Macri juggling act entangles Argentina's answer to the Permian

By Jonathan Gilbert on 11/28/2017

BUENOS AIRES (Bloomberg) -- One of the world’s biggest shale formations is getting caught up in Argentina’s efforts to balance its books.

After a win in the Oct.-22 midterm elections, President Mauricio Macri unveiled reforms to trim a fiscal deficit seen ending 2017 at about 4% of gross domestic product. The result: Macri will spend less on a subsidy that natural gas drillers depended on for their shale projects. While new wells qualify, it’ll be tough for those in production to get the higher prices.

For drillers like YPF SA and Pampa Energia SA, that means revising gas production plans in Vaca Muerta, the Patagonian shale play that is Argentina’s answer to the Permian. While the government’s curtailed subsidy will aid the deficit, it could complicate efforts to reverse another shortfall in natural gas trade.

“They’re looking to shrink the budget deficit however they can, and that’s meant moving the goal posts” for gas, said Juan Manuel Vazquez, head of equity & credit research at Puente Hnos. SA in Buenos Aires. “It’s a stick in the wheels for companies that already have investments.”

A Puente analysis of the budget bill for 2018 calculates an initial 10.7 billion pesos for gas production subsidies, 33% less than the initial allocation this year of 16 billion pesos. Months-long delays in the subsidy payments have already been affecting drillers’ cash flows, keeping smaller companies away, Vazquez said.

In 2008 Argentina became a net importer of gas, a consequence of artificial pricing policies; before then, it generated a surplus sold to neighbors.

Under Macri, the plan is to ramp up production in Vaca Muerta, stop expensive imports of liquefied natural gas by about 2022, and then export to countries like Chile, South Korea and Japan.

The subsidy program, launched in March, set prices of $7.50/Btu in 2018, gradually reducing to $6 in 2021, for wells in Vaca Muerta and the surrounding Neuquen basin. The benchmark for gas supply in the Americas, delivered to Louisiana’s Henry Hub, is trading at about $2.90.

But under new rules published in a surprise resolution this month, only new projects qualify for the full subsidy. If the projects do not achieve consistent production of 500,000 cubic meters a day before the end of 2019, drillers must return the money.

Projects in full development will only get payments on their incremental output. Baseline production, measured from July 2016 to June of this year, will not be subsidized. That’s controversial because the government is not taking into account depletion and companies would need to spend heavily on new wells to produce additional gas above the baseline.

Switch to oil

For state-run YPF, which controls about 40% of Vaca Muerta, that could mean switching to shale oil, where it’s already made strides with Chevron Corp. in slashing well costs. Or it might ditch blocks such as Aguada Toledo, a tight gas operation with output of 5 MMcmg a day, in favor of developing new gas projects, according to a Nov. 9 earnings call.

Pampa, meanwhile, whose tight gas drilling accounted for nearly 10% of the 26 Bcm produced last year in the Neuquen basin, expects to see subsidy payments plunge in 2018.

But there are also winners: Tecpetrol SA’s new 150-well project in an area called Fortin del Piedra will get the full benefit of the payments, and the government has also recently extended the subsidy program to the Austral basin further south. Total SA produces 72% of gas there.

Still attractive

The changes may slow gas development in Vaca Muerta a little, though the play has momentum and remains very attractive, especially with the progress being made in well productivity, said Amanada Kupchella, a research analyst at Wood Mackenzie Ltd. in Houston.

More broadly for investors in Macri’s Argentina, analysts say it’s the sudden change in the rules, rather than the content of the changes, that are most worrying. “It creates uncertainty and a lack of predictability,” Kupchella said.

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