A blockbuster deal between the oil and gas industry, labor unions, and the Argentine government could pave the way for a flood of new investment in shale oil and gas in the South American nation. The deal involves a determination by the state to shoulder the cost of new drilling, but it could lead to the spread of the shale revolution beyond North America.
Argentina's government has agreed to extend regulated natural gas prices at elevated levels, in effect a public subsidy to entice major oil and gas companies to flock to Argentina's prolific Vaca Muerta shale basin. Prices for gas will be set at $7.50 per million Btu (MMBtu), vastly higher than market places in most parts of the world. The fixed prices were scheduled to expire this year. By way of comparison, natural gas prices in the U.S., home of the original shale gas revolution and still the largest natural gas producer in the world, are currently trading for $3.33/MMBtu, or less than half that price.
For years, Argentina has been cited as the most likely place to replicate North America's shale revolution. While international oil and gas companies have invested capital and drilled wells in places like China, Argentina, Mexico and a handful of European countries, a new major source of shale production has not been achieved anywhere outside of the U.S. and Canada.
Argentina is thought to hold 27 billion barrels of oil and 802 trillion cubic feet of natural gas in its shale formations, according to the EIA. In terms of gas, those reserves are nearly 30 percent larger than the estimated reserves in the U.S., and are second only to what is thought to be located in China. If the shale revolution is to truly spread beyond North America, the Neuquén Basin - where the Vaca Muerta is found - is where it will unfold.
To be sure, Argentina has made progress, attracting companies like Chevron, Royal Dutch Shell (NYSE:RDS.A), Exxon Mobil (NYSE:XOM), Gazprom and others, and production has begun to climb. But costs have remained high and production has grown at stubborn rates. Despite the massive oil and gas resources trapped in Argentina's shale, only two of the 19 concessions awarded in the Vaca Muerta have actually begun producing, according to Reuters.
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The latest deal holds out promise to accelerate the transformation. Not only will there be regulated prices, but Argentina's labor unions also made some concessions. The industry has cited high labor costs as one substantial barrier to investment, with unions demanding more workers on drilling projects than companies say they need. As part of the deal, Argentina's unions have agreed to more flexible contracts.
One more carrot has been offered to the industry: the government recently allowed a 15-year-old export tax on oil to lapse, further boosting drilling economics. The move is consistent with Argentine President Mauricio Macri's business-friendly approach, which he hopes will lead to higher foreign direct investment.
However, regulated prices are not consistent with the free-market principles of President Macri. He is saddling the public with the huge subsidies to the industry, but his government argues that the price supports will be "indispensable for attracting long-term investment." Oil and gas companies promised to invest at least $5 billion in Argentina's shale in 2017, and potentially double that amount in the years ahead.
Higher investment from private industry will also be combined with more spending from Argentina's major oil company. "We would likely invest 20% to 30% less this year without the agreement," said Miguel Gutierrez, CEO of Argentina's state-owned oil company YPF. Gutierrez predicts that the regulated prices and the injection of investment that will flow from the deal will help YPF cut investment costs by 10 to 30 percent. YPF accounts for about 90 percent of all new wells drilled in the country right now, according to the WSJ.
While Argentina will pay a pretty penny in order to entice international companies, the government is hoping that domestic production will help close its energy deficit, which in turn will help narrow budget shortfalls.
The subsidized prices will not last forever. Prices for gas will be fixed at $7.50/MMBtu, but will be gradually phased down to $6.50/MMBtu by 2021. It remains to be seen if the deal does indeed open up the investment flood gates. Some oil companies are likely to approach the deal with a bit of cautiousness, given President Macri's growing unpopularity and the questionable durability of government policies when power changes hands in Argentina.
By Nick Cunningham of Oilprice.com
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