(LatAm Investor, 20.Jan.2023) — Most international investors keep clear of Argentina. It has an unenviable record of default and expropriations while successive governments seem unable to manage the country’s incredible natural wealth. The return of the controversial Cristina Kirchner – who was Argentina’s first lady then president from 2003 to 2015 – as vice president was also a red flag for foreign firms. In one sense investors were right to stay away. The economy is a mess and inflation is currently running at 100% (it will probably be higher by the time this goes to print).
But there is one incredible economic success story coming out of Argentina – during the last two years, oil and gas production has increased by 80%. Analysts think oil output could increase by a further 300% over the next decade, propelling it into the world’s top 20 oil producing nations and bringing much-needed fuel to a global energy market strained by Russian sanctions.
Let’s not gloss over the facts. Argentina is a distorted, poorly-run economy, which is a difficult place for companies to do business. Despite those challenges, Vaca Muerta is a positive story that is already attracting the attention of institutional investors like Alfredo Mordezki, Head of Latin American Fixed Income for Santander Asset Management. “A very interesting trend in the oil and gas industry, that is off the radar, is how Argentina has been slowly but consistently increasing production. The growth is mainly in natural gas, and tight and shale gas plays linked to the Vaca Muerta formation. If you translate it into barrels of oil equivalent, Argentina now produces 1.5 million barrels per day. What it is interesting is that most of this development has been carried out by private companies, who are responsible for two thirds of total production.”
To understand how this happened, and how far it can go, we spoke to Ricardo Hosel, CEO of Oldelval, the pipeline carrying all of Vaca Muerta’s oil.
“We transport 100% of Vaca Muerta’s crude, so we are very sensitive to production there”, says Hosel. “In 2017 just 27% of all the liquids in our pipeline was coming from Vaca Muerta – today it accounts for more than 70% of our fuel, so the growth has been incredible. Indeed, Neuquén now produces 60% of the country’s oil and gas, while Vaca Muerta accounts for 60% of all of Neuquén’s production.
“We have always asked our clients – who are also our shareholders – for their production plans. For many years those goals were very ambitious but they never seemed to be achieved. So, we had to be realistic and tone down our own expansion plans. But in the last two years, their production has increased dramatically. By October of last year, we were at full capacity, and implemented the ‘Vivaldi project’ which allowed us to increase capacity 25% by upgrading four pumping stations. But now we have reached full capacity once again, so the rapid growth of Vaca Muerta in the last 18 months has outstripped our ability to transport oil.
“This is an important turning point in Vaca Muerta, where the optimism has turned into reality. These producers invested heavily over the last five years and they have now found a way to produce oil at competitive costs. It takes longer to develop infrastructure than drill a well so they have taken us by surprise.”
At present, with less than 10% of the deposit connected to pipelines, Vaca Muerta is producing 270,000 bpd. The race is now on to boost transport capacity. “When we were finishing Vivaldi, we knew it wouldn’t be enough”, says Hosel, “so we began Proyecto Duplicar, straight away. That project will help us get from 270,000 bpd to 450,000 bpd and will involve building 525 kilometres of pipeline from Neuquén to Puerto Rosales. We will also have to upgrade four pumping stations.”
In addition to Oldelval’s new pipeline, there are plans to restart the abandoned Trans-Andino pipeline to Chile, which could eventually take 115,000 bpd. Work has also begun on a new gas pipeline to carry 39 million cubic metres of gas per day.
What’s surprising – given Argentina’s international reputation for chaotic bureaucracy – is that after making the decision in January 2022, Oldelval has the permits in place, has completed the tenders and is already soldering some of the pipes. “Without doubt it helps that both the provincial and national governments realise the fundamental importance of this project”, says Hosel. “Nearly all the capacity that we are adding will be exported and earn much-needed hard currency for the Argentine economy. That’s what probably encouraged the national government to renew our concession past 2027 to 2037, which was vital if we were going to be able to sign the long-term ‘ship or pay’ type contracts with our clients.”
The speed with which the $750mn Duplicar Project is advancing is impressive but McKinsey estimates Vaca Muerta will need an extra $45bn over the next ten years to achieve its potential. That’s a big ask for a country that has burnt international investors many times in the past but industry insiders believe it will happen.
Hosel believes that Vaca Muerta will need more than $45bn but he is optimistic the money will arrive. “In the last year the government has realised it needs dollars for the country to grow. At present the biggest source of export earnings is agriculture. Hydrocarbons are in second place but it could overtake agriculture if we reach our potential. Last year Argentina imported $12bn of natural gas, but if we utilise the associated gas in Vaca Muerta we could become a major exporter. We can also become a much more significant oil and gas exporter.”
