(S&P Global Platts, 18.May.2020) — Argentina’s move to set a $45/b domestic crude oil reference price this week has brought cheer to some oil producers, but analysts say it may take a couple of years to rebuild production, following its plunge in April, as companies keep to the sidelines because of the country’s financial crisis and erratic energy policies.
The reference price will remain in effect until the end of the year, unless Brent, the international benchmark price followed in Argentina, surpasses $45/b for more than 10 days. That may not happen this year; Brent is expected to average $35/b, according to Moody’s Investors Service.
Argentina’s oil-producing provinces applauded the reference price as well as an elimination of the 8% export tax when Brent is less than $45/b.
“It is a great stimulus for investment, production and especially for the protection of jobs,” said Omar Gutierrez, governor of Neuquen, the most productive oil province and home to Vaca Muerta, a huge shale play.
Despite the optimism, companies are not likely to ramp up production until oil demand recovers. It fell as low as 200,000 b/d in April from an average of 450,000 b/d to 500,000 b/d after the government shut down the economy on March 20 to try to contain the spread of the novel coronavirus.
The quarantine has been loosened since, allowing crude runs at refineries to recover to around 60% of capacity in May from less than 50% in April. But until it is fully lifted, there will be little incentive to increase output by more than demand, given that producers sell the bulk of their crude domestically. This is putting a limit on how fast producers can rebuild production to pre-pandemic levels of 518,000 b/d, analysts said.
“We are oil producers, not exporters,” Emilio Apud, a former national energy secretary, told S&P Global Platts. “The industry lives off of local demand.”
A former government energy advisor, who asked not to be named, said he expects production to recover only to 400,000 b/d following the quarantine, in part because the economy is expected to contract by more then 5% this year, keeping down demand.
EXPORTS NEEDED FOR PRODUCTION GROWTH
That amount of production is not enough to rally investment, in particular in Vaca Muerta, which has been driving a recovery in oil production from a 28-year low of 479,000 b/d in 2017.
Vaca Muerta has attracted majors like Chevron, ExxonMobil and Shell to invest billions of dollars on the bet of long-term production and export growth. Vaca Muerta has around 250,000 b/d of pipeline capacity that can be put online with little investment to increase shale oil production, which reached a record 123,422 b/d in March. As the country was already running a surplus of oil, that means the additional output can be exported.
“What was creating the momentum for Vaca Muerta was the fact that companies saw that they would be able to export at reasonable margins even with export taxes,” the former advisor said. “Now they have to depend on the local reference price, a small domestic market and an uncertain energy policy. I don’t think companies will put significant investments forward, at least not this year.”
Indeed, fracking activity slowed to zero in April from 430 in March, as the low demand coupled with low international prices and limited storage capacity deterred new developments, according to data compiled by Houston-based services company NCS Multistage.
WAIT AND SEE
Apud said he expects the majors to wait for conditions to improve before stepping up investment again in Vaca Muerta. “They will sit on the concessions with very little activity, working a few wells in production,” he said.
One reason for holding back is a more long-term concern about how state intervention through the reference price could affect the business, as it now depends on political whims, not supply and demand.
“Investment decisions are not based so much on the price of oil today, but the signs that the government sends out,” Apud said. “Even though the fields are spectacular in Vaca Muerta, how do companies know that a new government is not going to come in and change the prices, export taxes and all of the rules of the game. There is no confidence in the decisions that the government takes.”
Apud warned that if investment in Vaca Muerta is stalled too long, this could lead to a production decline because shale wells wane rapidly, raising the risk of a rise in imports and a delay in export growth. Before the pandemic, the government had forecast that Vaca Muerta could lead a doubling of the country’s oil production to 1.1 million b/d in 2030, allowing exports to surge to 500,000 b/d by then from around 60,000 b/d in 2019.
The former advisor said that the majors cut their investment by 25% to 50% in the play after the government froze diesel and gasoline prices in August 2019, a measure still in effect.
“Until last year when prices were more or less aligned with international references, investment had started to take off,” the former advisor said. “You had 10 projects that had gone to full-scale development with $4 billion in investment, and companies could make their decisions based on Brent and their economics. Most of them had a breakeven for oil in the range of $30, $35, to $40, depending on the fields.”
As the outlet for the full-scale development of Vaca Muerta is exporting, if Brent is under $40, that will keep companies cautious about their investments, the former advisor said.
Another challenge is that Argentina is at the risk of defaulting on $66 billion in foreign-currency debts, which would make it harder for companies to raise the low-cost financing they need to develop Vaca Muerta.
“Without financing, Vaca Muerta is not worth anything,” said an oil consultant, asking not to be named. “It is a piece of land that has no value at all without financing.”
DECLINE IN BREAKEVEN PRICES
Companies have made advances in bringing down costs in Vaca Muerta, more than halving the breakeven price at full-scale developments from $80/b over the past few years, but new projects are breaking even at more than $50/b.
“At $45, you have to be very careful with your costs,” Hugo Giampaoli, an oil analyst at Giga Consulting, said of the new reference price.
It’s not all bleak. A sharp devaluation of the peso — it has lost 50% of its value against the dollar over the past year — and a lack of work mean that services companies are more willing to reduce their prices, and peso-based salaries are lower in dollar terms, said Daniel Gerold, head of G&G Energy Consultants.
“Everything is going to get more efficient,” Gerold said. “That is what happens whenever there are such big shocks like this. The breakeven prices could come down more and that will make it possible for new investments.”
Gerold said he expected production to decline this year and next, and not return to growth until 2022, but without causing a mass exodus of producers.
“I think Vaca Muerta is going to continue be an opportunity and there are going to be profitable projects, but at a lower magnitude that had been previously thought,” he said.
— By Charles Newbery