​Argentina appears ready to tap its massive shale play, creating opportunity for Canadian companies

Murray McCartney isn’t crying for Argentina.

That’s because the company he is president and chief executive officer of, Calgary-based Crown Point Energy, believes there are huge oil and gas development opportunities for it in that South American country.

“The potential in Argentina, with the use of horizontal wells and fracking, is immense,” says the veteran oil executive who has led the Argentina-focused junior since 2008.

And in a country where shale oil and gas reserves are considered to be among the highest in the world, Crown Point is not alone in that thinking.

For a country that has defaulted on its sovereign debt obligations seven times in its 200-year history, attracting oil and gas investment is considered a key to its recovery.

The country’s most recent default stretched into the presidency of Cristina Fernández de Kirchner, who left office last year. It has since restructured its US$93-billion in obligations, and what’s happening with its oil and gas sector is akin to a reincarnation.

Fernández, who succeeded her husband, Néstor Kirchner, carried on with the left-leaning policies of the Peronists, who had governed the country (with the exception of occasional military dictatorships) since the 1950s. Fernández, in power from 2007 to December 2015, introduced a universal child benefit, which reduced poverty in the country of 42 million and nationalized Yacimientos Petroliferos Fiscales (YPF), the country’s dominant oil and gas producer, formerly majority owned by Spanish oil company Repsol.

Fernández was replaced last year by centre-right opposition politician Mauricio Macri, the former mayor of Buenos Aires and the leader of the Cambiemos (let’s change) alliance.

But before that happened, the stage was set for the country to be friendly to outside investment in the oil and gas sector. In 2014, Argentina’s congress agreed to pay Repsol US$5 billion in bonds for its expropriation of Repsol’s 51 per cent share of YPF. Repsol’s ownership stake had been unilaterally reduced to 12 per cent. It sought a US$10.5-billion settlement, and it may be eligible for another US$1 billion, depending on what the bonds trade at.

Despite the country’s past treatment of the oil and gas sector, it has attracted a good deal of interest from juniors like Crown Point and majors like Chevron, ExxonMobil, BP and Royal Dutch Shell.

McCartney and other oil industry executives credit the Macri government with that turnaround. Macri appointed former Royal Dutch Shell executive Juan Jose Aranguren as his energy minister. Aranguren has accused the previous government of distorting the energy market with subsidized domestic energy and power prices.

“Argentina got used to basically having energy that was next to free,” he said shortly after being appointed.

But while the new Macri government has mused about reducing subsidies for oil and gas, the country’s “made in Argentina” incentives, along with its rich oil and gas reserves, are turning it into an energy development hotspot.

Since taking office in December, the Macri government has been reversing the policies of the previous government, undoing everything from currency controls to export taxes. However, the government has expanded programs aimed at decoupling energy prices from global markets.

“This is so important, strategically,” said Miguel Galuccio, former chief executive officer of YPF, when interviewed this past winter.

Prices in the country for light oil are set at US$67/bbl and natural gas at US$7.50/mmBtu, significantly higher than world levels.

The country spent US$11 billion last year to bolster oil and gas prices.

However, in late September, YPF’s president, Miguel Ángel Gutiérrez, told Bloomberg he believes the government may remove subsidies by the end of 2017. And he suggested that it would be a good thing as the country moves to a more market-oriented economy.

He said the country’s shift to a less state-controlled economy could attract as much as US$5 billion to US$10 billion of investment into the country’s oil and gas sector by the end of next year.

While he said it appears as if subsidies for natural gas production will remain in place for another three years after they expire in 2017, producers in the country need to manage their costs and prepare for market-based prices.

“We need to demonstrate to the world that we are able to reduce costs,” Gutiérrez said. “We are moving toward a market economy, no doubt. Our industry is no exception.”

While he said YPF will “no doubt” remain government-controlled, it must lower costs and remain competitive.

YPF is negotiating with unions and contractors to lower costs because labour costs are currently higher than in the U.S. or Canada. Meanwhile, local governments near the Vaca Muerta Play have spent billions on roads and other infrastructure, which will also lower development costs.

Gutiérrez said Argentina will likely remain a gas importer for at least another five years, but it has the potential to be self-sufficient and eventually an exporter.

Despite the country’s tortured economic and political history, its oil and gas development potential is beyond dispute.

At the heart of the country’s promising energy future is the oddly named Vaca Muerta unconventional energy play. Vaca Muerta means “dead cow” in English, but that hardly explains the interest in the play, which has attracted many of the majors.

The Vaca Muerta has the world’s second-largest shale gas and oil reserves, which lured Chevron in 2013 to announce it would spend US$1.6 billion on a pilot project with YPF as a partner. Following the success of drilling there, the two companies agreed in 2014 to extend the venture for another 35 years. They have since drilled 400 wells.

A senior Chevron executive says the cost of drilling in the Loma Campana field in the Vaca Muerta have dropped to US$11.2 million per well, down from US$14 million. That’s close to the Chevron-YPF joint venture of $10 million per well.

