[NGW Magazine] Argentina Loses Nerve on Prices

The endless trade-off between economic growth and populist appeal has swung now towards the latter in Argentina: cutting prices at the wellhead means dissatisfied producers, on which the country will depend.

The Argentine Senate’s recent vote to reduce the government's planned increases in natural gas tariffs represents a potential setback for the energy investment ambitions of the president, Mauricio Macri. It has also contributed to instability within the energy ministry.

In May, the upper house voted to return gas pricing to the levels seen in November of last year, as well as limit rises in future to wage growth. The decision came as a blow to Macri, who has been president since December 2015, and has steadily been increasing gas, power and other utility tariffs.

Pro-business Macri’s intentions were to reduce subsidies, in an effort to narrow the country’s fiscal deficit as well as the 25% gas deficit.

Since he came to power, he has been raising the price of gas at the wellhead, with the goal of bringing it up from $3.42/mn Btu in October 2016 to $6.80/mn Btu in October 2019.

In June, Macri fired his energy minister of two-and-a-half years, Juan Jose Aranguren, with no explanation and replaced him with oil engineer Javier Iguacel. The government has come under fire from the public in recent weeks for its policy of reducing energy subsidies.

Indeed the tide of public opinion has begun to turn against Macri, as the economy – which was initially expected to see 3% growth this year – deteriorates and steadily slips into recession.

However there are also rising tensions in the energy industry over the uncertainty regarding what will happen with subsidies in future, and how this will affect production. 

Macri’s decision to fire Aranguren nonetheless may weaken confidence in the energy sector further, since the former minister was seen as pivotal to the success of developing the Vaca Muerta shale formation.

Ramiro Castineira, a consultant at Buenos Aires-based advisory firm Econometrica, said on Twitter that Aranguren had helped to launch development of the giant Vaca Muerta and revive hope in the oil sector.

Macri’s policy of raising the price of gas at the wellhead represented a sharp reversal from that of previous governments, which kept gas tariffs low for nearly two decades before he came into power.

Low gas tariffs deterred companies from undertaking exploration and production work in the country, something that Macri’s government has been keen to change by making wellhead gas prices more attractive to energy companies.

International majors including Chevron, ExxonMobil, Shell and Total have flocked to the Latin American country since Macri took office, and there have been increased investments from local players like YPF and BP-owned Pan American Energy as well.

Vaca Muerta, one of the world’s largest shale plays, has been the focus of much of the billions of dollars in investment that has been ploughed into the country’s energy sector in the last two years. The unconventional play, which is around the size of Belgium, is located in Neuquen province in the central part of the Patagonia region.

Vaca Muerta contains around 308 trillion ft³ of shale gas and 16.2bn barrels of shale oil, according to statistics from the US Energy Information Administration.

Last year, the government inked an investment deal with several energy companies including the oil companies listed above, for the development of Vaca Muerta. The companies agreed to collectively invest $5bn in the formation last year and $15bn a year beginning this year.

In spite of the investment, there are still concerns over the viability of developing the shale play, mainly centred on high production costs and poor infrastructure provision. All areas of infrastructure at Vaca Muerta require “vast improvements,” Shell spokesperson Natalie Gunnell told NGW. 

“New and better routes, railways, pipes and ports are needed,” she said, adding that this could be achieved by co-operation between national and provincial governments, oil companies, labour unions and other stakeholders.

The biggest challenge in developing Vaca Muerta “is to continue reducing the costs of both capital and operations,” the consultancy PwC said in a new report on the shale formation, published last month.

Vaca Muerta (Credit: YPF)

According to estimates provided by different companies, the cost of drilling a vertical well at Vaca Muerta is now $7mn, down from $11mn five years ago, PwC noted. In addition, completion now takes 25 days, compared with 45 days five years ago.

That makes well costs more competitive – but still higher – than in the US, where drilling a vertical well costs $6mn, the report said. Meanwhile, operating costs at the formation also continue to fall.

As such, significant headway has been made with making production a more attractive prospect for investors at Vaca Muerta, but improvements still need to be made. If wellhead prices are lower than investors were expecting, that could discourage them from making further investments at Vaca Muerta. The country is expecting $20bn in annual investments from 2019 onward, ex-minister Aranguren said last year.

However the government has guaranteed incentivised wellhead prices for the next two years at Vaca Muerta, meaning that only longer-term investment prospects might be affected by the Senate’s recent decision. Last year, the government said it would extend a natural gas wellhead price subsidy until 2020 at the shale play. 

Through the subsidy, which had been due to expire this year, companies are paid as much as $7.50/mn Btu for new gas production. The government also announced in March 2017 that it would raise overall gas wellhead prices by 10% as part of its strategy to attract new investment in the sector.

Whether that increase still stands is uncertain, given recent events. There is little doubt that Argentina has made important headway opening up the energy market to international investors in the last two years. Nonetheless it needs to maintain clear and stable policy going forward, to avoid a backlash against that progress.

Sophie Davies

Cover photo: President of Argentina Mauricio Macri (Credit: Governement of Argentina)