Argentina’s Energy Potential

Remember when observers were horrified at Argentina’s decision to nationalize Repsol-YPF? Remember when seasoned observers thought that it would not even be possible in the first place?

My favorite conversation about this came a few months before the happenings when I corresponded with a former US ambassador and adviser to a Chinese state oil company if energy-hungry China had caught wise to Latin expropriation habits.

His (somewhat sneering) response – try and parse through the commas:

“I suspect that, inasmuch as expropriation is now rare internationally, the company has not given the thought to it that it might.  Argentina is, as you are aware, however, where the right of states to confiscate foreign investment was most articulately asserted in the early decades of the last century.  The typical pattern more recently has been forced buy-out, revision of production splits, and contract cancellation. ”

Whoops Mr. Ambassador. Either way, the deed is done now and I missed my chance to short YPF stock.

That said, we’ve come a long way from only seven months ago, when the decision to expropriate the Spanish assets of the former national oil company provoked calls from the Spanish government and the European Union to sanction Argentina and restrict trade in retaliation.

On the back of howls from the Spanish government and investors that the country was being kicked when it was down, and that the rule of law would always prevail over nationalism, a steady stream of suitors have been sidling up to Argentina’s formidable oil and gas resources. These suitors have not just been dodgy, opaque national oil companies from the Middle East and China. Instead, they have included Chevron, Petrobras, Carlos Slim’s holding company, and now Statoil – that shining star of international energy governance.

And they like what they see. The country’s Vaca Muerta shale is estimated to contain reserves comparable to large US fields and the potential to double Argentina’s output within a decade. The demand fundamentals are there too, with robust internal oil and gas consumption and a natural gas distribution network is far and away the most comprehensive on the South American continent – and increasingly under YPF control. 

The dark side of the equation is that the Argentine government controls domestic prices, although they have slowly lifted these controls in response to shortages. This is unlikely to change, given the government faces considerable political pressure to keep energy prices affordable given raging inflation in other parts of the economy.

Anyone who knows Argentina knows that the country only negotiates on its own terms, foolhardy and masochistic as that may be. It is a country where nationalism transcends politics – shown in the vast support for moves like the YPF nationalization or the refusal to cave to foreign creditors. It boggles the mind that a major oil company, and a Spanish one at that, had yet to learn this lesson. But risk is risk and the high political risk inherent in Argentina promises a high reward to investors who know how to navigate it.

One of the country’s main goals for the expropriation was to exert more control over YPF’s capital investment plan, which the government long accused Repsol of ignoring. With the country shut out of international credit markets, and a government hungry to develop a vast natural resource with the potential to bolster the state’s deficit-happy budget, smart investors might find it’s a risk worth taking.

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