Shale Shock Threatens Argentina's Recent Energy Gains
WHY YOU SHOULD CARE
Soaring inflation and a collapsing currency may undo Argentina’s recent energy sector gains.
By Benedict Mander
The collapse of the Argentine peso and the government’s struggle to tackle soaring inflation are causing disquiet among companies developing Vaca Muerta, one of the world’s largest deposits of shale oil and gas.
In his drive to liberalize Argentina’s energy markets, President Mauricio Macri phased out consumer subsidies and increased tariffs. Local oil prices rose and converged late last year with those of international crude, providing an important stimulus for companies in Vaca Muerta, Argentina’s star investment attraction. But the government has now capped the price at which companies producing oil in Argentina can sell to refineries, along with the price of petrol at the pump, to shield consumers from rising global oil prices and prevent inflation soaring even further.
If there’s one thing markets hate, it is uncertainty.
Anuj Sharma, Phoenix Global Resources
Companies now must sell at prices considerably below the international level, which last week was above $77 a barrel for Brent crude oil, the global benchmark. This, as well as the devaluation of the peso, is hitting profitability and forcing companies to reassess their plans in Vaca Muerta.
“Suddenly from moving in the right direction, it feels like the country is taking a step back,” says Anuj Sharma, chief executive of Phoenix Global Resources, a midsize oil company investing in Vaca Muerta. “If there’s one thing markets hate, it is uncertainty. It makes planning very difficult.” He added that it was hard to plan more than three to five months ahead.
As little as four years ago, the state oil company YPF estimated that the break-even oil price for wells in Vaca Muerta to be economically viable was about $80 a barrel. Wood Mackenzie, an energy consultant, now estimates the break-even price to be $56 a barrel. After the first well began producing commercially in 2013, Vaca Muerta is now producing 120,000 barrels a day, or more than 10 percent of national production.
“Just five years ago Vaca Muerta was a dream. Now it is starting to become a reality. It is at an inflection point where you can actually make money drilling it,” says one senior executive whose company is investing in Vaca Muerta. “You can argue that at $67, $68 a barrel you can make more than the break-even price, but you are not obliged to drill Vaca Muerta. Elsewhere you get $75 or even higher if oil prices go up … if there’s no [price] visibility, it’s very hard to deploy billions into Vaca Muerta.”
With Javier Iguacel replacing Juan José Aranguren as energy minister as part of a shake-up last month, the government’s plans remain unclear. Aranguren, a former executive at Royal Dutch Shell, was widely applauded by the private sector for increasing the tariffs that consumers pay for electricity and natural gas, which enabled the government to cut subsidies in its effort to rein in the fiscal deficit. But he was unpopular with voters.
How Iguacel, a petroleum engineer who also has a private sector background, proceeds depends on a precarious political scenario for Macri, who is seeking re-election next year. Tariff hikes — as well as a $50 billion bailout from the International Monetary Fund in response to the currency crisis — was one of the main motives for trade unions in late June holding their third national strike since Macri took power.
Freezing prices at petrol pumps may go some way to keeping voters happy, even if it is debatable what impact it might have on inflation, which is running at more than 25 percent annually. But international companies are not keen on effectively financing Macri’s “gradualist” economic reform program, which seeks to cushion the impact of austerity on poorer Argentines.
“If prices remain uncoupled, that would be negative. Without doubt, investment would fall, production too, and we would have to import more,” says Daniel Gerold, an energy consultant in Buenos Aires. “If it becomes clear that prices do not follow clear rules or the law is not respected, even if costs are low in Vaca Muerta, investments are not going to come.”
Nevertheless, analysts are broadly optimistic about the prospects for Vaca Muerta, which has seen a sharp fall in costs in recent years, while production has jumped dramatically. Argentina might even have an oversupply of natural gas this summer, when demand is lower, says Amanda Kupchella, an analyst at Wood Mackenzie.
“There are a lot of things that just come with the territory in Argentina — like price controls, working with unions and so on. They are things that operators are used to dealing with,” says Kupchella. “Productivity in Vaca Muerta is so good that it doesn’t seem to be keeping [investors] away … wells just seem to be getting better and better.”
Alejandro Bulgheroni, chairman of Pan American Energy Group, expects that in two to three years it will be as cheap to drill wells in Vaca Muerta as it is in the U.S.
“Let’s hope this is resolved and that we return to international prices,” says Bulgheroni. Although it was a “difficult moment,” he recognizes that under this government, negotiations have always ended in mutual agreements, with no impositions. “We have lived through much worse times,” he says.
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