Kick starting Argentina's Vaca Muerta
Argentina’s shale patch is going through its first downturn, but the outlook is still bright. Just don’t expect its shale development to look like progress in the US
"ARE YOU here for the petróleo?", the taxi driver asks as we pull out of Neuquén's Presidente Perón airport and head towards town. The quiet provincial capital of Argentina's Neuquén province has long been a gateway for explorers and tourists to Patagonia's natural wonders. That's another way of saying most people didn't have much reason to stick around long. Now outsiders are coming - and staying - for a different sort of natural wonder: the oil- and gas- soaked
Vaca Muerta shale that sits beneath the region, a huge energy trove that could transform Argentina's economy and its place in global energy.
Petrodollars have been arriving into this Patagonian outpost, first in a trickle then in a torrent, as companies set up shop in the first major shale development outside North America. The city bears the hallmarks of an oil boomtown. Corporate jets prowl the airport's single runway. Schlumberger, Halliburton, Weatherford and other service companies have plonked down offices along the road from the airstrip to the city. A new shopping mall gleams on the outskirts of Ciudad de Neuquén, reflecting the dusty scrubland surrounding it. Posters hang in front of vacant lots promising shiny new towers that will send the low-slung city's skyline ever higher.
But the early exuberance has given way to some reality. The locals are coming to understand how difficult it will be to turn the promise into something tangible. Vaca Muerta will be the
first large-scale shale development outside the US. And just as it started to hum with activity, global oil prices sank. The play is going through its first slowdown since investors got to work two years ago. Thanks to a government policy to keep oil prices above international ones, the rig count had remained stubbornly high, at about 105, through 2015 - even while such numbers were plummeting in North America's shale patch. But the international slowdown is now stretching to Neuquén too. By May the number of rigs in the country had fallen by more than 30%, to 71.
The downturn has sapped the main investors' ability to invest - a fact for both state-owned YFP and the foreign partners. The national oil company is cutting investment by a quarter in 2016. It has sacked or furloughed thousands of Vaca Muerta workers. Drilling has slowed and shale output dipped for the first time in the early months of this year.
Still, a cautious optimism for Vaca Muerta's long-term prospects remains. Early drilling, much of it at YPF's joint venture with Chevron, was promising, seeming to confirm early estimates that put Neuquén among the top tier of global shale plays. International oil majors and a handful of independents were quick to grab a slice of the new prospect when they could, and are starting their own pilot drilling programmes.
Politics, not geology, was the main hazard to development in the early stages. But the election of
President Mauricio Macri last December has brought a radical shift in the country's investment climate. Macri has taken important steps towards bringing Argentina back into the international financial system after years of capital-starved exile. His government's energy ministry says it wants to make the country's oil and gas fields a more welcoming place for foreign investors.
It has good reason to do so. Vaca Muerta is key to addressing some of the government's most pressing energy and macroeconomic problems. Declining output from Argentina's aging conventional oil and gas fields has opened up a costly energy deficit, draining more than $20bn from the nation's coffers since it became a net importer in 2011.
Closing that gap is the first order of business. Government forecasts show oil demand rising moderately from 0.615m barrels a day (b/d) in 2015 to 0.653m b/d by 2025. That implies at least 150,000 b/d of new production will be needed from Vaca Muerta on top of current total output of 0.530m b/d to catch up with demand and overcome natural declines from older fields.
Optimism for Vaca Muerta’s long-term prospects remain. Drilling seems to have confirmed early estimates that put Neuquén among the top tier of global shale plays
Closing the gas gap will be even tougher because demand is surging. Gas consumption is expected to rise more than a quarter from 150m cubic metres a day (cm/d) to 190m cm/d in 2025. Production would have to nearly double from its current level of around 100m cm/d now to eliminate the need for imports - and in fact production capacity would have to be much larger to meet winter demand spikes. A healthy government-set $7.50 per million British thermal units gas price means much of the early drilling could go towards gas production.
It's a big job. At its peak around 2025, output from the Chevron-YPF Loma Campana project is expected to reach around 50,000 b/d of oil and 3m cm/d of gas from 1,500 wells at a cost of $15bn, according to calculations done by analysts at investment bank
Macquarie. Argentina would need four or five similar-sized projects to get off the ground in the next of couple years to close the import gap by 2025.