ExxonMobil, which called the play one of nine key activity areas in the Western Hemisphere, and other majors have acquired leases in the shale play. BP group chief executive Bob Dudley says his company would rather invest in the Argentinian shale play than in Texas’s Permian Basin.

Dudley says the company, which is negotiating to buy more assets there, sees the Vaca Muerta as having “enormous potential,” adding that “there’s a lot of future here.”

BP would make its future investment there through its joint venture, Pan American Energy, of which BP owns 60 per cent (along with Argentinian partners and China’s CNOOC).

In late September, Royal Dutch Shell said it plans to invest US$300 million a year through 2020 on exploration, refining, distribution and marketing in the country.

Just how much potential there is in the Vaca Muerta was recently outlined in a report from Houston-based IHS Energy.

In the August report, IHS Energy Vaca Muerta Insight Series: Supply Scenarios for Argentina’s Energy Future, the authors say the play could deliver 560,000 bbls/d of liquids and six bcf/d of gas by 2040, “increasingly meeting the country’s growing demands for energy with domestic production.”

Ricardo Bedregal, senior director of upstream research and consulting, Latin America, at IHS Energy, and a co-author of the report, says the Vaca Muerta could eventually produce 2.8 billion barrels of oil and 33 tcf of gas by 2040. However, this will require an annual investment of US$8 billion in drilling and completion at peak activity, which would in turn require continued government assurance of a stable business climate.

“The Vaca Muerta has the potential not only to reverse Argentina’s conventional production declines and satisfy its growing domestic energy demand, but also to enable Argentina to regain its position as an oil and gas exporter,” Bedregal says. “However, for the required investment to materialize, the government must continue to provide both assurance and a regulatory environment that gives long-term stability to investors. These issues go hand-in-hand because without that stability, the money will not flow in as quickly, and the play will be slow to develop.

The IHS report authors say the pace of development and foreign investment will be dictated by the country’s political and economic policies.

“The administration of President Mauricio Macri has taken important steps to improve investment conditions in Argentina, but these reforms are relatively new, and they must remain in place beyond the president’s first term for [the] Vaca Muerta to achieve its potential,” says the report.

The authors say the play would need about 140 drilling rigs in operation when it reaches peak activity levels.

Although there is a well-developed oilfield service sector in the country, they say there is a huge opportunity for oilfield service companies with experience in unconventional plays.

The Vaca Muerta, located in the Neuquén Basin, is similar to other super basins around the world, such as the Permian, says IHS. The firm adds that the play possesses high-quality, organic-rich shales, multiple unconventional targets and the potential to deliver billions of barrels of oil equivalent. But production there will not equal large plays like the Permian and Eagle Ford in the U.S. any time soon.

“Production in the Vaca Muerta will not grow exponentially overnight,” Bedregal tells Oilweek. “The global oil market conditions are very different now than they were a few years ago. Global prices are considerably lower now, CAPEX budgets are much more constrained and the operating conditions in Argentina are much different.”

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He says the fact that much of the acreage in the Vaca Muerta is in the hands of a few majors and YPF, as opposed to the competitive Eagle Ford where there were 70–80 different operators, will also constrain activity.

Exploitation of the Vaca Muerta is relatively new and so far has taken place in a relatively small area of the 115,000-square-kilometre Neuquén Basin, with 600 wells having been drilled. That compares with 14,000 wells in the Eagle Ford since 2008.

Bedregal, an expert on energy development throughout South America, says he believes the continent has entered a new political reality, with a shift to the right by most governments. That has happened in Paraguay, Chile and Colombia and is starting to happen in Brazil, where the economy has been in freefall, and Argentina.

“There is a shift to a pro-market [approach],” he says. “Brazil and Argentina had to act quickly to stop the bleeding.”

While he is optimistic successors to Macri will continue with the same market-friendly approaches, he says majors like ExxonMobil, Chevron and BP know how to operate in Argentina.

He says it’s likely oil and natural gas subsidies will be gradually phased out, particularly as world prices rise. IHS thinks that could happen fairly quickly, forecasting oil prices will rise to about US$70 by 2020.

“I think the government was thinking oil prices would rise sooner than they have,” he says.

He says the subsidies, which are being paid by the consumers, through higher gas prices, have played a factor in attracting energy investment, which is why they won’t be eliminated any time soon. Unions that represent oil and gas workers are also very strong in Argentina, which is another reason they will be phased out over time.

“But foreign investors would like to see the prices regulated by the market rather than by government decree,” Bedregal says.

Unconventional oil in the Vaca Muerta also can’t yet be produced for less than the high $60s, he says.

But Bedregal believes that, as more horizontal wells are drilled in the play and fracking technologies become more refined, the cost of production could approach the $30/bbl level that is common in U.S. plays.

