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Chevron to deal breathe new life into Argentina's Vaca Muerta

State-owned oil company YPF has sealed a deal with the US supermajor Chevron to develop a section of the highly touted Vaca Muerta shale play

After months of negotiations, Argentina's state-owned oil company YPF at last sealed a deal with US supermajor Chevron to develop a section of the highly touted Vaca Muerta shale play in Argentina's Patagonian Neuquen province.

Chevron has committed to spend $1.24 billion through the end of 2014 to cover most of the costs of a pilot development programme in a newly delineated section of the Vaca Muerta shale called General Enrique Mosconi. The new licence, which will be split 50:50 between the companies, incorporates a 5,000-acre area of the Loma La Lata Norte and Loma Campa blocks, where much of YPF's early drilling has taken place. The companies will drill at least 100 wells in the area during the pilot phase. YPF will act as operator of the project. The Argentine company is already producing about 10,000 barrels a day (b/d) of oil equivalent on the acreage, the company said.

After the pilot stage, the companies have the option under the terms of the agreement to continue onto a second phase. During that phase, YPF says that it hopes to drill an additional 1,500 wells by 2017 and be producing 50,000 barrels a day of oil and 3bn cubic metres a day of gas. 

It is an ambitious plan. YPF did not say how much investment would be required during the second phase, but if the companies are spending more than $1bn on the initial 100-well programme, it implies an investment of around $15bn. Analysts estimate the average well in Vaca Muerta costs between $7.5m and $8m, though that could come down with more experience. The companies would split investment 50:50 - in line with their ownership stakes - during the second phase of development.

The deal is clearly a step forward for the Argentine energy sector and efforts to develop the Vaca Muerta shale. A recent Energy Information Administration assessment said the play could hold a staggering 308 trillion cubic feet of recoverable gas resources and 16.2 billion barrels of recoverable oil. Government and industry officials have pinned their hopes for turning around Argentina's energy sector on developing Vaca Muerta.

YPF badly needed the deal. Since the nationalisation of Repsol's majority stake in the company in May last year, YPF and Argentine government officials have scoured the globe for investors, with little to show for their efforts. YPF hailed it as a "historic strategic partnership". Chevron will cover much of the initial exploration and development costs, while YPF has retained operatorship of the licence and will gain vital technical know-how from its US partner.

Crucially for YPF, if it is able to get the pilot development up and running profitably, the project will generate much needed cash, which it can reinvest in development elsewhere. Acquiring enough funds to kick start development in Vaca Muerta has been a major impediment for YPF, as the company has struggled to access to foreign capital markets.

For Chevron, the deal gives it a foot in the door of potentially one of the most prolific shale plays outside North America. It has been eyeing Vaca Muerta since before the YPF nationalisation, and it was one of 15 companies that Repsol says it was in serious negotiations with before its stake in YPF was nationalised. By signing up to a short-term pilot phase with an optional subsequent full-field development phase, it has a quick exit option if the investment environment deteriorates or the Vaca Muerta shale turns out to be more challenging to develop than initially thought. 

The company, though, appears to have paid a premium for the acreage. Analysts at Tudor Pickering and Holt broke down the numbers: "Out of the $1.24bn planned spend, around $750m will be assigned to carrying YPF [costs] and $500m will be assigned to [Chevron's] 50% share - therefore valuation is about $15,000/acre, without adjusting down for current 10,000 boe/d of production (60% oil), or $12,500/acre assuming $250m gross value for current production."

That acreage value is in line with prices seen in more established North American shale liquids plays such as the Eagle Ford and Bakken. Tudor Pickering and Holt analysts considered the price to be "rich".

The deal has also opened Chevron to legal challenge from Repsol. The Spanish company is still fighting the Argentine government over compensation for its stake in YPF, and has said it will sue any firm that works with YPF in Vaca Muerta. A Spanish court has agreed to hear Repsol's unfair competition case against YPF, and a similar case against Chevron is expected to be accepted by the court. YPF argues that the case will have limited effect outside Spain. 

Chevron, though, will be able to take advantage of new financial incentives for shale projects, announced just days before the deal was finalised. If Chevron invests at least $1bn after five years, it will be eligible to export 20% of its production at international prices without paying export taxes. It will also be able to freely move the earnings from those sales in and out of the country. The incentives allow investors to avoid Argentina's strict domestic price foreign exchange controls, which have been constant sources of complaint for foreign companies.

Although cheered by YPF and the government, the deal has attracted strong criticism from the government's opposition, some of whom were broadly supportive of the nationalisation of YPF last year. Many have argued that the government has been forced to hand out better terms than they would have before the YPF nationalisation just to win back investors.

The government, though, has rejected the criticism. "There is no state-run oil company, including Venezuela's [PdV] Russia's Gazprom or the models of Norway or China, that does not work with foreign capital," said Axel Kicillof, a deputy economy minister who was instrumental in the YPF nationalisation and the formulation of president Cristina Fernandez de Kirchner's energy policy.

Outside Argentina, many doubt that either the fresh financial incentives or the Chevron deal will enough to revive near-term hopes of developing Vaca Muerta.

Analysts at Fitch, a credit rating agency, said: "[We do] not anticipate the new regime to trigger the enough foreign investment to truly and quickly develop Argentina's unconventional resources. A robust regulatory environment, long-term predictability, and ability to transfer dividends abroad are key factors to attracting the great deal of investment needed to develop these unconventional resources".

Talks with Repsol also remain crucial to attracting investment. Although Chevron has decided to go ahead with a deal with the issue still unresolved, other companies have been less willing to step in.  "We think that it is critical that the authorities follow through in the negotiations with Repsol," Analysts at Barclays wrote recently in a research note.

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