Vast reserves The reserves appear to be there for a much larger production ramp up. The now famous study carried out for the US Energy Information put Vaca Muerta's recoverable shale oil resources at 16bn barrels and more than 300trn cubic feet (8.5bn cm) of gas. That compares favourably with, for instance, the US' Eagle Ford shale play that is producing more than 1m b/d of crude. Whether enough cash will flow into Argentina to reach that pace of development though is another question.
For a gauge on how far shale development has come, look to
YPF. The state firm holds about a third of Vaca Muerta's acreage and is the only major producer. YPF says it is producing from 466 shale wells, 34 of which came on stream in the first quarter of this year. Its output is 50,000 barrels of oil equivalent a day, most of which is gas. The bulk of the early drilling has been in the Loma Campana block, about 100km outside Neuquén, where Chevron and YPF are pioneering Argentina's shale industry.
It's a worthy start. But many in the industry question the effectiveness of YPF's early development strategy. The company, and its former chief executive Miguel Galuccio, was under heavy political pressure from Cristina Fernández de Kirchner's populist government to show quick production gains and, in doing so, justify the government's 2012
nationalisation of Repsol's majority stake in YPF. To that end, many argue, the company dropped as many cheaper vertical wells as quickly as possible to juice the production figures.
While successful in getting barrels and gas molecules flowing from Vaca Muerta, it might not have lit a profitable path to develop Argentina's shale riches. Early drilling results from YPF and others have shown that, as in the US, it will be the twin technologies of horizontal - not vertical - drilling and fracking that will crack open the play.
"Unfortunately we're about three years late because all the focus was on these vertical wells that I don't think added much to the learning on where to put horizontal wells in the Vaca Muerta," argues Richard Spies, the chief executive of Pan American Energy, one of Argentina's largest independent producers and a company that has started its own pilot shale drilling.
Macri's government has pushed for a more commercially-minded approach at the state company and entrusted it to a new corporate leadership. That has heralded a course correction. In light of lower prices,
YPF is scaling back its drilling programme and looking to reduce debt. But nearly all Vaca Muerta drilling at the flagship Loma Campana venture with Chevron this year will be for horizontal wells - a move that should give a clearer idea of Vaca Muerta's true production costs and help push forward new technologies. The company is also experimenting with more frack stages at its wells and with drilling multiple wells from the same pad - both key components of the continued efficiency gains seen in US shale wells.
150,000 b/d of new Vaca Muerta production is needed
But Argentine shale still has a long way to go. Start with the costs. YPF says that to drill a shale well in Vaca Muerta costs around $12m, though it hopes to get that down to $10m by the end of the year. That is a steep fall from the $25m it cost to drill a horizontal well last year. But to be competitive with the US - especially at prevailing international oil prices - the per-well price tag will have to fall further, to about $6m for Argentine shale to be competitive with the US.
US shale companies were able to drive down their costs quickly thanks to shoulder-to-shoulder competition between operators and service companies as well as cooperation on sharing data and techniques.
But those conditions have been absent in Vaca Muerta. YPF has the greatest institutional knowledge of the play, but has been reluctant to pass it around, say industry sources. "There is not a lot of sharing going on because there are fewer operators and service companies, and there isn't a culture of sharing," says Pan American Energy's Spies.
Ali Moshiri, head of Chevron's Latin America business, argues that more competition and sharing will be critical to the development of Vaca Muerta. "We want to see other companies come in because it makes the knowledge base much greater. One of the advantages you see in the US: not only you learn what you do but you learn from offset operators. We don't have any offset operators in Argentina," Moshiri told
Petroleum Economist in a recent interview in Houston. Infrastructure hurdles
Infrastructure bottlenecks also keep costs high. Neuquén has long produced oil, so it isn't starting from square one. But the region has been overwhelmed by the intensity of round-the-clock shale development. The existing infrastructure is creaking and much of what is needed still doesn't exist.
Route 51 - the two-lane main road from Neuquén to the oilfields - for example wasn't built to hold up under the weight of frack trucks, water haulers and other heavy-duty traffic. And the strain is showing. Where the road isn't crumbling back into the desert below, it is deeply rutted and perpetually congested, making it slow and difficult to get equipment, supplies and workers to the fields.
Operators also complain about the difficulties in getting the huge amounts of sand and water needed for fracking to their well sites. Water still has to be hauled in by trucks from the nearby Colorado and Neuquén rivers for lack of pipelines or hoses. Sand has to come from mines much further away, or even abroad: there's still no way to source and refine it around Neuquén.
