The discovery of world-class shale oil and gas in Latin America’s second biggest economy offers an opportunity to reverse the downward trend in conventional oil and gas output as well as to transform Argentina’s economy. Industry insiders suggest that Argentina’s shale formations are checking many of the right boxes despite its political risk, energy policies, and regulatory environment, which at first sight appear daunting to potential investors and the foreign energy majors.

However, as Joe Amador, managing director at Tudor Pickering Holt & Co., observed, “Argentina is too important a prospect to pass by for international oil companies because it has a good domestic market and offers great export opportunities in the neighboring Southern Cone countries with pipelines waiting to transport the gas.” Political and financial uncertainty remain stumbling blocks. Argentina’s inability to access international financing at reasonable terms following its default on nearly US $100 billion in debt in 2001 limits state energy company YPF in raising the capital it needs to develop its one-third share of the Vaca Muerta acreage.

To attract foreign investment, technology, and knowhow, Argentinian President Cristina Fernandez de Kirchner’s government has recently introduced a few fiscal and regulatory measures designed to foster rapid exploration and development in the most promising of Argentina’s four shale formations, namely the Neuqu?n basin’s Vaca Muerta, which is Spanish for “dead cow.”

Resources: shale oil and gas

Argentina is endowed with world-class conventional and unconventional plays of oil and gas. The US Energy Information Administration’s (EIA) June 2013 report states that Argentina has some of the world’s biggest and best-quality reserves of shale hydrocarbons, ranking Argentina behind only the US and China with its 22.7 Tcm (802 Tcf) of technically recoverable gas resources and fourth behind Russia, the US, and China in shale oil with an estimated 27 Bbbl.

The discoveries since 2010 have the potential to increase Argentina’s hydrocarbon production 50% by 2019, claimed Sebastian Eskenazi, YPF CEO. He was quoted in Business Report in October 2013 saying he views development of Argentina’s unconventional resource as “our top challenge and the key to our oil and gas independence.”

Almost a century after its first oil discovery, a new exploration frontier has opened in Argentina offering the prospect of a shale energy revolution comparable to that of North America. The largest shale play lies in the Neuquen basin, where YPF discovered 127 Bcm (4.5 Tcf) of shale gas in the Loma de la Lata block of the Vaca Muerta formation in December 2010. The area has transportation and field service infrastructure that was developed for conventional oil and gas fields.

Four shale basins

Argentina’s four shale oil and gas plays lie in areas far from main population centers. The three prospective and mainly untested basins are the Chaco basin in the north, the Golfo San Jorge basin in the south, and the Austral basin in the far south close to Antarctica.

The largest shale oil and gas play is located in the arid expanse of the Neuqu?n basin in the west. The basin contains two main formations. The first is the Los Molles shale, which is said to contain some technically recoverable resources of 7.8 Tcm (275 Tcf) of shale gas and 3.9 Bbbl of shale oil. The second and biggest formation, the Vaca Muerta, is spread over some 22,000 sq km (8,500 sq miles) with estimated technically recoverable reserves of 8.7 Tcm (308 Tcf) of shale gas and 16 Bbbl of oil and condensate.

Discovered in July 2010 by Repsol and YPF, this rich, giant shale oil and gas formation represents for Argentina “new energy, a new future, and new expectations,” said Eskenazi.

Features of Vaca Muerta

Argentina’s shale developments overlap existing oil and gas production areas and are suitable for the application of US technology. However, the Vaca Muerta formation’s depth of 3,000 m (9,840 ft) is greater than that of the US

Barnett at 2,286 m (7,498 ft) and much deeper than the Bakken field at 1,829 m (6,000 ft), adding to drilling costs.

Based on 15 vertical wells drilled, YPF concluded that this shale has better properties than counterparts in North America. It ranges from 30 m to 450 m (98 ft to 1,476 ft), thicker than, for example, Eagle Ford’s range of 10 m to 80 m (33 ft to 262 ft).

In terms of scale, the Vaca Muerta at 5.72 million acres is smaller than the US Bakken play (7.32 million acres) but bigger than Eagle Ford’s formation at 4.1 million acres. In terms of drilling strategy, horizontal well drilling is ubiquitous in the US. However, Brenda Rangel, Dow Chemical Co., explained that local operators in Argentina have prioritized vertical wells, which cost about $10 million compared to $30 million for horizontal wells.

These features have acted as a magnet for foreign independent E&P companies, galvanizing YPF and local companies and attracting global energy service companies.

