Summary
Following the expropriation of YPF a year ago, Argentina has made it a national priority to revitalize the country's declining energy sector. Buenos Aires reviewed the regulatory system for hydrocarbon producers and has selectively improved terms to lure investment. These efforts appear to have yielded some success, with major energy companies Chevron and Total signing deals in recent months.
Despite renewed interest, however, a full recovery of the energy sector is dependent on a political transition. For the remainder of Argentine President Cristina Fernandez de Kirchner's second term, Argentina will most likely continue to rely on oil and natural gas imports. This will continue to damage the country's national accounts and hold back economic progress. Even if a new political alternative emerges, reversing a decade of government subsidization will be a daunting task.
Analysis
Argentina's energy sector has been deteriorating for much of the past decade, with production of both oil and natural gas in steady decline since 2006. However, buoyed by the populist economic policies of former President Nestor Kirchner and his successor, Cristina Fernandez de Kirchner, consumers continued to devour subsidized oil and natural gas, further increasing internal demand. As a result, the country has transitioned from being a net energy exporter to being a net energy importer.
These production and consumption trends have been particularly apparent in Argentina's natural gas sector. Fixing domestic prices artificially low and effectively prohibiting exports made consumers turn to natural gas as an energy source, while producers retreated from the country. As a result, production has fallen 18 percent since 2006 and is expected to fall a further 17 percent by 2016. In comparison, consumption has increased by more than 50 percent since 2002. The country hit an inflection point in 2008 when consumption finally surpassed production and Argentina began importing substantial quantities of natural gas from neighboring Bolivia and other providers of liquefied natural gas. As a result, Bolivia is experiencing a natural resource-led boom while Chile, previously a major importer of Argentine natural gas, has had to weather high electricity prices and has been forced to look elsewhere for energy supplies.
Petroleum production has fared slightly better, although another inflection point is approaching. Until now, Argentina has been able to export enough crude oil to compensate financially for increased imports of refined products, such as diesel. But with consumption about to surpass production, the country will soon need to import oil for its refineries as well as processed hydrocarbons to support domestic demand. This is problematic for a country that is isolated from international capital markets and has rapidly falling foreign reserves.
Adjustments
In response to the production/consumption dynamic, the government has been working for the past year to try to reverse the trend while at the same time retaining control of domestic price-setting, export restrictions and tax and royalty revenues. In November 2012, Buenos Aires increased the maximum price of natural gas at the wellhead threefold, to $7.5 million per million British thermal units. To shield consumers from the impact of increased prices, the government assumed the difference between the existing price ceiling and the new one. Producers now fetch a higher price at the wellhead in Argentina and the state does not relinquish its ability to control the price paid to producers or charged to consumers.
The next major adjustment came at the beginning of 2013, when the national government eased export duties on oil. Previously, the government retained the difference between the West Texas Intermediate price of oil and the benchmark rate of $42 per barrel. In other words, if the international price of oil was $100 per barrel, the producer would make $42 and the government would take $58. As a result, the government, not the oil producers, benefited from the recent surge in oil prices. Facing steady declines in oil exploration and production, in January the government raised that benchmark rate to $70 a barrel -- closer in line with the international price. Exports of natural gas remained taxed at 100 percent of the highest price at which natural gas and liquefied natural gas is imported, effectively barring natural gas exports. As with the price controls, rather than fully liberalizing them, the government is instead incrementally making the terms more gracious for producers.
Finally, in July, immediately prior to reaching an agreement with Chevron, the Argentine government decreed that new investors would be allowed to export 20 percent of output from new projects tax-free. They would also not have to repatriate revenues to Argentina. The Neuquen provincial legislature, which governs the regulatory framework for the natural gas-rich region, approved the measures despite resistance from local indigenous groups and opposition politicians. While this was well-received by energy firms, there are still export restrictions on the remaining 80 percent of production as well as heavy tax burdens. In addition to export taxes, there is a corporate income tax of 35 percent, a Social Security tax from 23 to 27 percent, and provincial-level royalties on production of 17 percent. These taxes put additional constraints on profitability.