Politics, not geology, was the main hazard to development in the early stages. But the election of President Mauricio Macri last December has brought a radical shift in the investment climate
A visit to the tiny township of Añelo, about 100km north of Neuquén but closer to Vaca Muerta's most active drilling sites, shows how far the shale industry has come - but also how far it has to go. Añelo, a forgotten village of one-story mud-brick buildings, has found new life as "the capital of Vaca Muerta" because it has become a home base for oil workers and the companies working the nearby fields. But Williston, North Dakota or Midland, Texas it is not.
A new industrial park has been built for the influx of new oilfield-service companies and offices are springing up in town. Hotels are being built and new restaurants serve oil workers. But the man-camps at the edge of town are evidence of a severe housing shortage in a town that has seen its population more than double from 2,500 a couple years ago to around 6,000 now. The town's dusty dirt roads will hardly cope as more workers and companies move in. Longtime residents also bristle about soaring living costs and a sense that many are being left behind.
Solutions to these problems can be found. Crews are rebuilding and widening Route 51. YPF plans to have its first sand-refining facility in Añelo - a $170m project - fully operational by the end of the year. It is also building a new $130m plant to treat and process the growing amount of very light - 40 to 45 degree API - shale oil that is coming from the Loma Campana block. Añelo's local government has drawn up ambitious plans to build schools, parks, hospitals and even an airport to keep up with the desert outpost's breakneck growth. But there is still a long way - and many billions of dollars in investment - to go before the reality on the ground catches up with the ambitions of Vaca Muerta's champions.
Navigating the country's shifting politics will be even trickier for foreign investors eyeing Vaca Muerta. So far, they feel encouraged. In his first months in office, Macri returned the country to international financial markets by
cutting a deal with the US-based hedge funds - also known as "vulture" funds - Argentina had been feuding with over the settlement terms of its 2001 default. He has also slashed the government's bloated payrolls and removed currency restrictions. His energy minister Juan Jose Aranguren has been busy dismantling the price controls that delivered cheap energy to consumers but discouraged production.
The Macri government hopes that the short-term pain brought on by these measures - high inflation, slower growth and rising unemployment - will be offset by an influx of new foreign spending, much of it in Vaca Muerta.
Daniel Redondo, a senior official at the ministry of energy and mining, says the country's oil and gas sector needs $150bn in investment over the next decade to help wipe out import dependence. "We need all the investment we can get," says Redondo.
International firms are starting to hear the message. ExxonMobil's chief executive
Rex Tillerson visited with Macri in Buenos Aires in June and came out of that meeting pledging to spend $250m in the coming months on a shale-gas pilot project in the Bajo del Choique-La Invernada area of Vaca Muerta. The investment will go towards drilling five horizontal wells as well as pipelines and gathering facilities. Tillerson said that if all goes well his company could pump more than $10bn into Vaca Muerta over the next couple of decades.
Shell and Total have pledged to invest hundreds of millions of dollars in their own pilot drilling programmes. YPF has signed joint venture deals with Dow Chemical, Petronas and Wintershall that will see more drilling over the next year.
Argentina will, though, need even more such commitments if it is to fulfill its plans.
From his position in the ministry, Redondo argues that investors should be bold and come now, not wait. "Don't expect all the ideal conditions to be in place. But we have a good record, we've been working hard and we've been making decisions," he says. "Investors need a bit of faith and we're willing to work together."
Under pressure from the wider market, investors will want to know that the recent market-friendly turn is durable enough to justify a 25-year $10bn plus commitment. The YPF debacle of recent years hangs over that calculation, and
Repsol serves as a cautionary tale. The company bet big on Argentina during a period of market reforms in the 1990s, pumping money into Argentina's mature oilfields and discovering the Vaca Muerta, only to see its business nationalised 15 years later when the country's politics swung left.
Pulling out of Ciudad de Neuquén and into the oilfields, the flat, vast and scrub-covered plains bear more than a passing resemblance to the shale industry's familiar drilling terrain in west Texas or North Dakota. But shale development here probably won't look a whole lot like what happened in the US. Neuquén will probably never offer enough operators and service companies to foster the sort of hyper-competitive environment that fueled the drilling frenzies in the Eagle Ford and Bakken. But Argentina is sitting on huge cache of shale oil and gas reserves, enough to fuel its own kind of unconventional revolution. If the government stays out of the way, it has a chance.
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