Despite its considerable attractions, development of the Vaca Muerta field is still in the preliminary stages, and progress has been slow. By September 2013, only around 90 wells had been drilled. In July 2013, YPF was producing 8,000 b/d of shale oil with an expectation of 17,000 b/d by year-end 2013, rising to 38,000 b/d in 2014.

Constraints

Constraints on shale development include anticipated higher costs than in the US, shortages of equipment, insufficient infrastructure of services and transport, and water scarcity. According to the Financial Times, even a small section of the Vaca Muerta field will need 1,500 wells costing $15 billion in total to reach the production target of 75,000 boe/d. These costs will multiply with extensive development.

The crucial challenge is Argentina’s shortage of key shale E&P equipment. First and foremost is a lack of drilling rigs suited to shale gas applications. According to Baker Hughes, in October 2013 the number of rigs operating in the US was 1,742, while in Argentina only 83 rigs in total were in action. Of those, only 20 were dedicated to shale. It is expected that 10 more rigs will be added over the next year, but imported, advanced high-tech rigs will require a significant investment in local training.

There also is the lack of suitable infrastructure. “Argentina lacks developed service infrastructure for unconventionals that is required for exploration, drilling, and extractions, so the speed of development has been slower until now,” Rangel said. Additionally, trucks are in short supply, and transport is subject to a strong trucking union.

As Silvio Bresciai, vice president of Nabors International, pointed out, Argentina “has access to suitable roads and spare parts. But even so, Argentina has a lot to catch up on.”

Last, hydraulic fracturing requires huge amounts of water. Argentina’s first shale gas well required the simultaneous use of 16 water tankers, according to Argentina’s National Academy of Engineers. Potential solutions to the scarcity of water include a proposal to channel water from a desalination plant some 400 km (250 miles) away via an aqueduct that has yet to be built.

An alternative solution is to use less water as David Aron, managing director of PDC Energy, suggested, either through recycling produced water or using propane for fracturing.

Business environment

Political and economic risk, along with lack of finance for investment, haunt the country’s drive to develop the Vaca Muerta and achieve energy self-sufficiency by 2030. Argentina’s dispute with holders of its defaulted sovereign bonds constrains YPF’s ability to raise capital.

Shortly after the shale oil and gas discoveries, the government expropriated Repsol’s 51% stake in Argentina’s YPF without compensation and nationalized it. The crucial lack of money is perhaps the main reason the government reportedly offered Repsol $5 billion – less than half of the company’s $10.5 billion claim – payable in government bonds during the last week in November 2013.

According to a press release issued by the governments of Argentina, Spain, and Mexico, “An agreement in principle has been reached over the compensation for the expropriation of 51% of YPF’s shares in April 2012. The agreement will imply fixing a compensation figure and its payment with liquid assets and that both parties will end their respective legal actions. The sides involved coincide that the current agreement in principle contributes to normalize and strengthen the historic links between the three countries.”

On Nov. 27, 2013, Repsol’s board of directors said in an official notice that it “reviewed and views favorably the heads of agreement announced by the Argentine government related to the compensation of 51% of YPF. Repsol has decided to start in due course conversations between its teams and those of the Argentinian government with the objective of finding a fair, effective, and quick solution of the controversy.”

Lack of finance is only one of the problems facing the country. Inflation of around 25%, strict currency controls, high taxes, populist price controls on energy, regulatory controls, and even import restrictions on essential equipment have contributed to slow and limited foreign investment in Argentina’s shale discoveries. However, the business environment is becoming more favorable. Amador continued, “Unfortunately, the past price controls caused problems, and now these are being relaxed sufficiently to attract international oil companies.”

Indeed, the government tripled wholesale gas prices to encourage conventional and shale drilling. Companies such as Total, YPF, BP, Pan American Energy, Petrobras, and Apache Corp. have already benefited from such a move.

Argentina’s reserves have dropped below $35 billion, the lowest level in more than six years, reported The Economist, putting pressure on the government to liberalize the economy. The government has begun to offer a series of policies designed to attract foreign investment and to raise returns for oil and gas companies.

For example, in Decree 929 energy companies that meet Argentina’s $1 billion, five-year investment requirements will be able to sell 20% of the production in international markets without paying export taxes and keep export revenues from 20% of output outside Argentina. In effect, this raises oil exporters’ cash payments by 67%, benefiting existing players including BP, Pan American Energy, and Sinopec. In addition, companies also will be able to sell oil and gas originally destined for export in the domestic market at international prices when local supply is insufficient. These are carrots instead of sticks. To drive shale field exploration and development, the government established a commission to oversee oil companies’ business plans with powers to fine companies that fail to meet the investment commitments to shale development. And to ensure cooperation of and share the benefits with shale-endowed provinces, YPF has signed an agreement with Santa Cruz Province to pay 15% in royalties for its oil and gas output and 10% in royalties for its shale production.

