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Argentina - closing the deal

Argentina will spend 2017 trying to come good on its upstream promise

The honeymoon is over for Argentina's president, Mauricio Macri. In 2016, the new president was given plenty of slack; a recognition of the mess he inherited and the wide-ranging reforms needed. In 2017, Macri and his team of technocrats will need to show results: that means getting the promising energy sector, especially shale development, on track and winning back investors.

Market-pricing reforms should move ahead in 2017. Oil producers in Argentina were largely shielded from the collapse in international crude prices, as the government propped prices up well above international levels - most recently at $67 a barrel. That will have to start moving down towards the prevailing international price over the course of 2017. Although an enticing incentive in theory, the subsidy didn't do much to spur oil drilling - as the number of wells, investment and crude production were all down in 2016, in line with the global trend. Scrapping the costly giveaway would be a positive sign of the government's commitment to reform.

Some natural gas price incentives, though, are likely to remain in place. The Argentine government offers up to $7.50 per million British thermal units for new gas production, which has been effective in spurring investment, and gas output has been on the rise.

But lifting heavily subsidised consumer prices to match these levels has proved devilishly difficult. Macri's government proposed a 400% increase in early 2016, to around $4.72/mBtu from $1.29/mBtu. The Supreme Court eventually nixed this unpopular proposal. Macri's government did manage to push through a smaller 200% increase for consumers, and the plan is now to raise domestic consumer prices in increments to nearly $7/mBtu by 2019.

Without progress in this area, the government simply won't long be able to afford its price subsidies to producers. So 2017 will offer an important barometer of progress on gas-price reform. Macri's ruling Cambiemos governing coalition faces tough midterm elections, and the opposition will place the sensitive subject of energy prices at the heart of its campaign. If gas-price reforms stall as a result, investors will not be pleased.

The coming year will also be important for shale development. After steady increases in production and the number of shale wells drilled from 2012 through 2015, 2016 saw activity slide, as investors slashed budgets and became more cautious. This is largely beyond Argentina's control. The Vaca Muerta shale is still in the early stages of development and companies will be reluctant to spend heavily there until global oil prices rise and the industry's financial health recovers.

Another slow year in 2017 could set back efforts to bring down the play's production costs, which is needed to lure in new investors and boost output. The state oil company, YPF, which is leading development of Vaca Muerta, said in the summer that the average shale well costs $11m to drill. That is down substantially from the $16m of 2014, but still far higher than the $6m-7m a well needed to be competitive with US shales.

But bringing down costs in the Vaca Muerta will need more experienced companies and competition, both of which will be in short supply without a substantial oil-price recovery. The play will also need substantial investment in the infrastructure needed to get water and fracking sand into the play, and oil and gas out.

So a lot depends on a broader oil-price recovery. Another year of weakness would also set back YPF's efforts to bring more partners into the country to help it develop its own vast Vaca Muerta holdings. The company wants oil majors to sign up, but hasn't seen much success beyond its flagship Chevron joint venture, agreed in 2014.

Although international majors have been slow to pull the trigger on big investment programmes, they've clearly been keeping a keen eye on developments. ExxonMobil's chief executive, Rex Tillerson, was in Buenos Aires in June to discuss potential shale development.

BP's Bob Dudley made the trek in September, when he said his company was keener on Argentina's Vaca Muerta than the Permian, the US' top shale play. Shell's Ben van Beurden met with Macri in October, pledging new investments in shale. Expect some of these men to be back next year. But in 2017, Argentina needs to start closing the deal.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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