is moving to renewables, expensive oil and gas has no room," he said. "Unless you are producing cheap oil and cheap gas in 2040, you will be out of the picture."

From Permian to Argentina?

Despite its uncertain conditions, Argentina could see an increase in shale investment from an unexpected source: the US.

Vera De Brito de Gyarfas, an energy expert at Mayer Brown, a law firm in Houston, said the decline in global oil prices and demand has pushed many independent companies to file for bankruptcy protection in the US, leading to a consolidation of that shale market. At the same time, US President-elect Joe Biden has suggested that he could stop issuing drilling permits for federal lands

A former energy advisor to the Argentinian government said that if fracking declines in the US, companies could move surplus equipment and talent abroad – and the only play with much development outside North America is Vaca Muerta.

"It's too early to tell, but companies like Exxon or Chevron now have an additional reason to continue to bet on Vaca Muerta," the former advisor said.

Lisa Viscidi, an energy expert at the Inter-American Dialogue, an international affairs think tank in Washington, is not so certain. If Biden restricts new licenses on federal lands, that would affect acreage that accounts for about a quarter of US oil and gas production, but not the big shale area in Texas, she said.

"There are still lots of new opportunities for drilling on non-federal lands" in the US, she said, adding that she doesn't think there could be a "sudden flight" of shale investment to Argentina.

"The issue is more whether Argentina can address its own bottlenecks in investment like price controls, restrictions on the repatriation of profits, and the general lack of uncertainty about future energy and economic policies," she said. "Those will have more of an impact on Vaca Muerta than what happens in the US."