Another believer is Alejandro Monteiro, Minister for Energy and Natural Resources of Neuquén province, home to Vaca Muerta. “What you need to remember is that unconventional oil and gas began in this country under the Cristina Kirchner presidency. That was when we had the contract between YPF and Chevron. Her populist left-wing government was replaced by the right-wing, market-friendly Macri administration. And despite having a completely different ideology, the support for Vaca Muerta continued. Anybody who comes to power in Argentina will want to support Vaca Muerta. The Argentine economy needs the export earnings, while our industrial sector can thrive on cheap energy and create jobs. What’s more, the most difficult part, establishing an industrial operation to extract shale oil and gas at competitive prices, has already been done. The different parties might disagree about how to do it, but they all want to develop Vaca Muerta.”
We aren’t trying to downplay the obstacles. “Of course, we have economic challenges that we must resolve”, concedes Monteiro. “We need to create a regulatory framework that allows us to build long-term investment, for example an LNG compression train because those long-term investments can’t be subject to the whims of national politics.” Hosel agrees, noting that “what we need at a national level is stability, to give investors the visibility they need to make long-term commitments.”
But this isn’t just about the conditions that authorities in Argentina or Neuquén offer investors. Both Monteiro and Hosel agree that the incredible competitive advantages of Vaca Muerta will encourage investors to take risks.
“The last two years haven’t been easy for the country – or the world – so an asset like Vaca Muerta that can solve the global energy crisis and help Argentina grow, can’t be ignored”, says Hosel.
“The 8% of Vaca Muerta that is producing so far is incredibly productive”, says Monteiro. It ranks alongside Permian in the US and has more impressive output than other basins in North America. Another great advantage for developing Vaca Muerta is that it is counter-seasonal to the energy demand of the northern hemisphere. We will have surplus supplies in the precise months that you most need them. The other plus is that we don’t have the geopolitical tensions you find in other major gas producers.”
The Vaca Muerta story isn’t just about volume – although that’s what makes it globally significant – it is also about low-carbon, low-cost oil. When it comes to cost, a report from consultants McKinsey found that Vaca Muerta’s technical break-even price for oil is $36.00 per barrel (BBL) and for gas wells is $1.60 per million British thermal units (MMBtu), both of which are in line with most US unconventional fields at $34.00 to $51.00 per BBL and $1.30 to $1.80 per MMBtu. “Higher local drilling costs in Vaca Muerta are mostly offset by higher well productivity, which is the result of higher initial production peaks and longer, sustained production levels.”
The low cost structure will encourage investors because it means Vaca Muerta can remain competitive in an oil market downturn. Moreover, now that producers have resolved the technical challenges, the huge resources of Vaca Muerta can be developed more quickly than offshore projects of a comparable size. Indeed one of the advantages of unconventional wells is that they have front-loaded production with high levels of output in the early stages that then tails off. That is ideal in today’s market, where oil and gas investors are unsure about the long-term prospects for black gold and want a quick return on capital.
You wouldn’t think it from the regular objections to ‘fracking’ in the UK but shale oil and gas can also be environmentally-friendly. As McKinsey explains, “Vaca Muerta’s production processes have an oil carbon intensity of 15.8 kilograms (kg) of CO₂ per barrel of oil equivalent BOE, which is among the lowest carbon intensities for oil and gas operations worldwide—and well below the global average of 23.0 kg CO₂ per BOE.”
“In addition”, continues the McKinsey report, “shale oil from Vaca Muerta is within the lighter range of oils and has low sulphur content (less than 0.5%, compared with the typical 1.0% to 3.0%). This makes it easier to refine and convert into gasoline and therefore requires less complex refinery technologies. Exports of US light crude to Europe (primarily France, Italy, and the United Kingdom) and East Asia (primarily China, Korea, and Singapore) have also recently increased. Thus, it stands to reason that Vaca Muerta’s oil could also be placed in these markets, given its similarity to US light crude.”
Argentina has vast quantities of cheap, low-carbon light crude that will sell well in international markets. The only bottleneck to tripling production over the next decade is pipeline capacity and, so far, work on new routes has been surprisingly rapid. Neuquén is currently producing 350,000 bpd and with the different projects planned, it should be able to extract 750,000 bpd in 2025 and 1 million bpd by 2030. The projections for gas are just as exciting. State energy company, YPF is already exploring an LNG export project, while existing pipeline connections to Bolivia and Uruguay gives Argentine gas easy routes into the lucrative Brazilian market.
It is a rare good news story for both Argentina and battered global energy markets. As Hosel eloquently puts it: “I feel fortunate to be involved in the industry right now. Vaca Muerta has given a second life to the Neuquén Basin. All the other oil regions in the country are in decline but Neuquén is growing.” And because development is being led by the private sector there are lots of ways for international investors to get exposure.