With the nationalization of YPF, Argentina moved away from privatization in an effort to boost oil and gas reserves, and get international oil companies to invest.

The Muerta Vaca shale formation is one of the cash cows that Argentina would like to tap into as it seeks ways to meet its energy demand by increasing reserves and production. With luck, YPF would provide revenue for Argentina’s government the way Pemex does for Mexico and PDVSA does for Venezuela.

But, the recent nationalization of YPF and continued price regulation will likely slow any international investment. The government pendulum keeps swinging from regulation to deregulation and back again, according to Silvia Marchili, foreign legal consultant, and Roberto Aguirre Luzi, partner in the international arbitration practice, King & Spaulding, Houston.

Speaking at the King & Spaulding Energy Forum on “Political Risk in the Energy Industry” on June 19, Marchili and Aguirre-Luzi detailed the corner that the Argentine government was backed into when it decided to nationalize Repsol’s YPF subsidiary.

The pendulum swung in favor of producers in the early 1990s when the government sought to attract foreign investment to increase oil and gas reserves and become a net exporter. That plan worked quite well.

“By the late 1990s, about $42 billion had been invested in the upstream sector. Natural gas production almost doubled, and oil and gas reserves increased. And, Argentina became a net exporter of gas to Chile,” Marchili said. “But the pendulum swung again 10 years later in 2002 when the government switched gears.”

In the middle of a macro-economic crisis, “the government wiped out every single right it had granted to producers. Where they had deregulated prices, the government began to interfere.  Prices were reduced dramatically. Producers had no incentive to drill for reserves,” she explained.

“At the same time, low prices fostered artificial demand for natural gas.  That’s quite a recipe for disaster,” Marchili said.

The government’s interference led to increased production, but declining reserves. The domestic prices depressed domestic energy supplies, forcing the government to import natural gas from Bolivia.

“In 2008, the price domestically was around $1.50 per million Btu [MMBtu]. The government was paying $10.35/MMBtu for that same energy coming from Bolivia,” she said.

Aguirre-Luzi noted that Argentina relies on natural gas. With the low domestic prices, natural gas supplies some 51% of the country’s energy needs.  “Argentina’s energy matrix relies on natural gas more than any other country,” he said. 

“This situation created a need for politicians to keep natural gas at a controlled price. With a booming economy supporting gas demand, Argentina went from a net exporter to a net importer in seven years.”

Faced with declining domestic production, the government recognized a need for incentives and introduced the Gas Plus program in 2008. This program allowed producers to charge between $5 and $7/MMBtu to industrial consumers that signed a contract with those producers.  

However, the Gas Plus customers are such a small percentage of total demand, there hasn’t been the boost in drilling that the country wanted.   

Since the industry wasn’t responding, the government decided to take matters into its own hands and nationalized YPF, something that had apparently been in the works for some time since a new plan for YPF was announced immediately.

Vaca Muerta (dead cow) is one of the main reasons why the company was nationalized. “They nationalized YPF so this government could get out of the hole it is in right now,” Marchili explained.  “Vaca Muerta is huge. And, it is only one of several shales identified with huge reserves.”

The new plan for YPF is very aggressive, she noted. The plan calls for adding 10,000 employees over the next five years and drilling up to 60 wells per year.

“They need funds, know-how, and foreign investors, such as international oil companies [IOCs], to come fix the problems,” Marchili said. “The government announced YPF would spend $3.5 billion in 2012 and double that to $7 billion for each of the next five years. They need partners, plans, technology and financing of this very aggressive program.

“YPF and the country need IOCs.  We’ve heard major oil companies have been approached by the government to participate with YPF. Who these will be is very uncertain,” she added. “At the same time, the president of Argentina was meeting with Vladimir Putin, Russia’s president, at the GC+20 meeting in Rio de Janeiro to talk about Gazprom as a partner for YPF.”

There is an opportunity for IOCs in Argentina, said Aguirre-Luzi. Companies will likely get better deals from the provinces than the federal government.  

However, it is highly unlikely that the government will change either its export withholdings or price-cap policies. “None of the contracts we’ve been able to see with YPF or the federal government include arbitration.  They provide for Argentine law and Argentine courts but not arbitration,” he emphasized.

The government also has a concern about capital flight. “There are no formal, legal rules about sending dividends to the parent company. They could call you at 2:00 a.m. and ask you to postpone paying dividends to the parent company.  It is another of the unwritten rules in Argentina,” he said.

“Argentina has been outside the financial markets since 2002.  There is no way for them to finance projects. That is why they need investment,” he added.

There are also restrictions on imports. How are companies going to get the equipment needed for the expanded efforts?  For example, the Argentine Olympic cycling team’s equipment was sitting on a dock in Buenos Aires for four months. The team had to enlist the help of the media to get the equipment.  Restricting imports keeps dollars in the country.  

“We think that the expropriation will not continue to go forward,” Marchili said. “The government needs investment and know-how, and for other companies to come into the country.  In the very short term, further expropriation seems unlikely. They do not want to increase the price of natural gas. Prudent investors should get risk insurance, ask for specific guarantees and get bilateral investment treaty protection.

“It takes two to tango, and Argentina is inviting you to dance,” she continued.  “I would think several times before joining Argentina in this.”

Contact the author, Scott Weeden, at sweeden@hartenergy.com.