Will Argentina’s Vaca Muerta Shale Play Ever Recover?

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By Matthew Smith

Last year was tough for the global oil industry as the COVID-19 pandemic and an ongoing oil supply glut rocked petroleum-dependent emerging economies, notably in South America, to their core. Oil companies around the world were forced to slash spending, shutter operations, and even look to restructuring balance sheets to survive. While the latest oil price rally, triggered by Saudi Arabia’s surprise one million barrels per day production cut has provided relief for many, Argentina and national oil company YPF are still struggling with the fallout. Even before the pandemic, Latin America’s third-largest economy was facing another financial crisis. Former President Macri’s reformist agenda and pro-business policies had failed, inflation was spiraling out of control and the Argentine peso had rapidly devalued. That triggered yet another fiscal crisis for Buenos Aires which forced Macri in 2018 to seek a bailout from the IMF. His administration ultimately received a $57 billion disbursement from the IMF, which was the largest ever released by the organization. That did little to rein in the crisis and saw current President Alberto Fernandez in December 2019 assumed the presidency of a country virtually in default, yet again. By May 2020, Argentina had defaulted on its sovereign debt, for the ninth time in its history, after failing to make a $500 million interest payment. This calamitous economic development highlights why Argentina’s crude oil industry and development of the Vaca Muerta shale formation has become such an important priority for Buenos Aires. Argentina’s national government perceives the Vaca Muerta to be a silver bullet for its economic woes, but significant headwinds are sharply impacting operations in the shale formation, which is often compared to the prolific U.S. Eagle Ford shale play.  The COVID-19 pandemic has hit Argentina particularly hard with it ranked 11th globally by cases. In response to a government quarantine and sharply weaker oil prices, YPF and other energy companies operating in Argentina’s oil patch were forced to shutter operations causing the Latin American country’s rig count to fall to zero during April 2020. Even by December 2020 according to Baker Hughes data there were only 29 operational drilling rigs in Argentina, which although three higher than a month earlier was still 11 rigs less than for the equivalent period in 2019.

A key issue for national oil company YPF and Buenos Aires are the high breakeven prices associated with operating in Argentina, particularly when compared to other South American jurisdictions. New projects in the Vaca Muerta are pegged to breakeven at above $50 per barrel while existing operations on average breakeven at $45 to $50 a barrel. As a result of those high breakeven prices and the oil price collapse which saw Brent plunge to less than $15 per barrel, Fernandez’s administration introduced a range of measures to attract investment. These included propping up oil and natural gas prices, suspending the 8% tax on oil exports and provide improved access to hard currency. This has yet to attract the required level of investment from foreign energy companies leaving YPF as the key driver of developing the Vaca Muerta. It is unlikely to draw much-needed investment because of the overhang of resource nationalism when current Vice President Cristina de Kirchner as president approved the seizure of YPF from Spanish energy major Repsol in 2012. There are significant regulatory hurdles associated with accessing foreign currency, repatriating profit to pay loans and dividends, uncertain pricing regimes, raging inflation, and a highly volatile domestic currency. Those factors along with the negative international perception of Argentina’s Peronist governments are deterring investment. They also make it extremely difficult for Latin America’s third-largest economy to compete against more investment-friendly jurisdictions, notably offshore Guyana and Brazil which are estimated to have an average breakeven of $35 per barrel or less. This is especially the case for as long as Brent prices stay low, trading at around $55 per barrel, and risks within Argentina remain high. That means YPF must essentially shoulder the burden of developing the Vaca Muerta’s vast oil and natural gas resources.

There are signs that Argentina’s national oil company could struggle to muster the required investment to ramp-up operations to the required level to successfully develop the shale oil and gas play. YPF announced a third-quarter 2020 $468 million loss, which came after a monster $1.3 billion second-quarter loss. The oil company’s ability to generate profits in the current low price operating environment is being affected by its high breakeven prices, although YPF claims it is aiming for an eventual breakeven of $30 per barrel. That could be some way off, however, because Buenos Aires debt default and the poor state of Argentina’s economy, which the IMF believes shrank by 12% during 2020, is making it more difficult to fund Vaca Muerta investments.

Buenos Aires’ renegotiation of its foreign debt has only complicated matters. YPF has earmarked $6.2 billion of bonds for a debt swap, forming part of the national government’s push to overhaul its sovereign debt and prevent a hard default. A key reason for this is the parlous state of Argentina’s economy and a lack of hard currency, notably U.S. dollars, which has seen the central bank restrict access to dollars to preserve its currency reserves in the face of a worsening economic crisis. That effectively prevented YPF from obtaining U.S. dollars to pay $413 million of outstanding bonds which fall due in March 2021. To complete the debt swap, Argentina’s national oil company will issue three new bonds in exchange for seven outstanding bonds that mature between 2021 and 2047. Implied in YPF’s statement is that if the deal is not agreed to by creditors then it could be forced to cease debt payments. As a result of the offer, international rating agency Fitch downgraded YPF’s standalone credit profile to c from bb, meaning its bonds are not considered to be investment grade making them highly speculative. Fitch took this move because the agency considers YPF’s actions to represent a distressed debt exchange, which is significantly undermining confidence in the company. According to Bloomberg, creditors are opposed to the deal and are preparing for a lengthy battle with Buenos Aires. Many of those creditors had already renegotiated a deal regarding Argentina’s May 2020 sovereign debt default just months ago.

These latest developments do not instill confidence in YPF or Argentina’s government and the country’s perennially crisis-prone and debt challenged economy. This could not come at a worse time for Buenos Aires. Not only will this act as a major deterrent for investment in the Vaca Muerta, but the government’s cash crunch likely means it is incapable of disbursing the funds required to meet planned natural gas drilling incentives. It also signified that Fernandez’s administration lacks the financial resources required to invest in YPF so the embattled national oil company can boost the tempo of operations and deliver the required oil and gas production increases. YPF’s desperation is underscored by rumors (Spanish) the company plans to sell its iconic Buenos Aires office tower, which it is estimated could fetch up to $400 million. Despite the Vaca Muerta’s considerable potential, which is estimated to hold the world’s fourth-largest shale oil and second-largest natural gas reserves, it may never be truly realized. This means the vast shale formation may never become the economic silver bullet contemplated by Buenos Aires.

By Matthew Smith for Oilprice.com

Crude Oil

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