Since my last update on developments in Argentina concerning the government's attempts to stem capital flight and gain greater control of the oil and gas industry; The Impending Nationalization Of Argentina's Oil And Gas Industry, there have been a number of interesting and significant developments. This has seen many analysts and commentators state that Argentina will take a more moderate approach regarding its treatment of YPF SA (YPF) since the intervention of Spain and the European Union. However, as we can see the Argentine government has pressed on with nationalizing YPF regardless of the international political fallout. With these events it is important to understand what will be the effects on existing YPF investors, can they mitigate their losses and whether the expropriation of YPF will see the government's appetite satiated.
Lately many analysts and commentators have been making comments to the effect that any concerns about the Argentine government nationalizing YPF or the oil industry are alarmist and presumptive as the government's approach has softened due to pressure from Spain and the European Union. It is likely economic and political pressure will have little short-term effect on the government's decisions as the country is already an international economic pariah since its 2002 international debt default.
This has left the government starved of capital as it is unable to access international credit markets making it desperate to maintain a trade surplus, as it is battling the effects of a devaluing currency, high unemployment and spiraling inflation. All of which are directly contributing to higher domestic tensions and popular dissent, leading many Argentinians to fear a repeat of the riots that foreshadowed the 2001 economic collapse. The latest news corroborates my view that the government is not particularly concerned by the comments made by either Spain or the European Union as it battles to maintain control of the economy. At the time of writing this article the Argentine government had sent a bill to congress which when enacted will allow them to expropriate a controlling interest in YPF from the company's existing shareholders.
The Argentine government will now expropriate a 51% controlling stake in YPF from Repsol's (REPYY.PK) controlling stake of 57.43%. The only shareholders affected by this will be Repsol and at this time other shareholders holdings are not under threat and won't be expropriated. This news has seen YPF's stock price drop by 11% to $19.50 with it being suspended from trading on both the New York and Buenos Aires exchanges. The ongoing government interference in the economy since President Kirchner's re-election in October 2011 and ongoing threats of nationalization have seen YPF fall by 53% in value since a high reached this year on January 23rd 2012 of $41.51.
The great unknowns for YPF shareholders now are how much the Argentine government will compensate Repsol for the stake it has expropriated, what is the likelihood of the government extending this expropriation beyond the controlling 51% stake and how will the government manage the company given its controlling share.
The first question is difficult to answer as the amended laws have made oil a matter of national interest conferring on the government the right to expropriate oil and gas assets as it deems fit. This would mean in a worst case scenario the government will not reimburse Repsol, leaving it out substantially out of pocket, though this is unlikely due to the international furor this would create and the effects it would have on crucial Argentine export markets.
It would also create an environment where many foreign oil and mining companies would be fearful of investing in Argentina's resources sector, leaving the country starved of the expertise and funding it needs to develop its natural resources. But it is difficult to see the Argentina government having sufficient funds, unless it dips into the state controlled pension funds, to adequately compensate Repsol for the stake it has expropriated.
The government has previously stated it will not use the state controlled pension funds as a means of financing the nationalization of any oil companies. This means Repsol is increasingly exposed to not being compensated for the share of YPF that it has lost. However, it is most likely that the Argentine government will affect a token compensation package based on what believes in fair compensation for the assets.
The second question I believe is easier to answer and while there are those that believe this signifies a greater move to nationalizing the entire oil and gas industry followed by other mining interests, I do not believe that is the case. President Kirchner has made it clear that the basis of her decision to expropriate the majority of Repsol's shares in YPF is to increase oil production and return Argentina to being a net energy exporter. She has also stated that the government is not choosing a model of nationalization but rather one that gives Argentina sovereign control of its energy natural resources.
It is doing this along the lines of the model used by the Brazilian government with Petrobras (PBR)with a hybrid government/private company that is publicly tradable with the majority shareholding held by the government. This she believes will give Argentina the flexibility and self sufficiency combined with the security and control it needs to maximize Argentina's benefits and address many of Argentina's economic problems.
