(Baker Institute, 17.Aug.2021) — Shale oil’s short-cycle production protects foreign investors from the risk of expropriation — government taking private property for public use — providing an opportunity for the increasingly risk-averse global petroleum industry, according to a new report.
The paper, “Shale Renders the ‘Obsolescing Bargain’ Obsolete: Political risk and foreign investment in Argentina’s Vaca Muerta,” was authored by the Baker Institute’s Gabe Collins, Mark Jones, Jim Krane, Ken Medlock and Francisco Monaldi. They are available to speak to the news media about the unique attributes of shale investments.
The authors focus on Argentina, a notoriously risky place for foreign investment, particularly in the oil sector. The Argentine government fully expropriated the in-country holdings of Spanish oil major Repsol in 2012, sending a shock wave through foreign investors interested in the country’s world-class natural resources, explained Krane.
Between 2013 and 2019, oil supermajors returned and invested $13 billion in developing oil and gas concessions in Argentina. But compared to investments in conventional oil like Repsol’s, post-2013 investments have been almost exclusively in the Vaca Muerta shale play. “With 153,000 barrels of oil equivalent per day in average daily production in 2018 and 250,000 by the middle of 2019, the Vaca Muerta had become the most productive shale play outside North America,” according to the report.
The authors say shale production has specific attributes that protect it from expropriation.
Unlike conventional extraction, shale — which requires horizontal drilling and hydraulic fracturing — has very short production cycles and fewer geological risks than other frontier plays, they explained.
“Shale oil and gas production has changed the incentive structure and the political calculus around resource-nationalist behavior,” they wrote. “The willingness of foreign investors to return to Argentina in the immediate aftermath of a major expropriation provides some evidence of these changes, as does the data showing that the new investments are heavily weighted toward shale.”
“The immense interest by foreign investors will almost certainly eventually trigger a series of midstream and downstream investments — including export facilities and domestic infrastructure to support industrial use — that will be crucial to full monetization of the resource,” they added, noting that the surge of shale investments has continued even after the 2019 elections that ousted the “pro-business” administration of Mauricio Macri.
Understanding why shale developments may be less vulnerable to political interference or expropriation is crucial to understanding the future of oil and gas globally, they write.
“To keep output stable, shale producers must maintain a constant rate of well-drilling — resembling more a manufacturing process than a traditional oil play. If the drilling is interrupted, shale production collapses,” they wrote. “Moreover, shale investors begin to recover their capital relatively quickly, sometimes after just one well has been completed. If the well is profitable, investors can bet again on another one, and so on.”
If the government violates contractual terms, companies can simply stop investing and oil production would quickly collapse. The government would find itself with little production or cash flow from the assets it seized.
Foreign investment into resource-nationalist Argentina signals a “watershed event” for the global petroleum industry and for the study of political risk in foreign investment, the authors argue.
“While we focus here on Argentina, the case may have implications for the global oil market. If risk is institutionally and structurally lower in shale investments, the realization could encourage wider proliferation of shale production outside the United States, all else equal,” they write.
This would create a broader geographic distribution of oil production beyond the major producer states that dominate and often manipulate oil markets, the authors argue.