Investments
Since these concessions were formalized, and likely as a response to them, there has been a steady stream of new investments in Argentina's energy sector, with particular emphasis on natural gas production. Beginning in July, Chevron and YPF announced a $1.2 billion investment to explore for natural gas in the Vaca Muerta formation. The first phase of the project entails drilling 100 wells throughout 2014, with more than 1,500 wells to follow in phase two (over an undisclosed time frame). Production estimates put future output at 50,000 barrels of oil equivalent per day and 3 million cubic meters per day by 2017.
The next major investment, announced in September, mirrored the Chevron deal. Germany's Wintershall and state-owned Argentine company Gas y Petroleo de Neuquen would invest $150 million in Vaca Muerta over two years, with an option for expansion to $3.3 billion over 10 years if successful. Around the same time, Dow Chemical announced that it would also partner with YPF to jointly invest $188 million over the next year in Vaca Muerta, producing an estimated 3 million cubic meters per day.
Most recently, in October Argentina's largest natural gas producer -- Paris-based Total -- agreed, along with Wintershall and Pan American, to invest $1 billion to $1.2 billion to develop the Vega Pleyade field, off the coast of Tierra del Fuego. Natural gas production is expected to begin in the third quarter of 2015 at 6 million cubic meters per day before increasing to 10 million cubic meters per day by an undisclosed date. Production is also intended to increase at the Carina field by 1.5 million cubic meters per day in the first half of 2014.
YPF is in the middle of a five-year, $35 billion investment program ($7 billion annually between 2013 and 2017). Because YPF is limited from borrowing internationally, it will require partners, restrained as it is from draining billions from Argentina's foreign currency reserves. Any partners must be prepared to commit a substantial amount of capital in order to realize YPF's strategic plans. The Chevron and Dow Chemical deals were an example of two such arrangements. They were, however, insufficient by themselves.
If all goes according to plan for Buenos Aires, by around 2017 these new projects could be producing as much as 18 million cubic meters per day (or roughly 6.5 billion cubic meters per year). To put this in perspective, government forecasts predict that production will decrease by 6 billion cubic meters by 2016 due to natural depreciation and depletion. In other words, these investments will only partially make up for natural decline in existing fields, not substantially reducing the overall energy deficit.
These ventures may be a prelude to another wave of investments due to begin in March 2014, when Argentina will once again auction off the rights to concessions in Vaca Muerta. Given that previous attempts to secure financing and production failed, it remains to be seen whether a new round of investment will be successful. Ultimately, despite modest improvements in the regulatory system, the country will most likely require a political transition and a greater ability to cooperate with outside investors before energy companies are willing to enthusiastically enter the Argentine market.
Despite modest progress, Argentina's energy sector will continue to struggle over the next few years to both attract investment and keep up with declining production rates amid strong consumption trends. Argentine policymakers are clearly willing and able to make the piecemeal adjustments needed to attract new investment. There has already been a steady stream of modest investments by energy companies looking to position themselves advantageously in anticipation of a political shift.
However, the current administration has yet to -- and is unlikely to -- prove itself reliable enough to generate the scale of investment needed to definitively reverse current trends. After a decade of economic interventionism, including currency controls, price controls and expropriation, investors remain deterred by possible risks to business as well as concerns about regulatory continuity. For a turnaround to occur, a political transition will be necessary.
Nevertheless, if a political shift were to occur, ushering into power a more market-friendly politician, it would prove immensely difficult to liberalize domestic prices and export restrictions without alienating voters who have enjoyed years of subsidies. Whoever inherits the system will therefore be faced with the challenge of carefully rolling back a decade of interventionist policies without losing the popular support of those who benefited from them.
Comments
Post a Comment