Argentina: The Recovery of the Oil & Gas Industry

Carlos E. Alfaro is the Managing Partner of ALFARO-ABOGADOS, an international corporate law firm from Argentina with correspondent offices in New York, Madrid and London.

Mr Alfaro stated that 2012 was a turning point for the Argentine oil & gas industry. He noted that the State expropriation (renationalisation) of Repsol’s 51% ownership in YPF brought the Argentine oil & gas industry back to life.

YPF is Argentina’s largest crude oil producer and one of the largest natural gas producers in the country. YPF had virtually stopped investments in developing new exploration sites and in recovery of secondary wells during the last years of Repsol’s control, which heavily contributed to a production decline at a national level.

“The renationalisation of YPF and subsequent aggressive but realistic strategic investment plan set out by the company became the new driving force behind Argentina’s energy sector, and it did not drive major foreign companies away,” observed Mr Alfaro. “Exxon Mobil Corp., Royal Dutch Shell Plc, Chevron Corp. and Total S.A. are continuing to drill in their existing concessions, and they keep on negotiating business alternatives with both YPF and the Argentine government.”

At the beginning of 2013, the Argentine government also implemented new measures aimed at encouraging production. It modified the thresholds applicable to export duties in terms such that when the WTI international price exceeds a reference price fixed at US$80 per barrel, the producer is allowed to collect US$70 per barrel.

“Later, in February 2013, the Commission in charge of the Oil & Gas National Investment Plan has resolved that all domestic producers injecting natural gas to the system in excess of current levels of production (as adjusted) shall be allowed to collect a price that will be grossed-up with a State subsidy, thus resulting for the producer in an aggregate revenue of US$7.50 per MM/BTU (which is almost triple than prior prices for domestic producers),” added Mr Alfaro.

He explained that YPF’s new investment plan comprises US$7,000 million in capital expenditure each year from 2013 to 2017, focusing on the unconventional reserves at Vaca Muerta and marginal fields. He stated that, given the huge amount of foreign capital that is needed to develop these shale reserves, more changes are expected in the regulatory framework and in the Argentine oil & gas business environment, prompting major international companies to again commit substantial capital.

“An audit carried out by US consultant Ryder Scott to assess the potential of the Vaca Muerta formation in Argentina’s Neuquén Province estimated prospective resources significantly in excess of those estimated in the past by both the US Energy Information Administration and Repsol,” he commented. “The newest estimations consider that Argentina has the potential to replicate the shale revolution that recently took place in the US.”

Mr Alfaro noted that the trend of importing more and more refined fuels and gas while exporting less and less crude oil is expected to continue, pushing the cost of imports higher. Indeed, gas imports cost US$4,700 million in 2012, with a heavy impact on the country’s trade balance.

“YPF says it has secured all the required shipments for 2013,” he continued. “YPF also reported it will continue negotiating with a list of 30 international LNG importers in hopes of securing further shipments.

“At the same time, domestic output is limited by refining capacity. Coupled with the expected development of unconventional resources in the upstream sector, the downstream industry shall have to invest heavily in refining capacity.

“Most of the new business opportunities shall require co-investing with YPF or a close relationship with government.” Chevron and Pan American Energy (Bridas-CNOOC) signed agreements with YPF to such effect.

Discussing the key factors currently affecting the oil & gas industry, Mt Alfaro stated that the fiscal situation needs to be tidied-up if Argentina wishes to secure substantial long-term investment and boost the country’s shale potential.

“Midterm elections in October also create expectations of policy changes,” he added. “Pressure from the agricultural exporters to increase the pace of devaluation is mounting . Foreign exchange restrictions have been resisted by the business community.

“But although the industry complains about export duties, import restrictions, fixed prices, restrictions to the repatriation of dividends, and labour union conflicts, the balance sheets of most players show that they conduct business at a reasonable profit.”

Production at existing oil fields is expected to remain high in 2013, primarily due to continued pressure on YPF to increase production since its nationalisation. Mr Alfaro believes that the level of success of the implementation of YPF’s five-year plan shall be crucial to the Argentine oil & gas industry.

“Production of natural gas is also expected to increase given to the government’s recent decision of allowing producers to collect US$7.50 per MM/BTU of new gas injected into the system.

“It is widely expected that after the 2013 mid-term national elections to be held in October, and as soon as the government announces new measures encouraging the market to invest, Vaca Muerta shall receive huge investments, both for exploration and infrastructure.”

Prices of fuel sales in the local market in Argentina are mandatorily fixed by the government. Mr Alfaro explained that there is a formula for pricing oil for exports, determining that when the WTI international price exceeds a reference price fixed at US$80 per barrel, the producer is allowed to collect US$70 per barrel, and the remainder is withheld by the Argentine State as an export duty (such an export duty works as an indirect cap for domestic prices of crude oil).

When it comes to gas, where exports have been shut off, the mandatorily fixed-price of domestic output ranges from US$ 2,50 per MM/BTU to US$ 7,50 per MM/BTU (in this latter case for gas injected to the system in excess of certain reference threshold of output).

“Even though the above mentioned prices are substantially higher than those applicable in 2012, they are still very low when compared to those of oil, gas and refined fuels in foreign countries,” observed Mr Alfaro. “In fact, when considering Argentina’s huge annual bill for imports of gas and refined fuels, it is evident that the fixed price of refined fuels, natural gas and crude still needs to be increased substantially to encourage production and balance the trade account. Since 2013 is an elections year, whether those price increases shall take place during this year or not is a matter with strong political implications that may not be foreseen in anticipation. However, sooner or later those price increases shall have to be applied.

“It is always difficult to make predictions in a country like Argentina because of its political imbalances but the year 2013 should bring new alliances and investments in the oil and gas sector particularly more partnerships between YPF and local and foreign owned oil companies to co-invest in developing its shale reserves” he concluded.