Reserves mess adds urgency to the need for reform
Repsol YPF's reserves write-downs in South America are not just a disaster for the company. Unless the region's governments take action, the reliability of natural gas supplies across the continent could be under serious threat. Robert Olson writes
THE 25 January announcement by Repsol YPF that it was downgrading some 25% of its proved reserves of oil and gas did not come as a complete surprise. The election of a government in Bolivia whose manifesto had included a promise to nationalise the country's oil and gas assets had already raised serious questions about the Spanish firm's reserves base. It had also all but killed off hopes of revising the country's onerous new Hydrocarbons Law, which increased wellhead taxes to 50%, from 18% under the previous regime.
With a quarter of its proved reserves in Bolivia, Repsol YPF was far more exposed to the country than any of the other big investors – including Petrobras, Total and BG Group – none of which seems to have been as aggressive as Repsol YPF in booking reserves in Bolivia.
After his inauguration, Evo Morales, the new Bolivian president, renewed his promise to nationalise the country's oil and gas industry, leaving little doubt about the extent of Repsol YPF's difficulties. The tectonic shift in Bolivian energy policy away from the liberalising initiatives of the mid-1990s that brought in foreign operators and billions of dollars of capital was complete.
The situation in the country is a heavy blow to Repsol YPF, which has relied heavily on reserves additions in Bolivia to at least partially cover for its dwindling reserves in Argentina. Between 2000 and 2004, Repsol YPF's total reserves edged down from 4.94bn barrels of oil equivalent (boe) to 4.93bn boe, even as reserves in Argentina fell from 3.47bn boe to 2.36bn boe. Over the same period, Repsol YPF's proved net reserves in Latin America, outside Argentina, soared from 0.78bn boe to 2.36bn boe.
Most of this increase was because of the firm's 2001 deals with cash-strapped Argentine oil companies Pecon Energia and Pluspetrol that gave it control of Petrolera Andina, Bolivia's largest oil company, allowing it to consolidate all of Andina's reserves on its balance sheet.
By the end of 2004, 1.309bn boe of Repsol YPF's proved reserves were in Bolivia. But the country's gas industry was under increasing pressure. A broad alliance of leftist groups, indigenous people and the urban poor, led in part by Morales, had already killed plans to export natural gas to the US through an LNG plant in Chile and their demands were escalating. The liberalising government that had backed the LNG plan had resigned and caretaker president, Carlos Mesa, was trying to maintain a shaky grip on power amid continued public protests against foreign ownership of the gas industry. In an attempt to accommodate the protestors, Congress passed the new Hydrocarbons Law. Mesa refused to sign the law, but he was overridden by Congress and, in May 2005, the bill became law.
Despite the passage of the law and the political turmoil in Bolivia, Repsol YPF announced a few days later at its 2005-09 strategy presentation that it expected that it would more than double production in the country from 107,000 boe/d to 227,000 boe/d by 2009 at a cost of $0.85bn. Just a few months later, this aspect of the strategic plan is in tatters. In the downgrade announcement, Repsol YPF said it would slash 0.66bn boe from its Bolivian reserves and that it has put investments on hold until it has a better idea of how the legal landscape will look.
Impossible to recover
But while Repsol YPF's problems in Bolivia attracted much of the attention in the wake of the announcement, the downgrade of some of its Argentine reserves is probably more significant in the long term. Although some of the gas in Repsol YPF's Bolivian fields can no longer be counted as proved reserves, for the most part the gas is still recoverable. However, a substantial amount of the gas written off in Argentina may prove impossible to recover.
Repsol YPF wrote down 0.51bn boe of reserves in Argentina, blaming the performance of the reservoirs at the Loma La Lata, Chihuido de la Sierra Negra, Ramos and Agua Toledo/Sierra Barrosa fields for three-quarters – 384.6m boe – of the write-down.
The write-down at the Loma La Lata field, in particular, could have a big effect on the future of the Argentine gas industry. The field is one of the largest gasfields in Latin America and plays a central role in balancing supply to the domestic market. Repsol YPF has not published its estimate of Loma La Lata's proved reserves, but according to government data, at the end of 2004, the Loma La Lata-Sierra Barrosa concession contained 0.78bn boe of proved reserves – 4.38 trillion cubic feet (cf) of gas and 50m barrels of liquids. As such, the concession accounted for 23% of the country's proved gas reserves.
Repsol YPF has the concession to operate the field until 2027, after negotiating an extension in 2000 in exchange for a $300m payment to the state. To help secure the concession extension, Repsol YPF also agreed to an $8bn investment programme in Neuquen province between 2000 and 2017 and pays 5% of its net cash flow to the provincial government from all activities arising in Neuquen.
Loma La Lata produced an average of 1.25bn cf/d in 2004, just under a quarter of total gas production in the country. But this figure masks the important function Loma La Lata plays in meeting peak winter demand. Government data show output from the field rose from as low as an average of 0.94bn cf/d in January 2004 to 1.39bn cf/d in July in the depths of the Argentine winter.
Production in 2005 from Loma La Lata has been declining, however. Over the first 11 months of the year, the field produced an average of 1.17bn cf/d, a drop of 6.4%. Peak production in July was only 1.27bn cf/d, a drop of 8.6%. Nevertheless, 75% of the gas Repsol YPF produced over the first 11 months of 2005 came from the field.