Unconventional oil and gas boom by 2017?

YPF has issued its first overseas bond offering since its nationalization in a bid to raise $37 billion to finance a step change in exploration and development of the Vaca Muerta. Since the Vaca Muerta requires around $42 billion in investment to be divided into $28 billion for oil production and half that for gas, it has announced a five-year planned (2013 to 2017) aggressive factory drilling program target of 48 horizontal and 84 vertical wells. YPF, together with foreign partners and their investment of $4.6 billion, hopes to increase production of oil and gas by 50% by 2017.

According to a Reuters study, four major companies control nearly 80% of the Vaca Muerta shale. Spearheading development are YPF, Apache, ExxonMobil Explortion Argentina, and Americas Petrogas. Apache at this time is working on an agenda for Phase II of exploration in the Vaca Muerta. The company has a net total of 1.2 million acres, with 950,000 acres in the oil/wet gas window of the shale.

YPF has concessions on 3 million acres and 1 million acres on joint concessions. In the last year, YPF has approached a number of foreign energy companies to jointly develop the Vaca Muerta, including Petrobras, Chevron, ConocoPhillips, and ExxonMobil.

Breaking ranks with its peers, Chevron has become the first major oil company to commit to YPF. The deal, worth an initial $1 billion, entails YPF transferring a 50% interest in its Loma de la Norte and Loma Campana fields to Chevron in return for 100 to 110 wells drilled in a 5,000-acre tract. YPF and Chevron will split the expenses and profits 50:50 on an expected output of 11 MMbbl of oil in the first year, rising to 50,000 b/d and 3 MMcm/d (106 Bcf/d) of gas by 2017.

As a reassurance, the agreement will be governed by US and Argentinian law, and disputes will go to the International Chamber of Commerce in Paris. Another partnership soon followed: YPF and Dow Chemical agreed to invest $188 million to jointly develop shale gas from the Vaca Muerta formation.

Acquisition of acreage, exploration, and drilling has been stepped up by companies already present in Argentina, including Americas Petrogas, Gas Y Petroleo De Neuquen, Total, Madalena Energy, EOG Resources, Tec Petrol, and Royal Dutch Shell.

Apache is a significant player with exploration rights on 1.3 million acres, including areas held jointly with partner companies. Apache has an interest in 32 concessions, exploration permits, and other interests in an area totaling 4.4 million gross acres in four of the main Argentinian hydrocarbon basins: Neuquen, Austral, Cuyo, and Noroeste. In 2012, Apache committed to investing $250 million for one horizontal and four vertical wells.

Halliburton completed South America’s first-ever horizontal multistage hydraulic fracture of a shale gas well on behalf of Apache. The well was drilled horizontally at a measured depth of 4,400 m (14,432 ft). Apache is a participant and beneficiary of the government’s Gas Plus Program introduced in 2008, which was designed to encourage new gas supplies through development of unconventional assets. Under the program, Apache can sell gas from qualifying projects at above the regulated price.

In fall 2013, Wintershall concluded a 50% joint venture agreement with Gas y Petroleum de Neuqu?n to explore for oil in 97 sq km (37 sq miles) in the Vaca Muerta. Wintershall’s $150 million commitment over two years toward exploration allocates $120 million for drilling two vertical and four horizontal wells. The agreement could be extended to some $3.35 billion for drilling 120 wells over 10 years. Local Argentinian-Chinese group Bridas recently announced an investment of $500 million to explore for shale oil in the Vaca Muerta.

The activities of local and foreign independent exploration and development companies in Vaca Muerta have acted as a magnet to attract oil and gas field service companies such as Schlumberger, Halliburton, and Calfrac Well Services to Neuquen Province. Oil service companies are expected to invest around $111 million to build an industrial park in Neuquen to support shale exploration and development.

The dream of energy self-sufficiency and the hope of fulfilling the promise embodied in Argentina’s shale oil and gas resource is ubiquitous. The signs are good. The Argentine government has significantly improved the business environment by introducing regulatory, fiscal, legal, and economic measures designed to attract and reassure foreign and indigenous energy companies willing to commit money, know-how, equipment, and people to Argentina’s new exploration frontier.