The Vaca Muerta will likely help the country achieve oil self-sufficiency by 2040 or at least come close to doing so, Bedregal says. IHS projects natural gas consumption will hit 6.6 bcf/d by 2040, with gas production in the play reaching six bcf/d by then.

But there are other plays, both conventional and unconventional. The Austral Basin, located in the country’s south, is just one conventional play with good potential.

“But the Vaca Muerta is world-class,” Bedregal says.

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Juniors continue to be active in the country, but he says it’s likely juniors and intermediates will have to partner with YPF, which dominates the Vaca Muerta, in order to take advantage of that world-class potential.

While Crown Point’s McCartney is an optimist about the potential in the Vaca Muerta, as well as in other parts of the country, the company announced in late September it was cancelling a rights offering to sell 130 million common shares, which was aimed at raising between $6.5 million and $8.22 million. In a release in mid-August, the company said Argentina-based Liminar Energía, already its largest shareholder, had indicated it would subscribe to buy the shares. However, Liminar did not exercise that option.

“Liminar and the company are engaged in active discussions regarding the company’s go-forward business plan,” Crown Point said in the late September press release, adding that it will be reviewing alternatives to lower its administrative and other expenses. It said it was also evaluating opportunities to grow its business in Argentina.

“After the company has advanced these initiatives and the Argentine government has finalized the natural gas and electricity price increases, the company intends to evaluate its options to obtain the financing required to fund its go-forward business plan,” it said in the release.

Interviewed prior to that press release, McCartney was optimistic about the company’s prospects in the country, where it holds interests in two properties.

These include a 25.78 per cent working interest in the Austral Basin, located in the country’s extreme south, where it holds 126,000 net acres (489,000 gross). It is a tight gas play, with a strong inventory of 3-D-seismic-defined locations, with production having reached 1,439 boe/d this year.

The company’s most promising asset is its 100 percent working interest in the Cerro de Los Leones area, located in the Neuquén Basin on the edge of the Vaca Muerta play. It holds 100,000 acres there and planned a fracture stimulation of a well this quarter. However, its failure to raise capital in the rights offering may jeopardize those plans.

In both of the areas where it is active, the company is now concentrating on conventional resources, although there is substantial unconventional potential in its Cerro de Los Leones holdings.

McCartney said in an interview in late September that his goal is to raise Crown Point’s overall production in the country to 5,000 boe/d in five years.

“This company needs to grow to that size, then to 10,000 boe/d,” he said.

McCartney said the company’s relationship with Liminar—directed by Pablo Peralta, who has been involved in the financial services sector for 25 years in Argentina—gives it access to a depth of knowledge and awareness of Argentina few small foreign companies could hope for.

Crown Point is not the only Calgary-based producer with operations in Argentina—and with financial issues.

Madalena Energy, which holds about 950,000 net acres in four provinces in the country, including in the Vaca Muerta shale, the nearby Lower Agrio shale, the Loma Montosa oil play and the Mulichinco liquids-rich gas play, announced in late August it had initiated a review of “strategic alternatives,” which it said might include asset sales, a merger, recapitalization or joint ventures.

That followed a release from the company in mid-July in which it announced several senior executives were leaving the company, including former president and chief executive officer Kevin Shaw.

The company announced on July 13 it had raised $1.8 million in a private placement and had reduced work commitments at one of its shale blocks “to alleviate current liquidity challenges facing the company.”

Its oil and gas production averaged 3,274 boe/d last year and it claims proved-plus-probable reserves in its conventional plays of 11.4 billion barrel of oil equivalent, with substantial unconventional resources yet to be proven up.

Madalena did not respond to a request for an interview.

Patricia Vásquez, the author of a recent report on Argentina’s oil and gas sector, says it appears juniors like Crown Point and Madalena have been affected by both the difficult investment climate for oil and gas producers overall and by investors’ reservations about Argentina’s politics.

“If you’re a small company, maybe you can’t wait until next year [for the business-friendly reforms to evolve],” says Vásquez, the author of a Wilson Center study called Argentina’s Oil and Gas Sector: Coordinated Federalism and the Rule of Law.

She says international investors may have been unsettled by a Supreme Court ruling in August that a planned 1,000 per cent increase in electricity prices (most power is generated by gas) should be reduced to 400 per cent instead.

“People don’t pay for electricity in Argentina,” she says.

The previous governments had seen subsidies for power rise from US$200 million in 2003 to US$17.6 billion in 2014, equal to 3.2 percent of the country’s GDP.

She says the 400 per cent increase, which means all but the poorest Argentians will now pay modest amounts for power, appears to have been accepted by most people in the country, which she views as good news.

For most of the last decade or so, oil and gas producers lost money in the country, which she says is now being reversed by offering subsidies.

Meanwhile, the goal of moving toward a more market-oriented economy continues. Vásquez is confident the Macri government, which won’t need to stand for re-election until 2019, is on the right road.

“Argentina has the resources,” she says. “They still have conventional resources and the Vaca Muerta. The government needs companies to come and start producing.”

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