The government's systematic process of striping oil concessions from foreign companies operating in Argentina, where those companies are failing to meet agreed production levels, is also evidence of this. This has occurred with Petrobras Brazil's Argentine subsidiary Petrobras Argentina (PZE) having its Veta Escondida concession revoked on Thursday April 5th 2012, Canadian oil junior Azabache Energy (AZBCF.PK) on Wednesday 4th April 2012 having its Neuquén concession revoked and YPF's Chubut province concession which was jointly owned by Chile's state-owned Empresa Nacional del Petroleo SA. However, these actions do raise concerns a clear red flag for foreign companies that they are not immune from government interference should it be deemed an economic or political necessity.
Further evidence of this intent to achieve energy self sufficiency and have sovereign control over Argentina's energy industry is President Kirchner's statement on Monday 15th 2012: "We do not choose a nationalizing model, but we promote a model focused on recovering the sovereignty of the country's resources." This desire for strengthening Argentine sovereign control of its natural resources rather than complete industry wide nationalization is further reflected in her statement: "We don't promote nationalizations, but we focus on recovering our resources".
The third question is the most difficult to predict and obviously the most important to answer for existing shareholders. I believe that the Argentina government will reinstate the concessions that were stripped from YPF once it has control. This is good news for YPF shareholders as it means the company will have assets that accounted for 27.7% of its 2011 production reinstated. Furthermore, it is likely that the Argentine government will use YPF as a spearhead to develop the shale oil and gas reserves in the Vaca Muerta region.
YPF's concessions in the Vaca Muerta alone are estimated to have reserves of over 23 billion barrels of oil. This would substantially add to YPF's existing reserves. In order to access these reserves Argentina will require foreign expertise and investment and this may see one of the many oil majors already operating in Argentina commence a partnership with YPF. At this time Chevron (CVX) is the fourth largest oil producer in Argentina and it is already exploring and operating in Vaca Muerta and has a stated strategy of expanding its access to non-conventional oil reserves. Other foreign oil majors operating in Argentina include Exxon (XOM), which last year divested itself of its Japanese refinery assets for the stated intent of increasing funding for the exploration and development of shale oil and gas reserves. At the end of last year Exxon committed to investing as much as $76 million to a joint venture with Americas Petrogas (APEOF.PK) in Argentina to explore for shale oil and gas in the Vaca Muerta region.
It is clear that YPF even under Argentine government control will remain a profitable and productive entity, with substantial oil reserves. However, it is also clear that it will remain captive to political interests and interference, which will not see it deliver full benefits to investors. This will include in the short-term the company ceasing to pay dividends in accordance with the government policy on preventing capital flight and previous demands made by the Argentine government. It is also highly likely that YPF will experience a drop in productivity over the long-term and not be able to fully extend its margins or take advantage of the high oil price.
Yet at the time YPF's stock was suspended the company was trading at six times its earnings and less than two times its book value of $11.57, which does make it appear cheap. While the unpredictable nature of the Argentine government and the opaque nature of their political and economic agenda makes it difficult to predict the future of YPF with any clarity, there may be short-term opportunities risk tolerant investors. But I must emphasize that any investment consideration carries an extreme degree of risk, until the government's intentions for the company become clearer. For a more detailed examination of the company's outlook I would suggest an article by another Seeking Alpha contributor; 'YPF Sociedad Anonima - A Short-Term Buy; Reduced Results Longer-Term'.
Despite the Argentine government's actions indicating that it is firmly on the road to nationalization of the oil industry particularly with the expropriation of almost all of Repsol's holding in YPF, there are some positive signs for companies operating in Argentina's resources sector and in particular the oil and gas industry. These are contrary to the populist and aggressive government rhetoric of the past months but it is clear from President Kirchner's statements that the government is informing the industry that there are limits to its intentions.
This has included making it clear that moving Argentina back to being a net energy exporter and having greater sovereign control over its energy industry and natural resources are priorities. This is certainly different from earlier signs that indicated the Argentine government was moving to an almost wholesale nationalization of oil and gas. Clearly the government has recognized that Argentina requires foreign expertise and investment if it is to tap its energy reserves, particularly the massive shale oil and gas reserves of the Vaca Muerta.