Argentina’s Brilliant, Terrible, Very Unclear Energy Future

Argentina, of all countries, should be an energy powerhouse. Yet, like the rest of its economy, Argentina’s energy sector is a basket case. The Southern Cone nation sits atop massive reserves of oil and natural gas, but spends billions of dollars importing fuel, with nasty consequences for a country battling double-digit inflation and unemployment and already experiencing economic contraction.

So Buenos Aires is trying to change all that by convincing foreign investors to pony up the better part of $200 billion to beat a dead cow back to life (the country’s oil-and-gas mother lode is in the Vaca Muerta — "Dead Cow" — formation). So far, it has coaxed Chevron, Petronas, Gazprom, and other international oil companies to invest in the field, with hopes of turning energy poverty to energy riches within a decade. Argentina hopes to finalize a new energy reform law later this month.

But this is the same country that infamously defaulted on its debt payments in July — for the second time in 12 years — and that has been locked out of international debt markets for more than a decade because of its cavalier treatment of international capital. Just two years ago, right as Vaca Muerta’s prospects were starting to shine, Argentine President Cristina Fernández de Kirchner snatched back the national oil company YPF from the hands of its owners, Spain’s Repsol, sparking a bitter, $10 billion fight. It’s little wonder that Argentina is the most sued country in the world.

Unsurprisingly, investors are skeptical of Argentina’s seeming embrace of market-friendlier policies, especially given its penchant for taking moves from its well-thumbed populist playbook that see it turn around and kick foreigners right back out.

"It’s hard for me to believe that President Kirchner is going to do an about-face," said Bernard Weinstein, associate director of the Maguire Energy Institute at Southern Methodist University.

"Before we see any significant foreign investment in Argentina’s energy sector, there has to be economic and financial reform" under the new government to be elected next year, he said. "Presumably the new leadership will be more enlightened, more moderate, more cognizant of the fact that you can’t develop your economy unless you have a functional government, rule of law, and sanctity of contracts."

Given all its aforementioned economic problems, plus its leaden currency and dismal growth prospects, some might scratch their heads as to why Argentina is focusing on energy-sector reforms. But it’s exactly for those reasons — energy could and should be a boost, rather than a drag, on its reeling economy.

Ever since its major debt default in 2002, Argentina has been unable to tap international credit markets. That means dollars are only available from exports, and indeed Argentina runs a healthy trade surplus. But it could be twice as large were it not for the country’s obligation to spend about $5 billion annually importing the very stuff that it has in such abundance. (Argentina even has to import nearly all of the sand it needs for hydraulic fracturing.)

Enter energy reform, as so many times in Argentine history. Even while Kirchner was wrestling with Repsol over the delayed and partial compensation paid to the Spanish firm for its majority stake in YPF, and even while she has been thumbing her nose at international creditors ("financial terrorists"), she has been wooing investment from oil majors.

Argentina has overhauled some investment rules, allowing companies that sink in more than $1 billion to evade restrictions on capital movements. Its draft bill would revamp a nearly 50-year-old law that puts the central government, rather than the provinces, in charge of energy exploration and production. That proposal, which passed the Argentine Senate Oct. 9, would also further loosen restrictions on foreign investment and make oil concessions last longer.

The rush to make nice with certain corners of the global investment community, at least, is easy to explain. On paper, Argentina has some of the world’s biggest unconventional oil and gas reserves, especially in Vaca Muerta; the most common estimate is that the "Dead Cow" holds about 23 billion barrels of oil equivalent (liquid oil and natural gas). International firms such as Chevron gush over the formation’s potential; even skeptical outsiders concede that it could rival Eagle Ford, one of the most productive shale basins in the United States.

"Argentina’s future lies in Vaca Muerta," said the ruling party’s Senate leader this month.

But to really milk that cow, Argentina and YPF need foreign money and expertise; YPF figures it could take at least 10 years and $200 billion of fresh investment there to turn the country’s energy deficit into an energy surplus — more than the state-controlled firm can possibly shell out.

Chevron, among others, is dipping more than a toe in the water. The U.S. firm invested $1.2 billion in a joint venture with YPF in 2013; this year, it agreed to spend another $1.6 billion to drill more wells. Chevron could invest as much as $15 billion in developing Vaca Muerta.

"Chevron is committed to investing in Argentina and to contributing to the country’s goal of energy self-sufficiency," a company spokesman said, adding that it "welcomes the efforts to establish a strong and stable legal framework aimed at increasing oil and gas investment and production in Argentina."

And that might be the rub. Since the beginning of the Argentine oil industry just over a century ago, the pace of its development has owed much more to politics than to geology. Economic distress tends to push governments into oil companies’ hands; populist politics usually then lash out at concessions made to foreign capital. One executive at an international oil company with experience in Argentina described the government as "brilliantly cynical."

Argentina’s love-hate relationship with foreign energy firms dates back decades. Government reforms to strengthen YPF in the 1930s chased away many private investors and sent production down until after World War II. Faced with a dismal economy, President Juan Domingo Perón engineered an abrupt 180 to court oil companies and boost production in the early 1950s. Just a few years later, the military government undid those reforms. By the end of the decade, another civilian government again sought to placate foreign energy firms — until those reforms, in turn, were undone in the 1960s.

The latest energy reform has some international companies watching warily from the sidelines. Shell’s Argentina country chair, Juan José Aranguren, calls the public debate over the future of the energy sector "a step forward," but he stresses that "all actors of the value chain should have the formal opportunity to express their views."

Argentina may have to tread carefully this time around. Other Latin American countries, notably Mexico, are taking serious steps to reform their own energy sectors to make them more appealing to international firms. Indeed, the IMF — which expects Mexico to far outpace Argentina’s growth — highlighted energy reform as one of the key elements in Mexico’s macroeconomic recipe.

Meanwhile, the boom in U.S. and Canadian production has given oil companies safe, attractive places to invest. At the same time, oil prices are slumping, which means that expensive, hard-to-develop projects like Vaca Muerta risk becoming uneconomical — even if the government maintains a stable energy policy for years to come.

"The biggest impediment could simply be the cost of doing business there," said Walter Molano, managing partner at BCP Securities and author of In the Land of Silver, a history of Argentina’s economic development. Argentina lacks many of the advantages that drove the U.S. fracking boom, from private mineral rights and a stable legal regime to a spate of small, nimble oil companies and plentiful energy infrastructure.

"That’s why I am so pessimistic about the future of fracking in Latin America," Molano said.