The decline in production is probably largely down to what Repsol YPF calls in its 2004 annual report to the US Securities and Exchange Commission "an unanticipated lack of vertical gas equilibrium" in the field. In other words, the various producing zones were not as interconnected as the company had once thought, so pressure in parts of the reservoir is declining faster than the company's reservoir models would have suggested. In response to the discovery of the problem, Repsol YPF wrote down its proved reserves in the Loma La Lata-Sierra Barrosa concession by 72.6m boe (326bn cf of gas and 14.6m barrels of liquids) in 2004.
A year later, the pressure problem at Loma La Lata has either worsened, or Repsol YPF has a greater understanding of it. In its January reserves announcement, the firm said it expected it would have to wipe 258.1bn boe of proved reserves from the field off its books, or nearly a third of what the Argentine government counted as proved reserves in 2004. Altogether, the latest Loma La Lata downgrade represents about 20% of Repsol YPF's entire reserves restatement.
Repsol YPF has tried to put a brave face on the write-down, especially in Argentina, noting that some of its other write-downs of fields in the country were because the firm had been overly optimistic about its chances of securing concession extensions beyond 2017 and that by implementing new production techniques it may well be able to rebook much of what it has had to write down.
But the substantial reserves write-down has exposed the aggressive approach Repsol YPF took to booking reserves in Latin America and calls into question the company's plan to use cash from its assets in Argentina, Bolivia and Brazil to help diversify its upstream asset base. It has even led to speculation that Repsol YPF could choose to sell its Argentine assets and cut its losses, although the company's management has rejected this idea.
"Although it is difficult to explain to you, it is a really good business," chief executive Antonio Brufau said of the company's Argentine operations on a conference call with analysts following the reserves announcement.
Regardless of Repsol YPF's determination to hold onto its Argentine assets, it is clear that the company is looking to reduce its exposure to Latin America. In its 2005-09 strategy presentation last May, the company said its upstream arm would focus on building its presence outside Latin America. The reserves write-down will intensify the focus on securing new upstream assets outside the region, which has proved a minefield for Repsol YPF.
Threat to investment
Another big question that arises from this debacle is just who is willing to increase investments in Latin America. Brufau obliquely underlined this point when he downplayed the financial effect of the reserves restatement during the analyst call. "The margins we have there are very low. In terms of production, the percentage may appear very big, but in terms of value, it is irrelevant compared with the value we will create with other production."
Repsol YPF is coming to the realisation that much of Latin America is not a very attractive place to do business either because of weak legal security or poor geological prospects. Most other big oil and gas companies came to this conclusion some time ago and, despite interest from niche players, the region has fallen behind the rest of the world in upstream investment. Even in Venezuela, where a very difficult investment environment is balanced by the possibility of gaining access to large reserves, investors feel they must have a large and diversified portfolio to help balance their exposure to the country.
Whether Repsol YPF's big reserves write-down will spur policymakers in Argentina to adopt more investor-friendly policies is unclear. Four years of warnings about falling gas reserves and imminent declines in production have not been enough to encourage a major reform effort. Legal uncertainty has discouraged exploration as well as the lack of a long-term pricing policy. The reservoir problems at Loma La Lata will be solved only with expensive and untested production techniques that cannot be economic at present prices. Even if compression facilities can be built to increase its recoverable reserves, Loma La Lata is undoubtedly in decline.
Replacing such a large field will not be easy without a large-scale exploration campaign. A number of vague plans for offshore exploration have been announced that will unite the fledgling Argentine state-owned energy company, Enarsa, with Repsol YPF, PdV and Petrobras, but nothing concrete has been announced. Meanwhile, a January auction of exploration licences in San Juan province attracted bids from only Repsol YPF and local independent, Oil M&S.
To meet gas demand, the government seems to be banking on securing a long-term supply deal from Bolivia or Venezuela. International agreements to study plans for a $20bn pipeline that would carry 3.5bn cf/d of Venezuelan gas to markets in the southern cone have generated publicity. But the ambitious forecast of the project's backers that gas could be flowing by the end of the decade looks unrealistic.
Venezuela neither has the gas reserves available for such a project, nor the financial means to support its development on its own, despite the surge in oil prices. In addition, no banker is likely to help underwrite a mammoth project whose off-taker is a country that only four years ago froze pipeline tariffs when the peso fell, forcing the main pipeline networks to default on their debts.
Instead, the focus on the pipeline from Venezuela is probably an attempt to put pressure on Bolivia to come to some sort of accommodation with its neighbours. The appointment of Andres Soliz as Bolivia's new energy ministry could well complicate matters. Soliz has long been an opponent of energy exports and in the 1970s, he helped to block plans to export gas to Brazil. While Soliz now supports exports to other Latin American countries, his appointment signals the determination of the government to push ahead with the promise to nationalise the gas industry.
Beat the clock
What shape or form this nationalisation will take is unclear. Bolivian officials have indicated that there will be a role for privately owned companies, but that too is unclear. Lacking capital and expertise, the country will need the help of foreigners to run its gas industry regardless of the legal structure it decides upon. But if Morales and his government are determined to relegate private-sector companies to the role of service providers, interest from foreign investors will be very limited. Regardless of the final structure of the Bolivian oil and gas industry, it will take a long time for this issue to be settled. Time, unfortunately, is what Argentina does not have.