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Upstream will be key to Repsol's plot for post-YPF future

Risks lie ahead for Repsol's post-YPF future, but it is set to emerge strong

As Repsol plots its post-YPF future ahead of a key 29 May strategy briefing, the company is positioned to emerge from the YPF nationalisation as strong as before, but its path is fraught with risks.

Repsol’s upstream portfolio will be at the centre of any recovery. Even with the loss of its Argentine production and stake in the multi-billion barrel Vaca Muerta shale play, the company is seen as having one of the most attractive upstream portfolios of any of its peers.

And the loss of YPF, which was heavily exposed to Argentina’s downstream and marketing sectors, will put that upstream portfolio firmly in focus. “Repsol’s sector-leading upstream growth will become a more meaningful driver of group earnings,” Deutsche Bank analysts recently wrote in a research note.

The investment bank reckons that Repsol will be able to deliver a strong production compound annual growth rate (CAGR) of 9% through 2016 and 7% through 2020, in line with the company’s previous target, even with the loss of its Argentine business. Bernstein Research puts that figure at a slightly lower, but still strong, 6% CAGR between 2010 and 2015. The outlook is much brighter than some of its major rivals, which are struggling to produce any sustained volume growth.

Repsol’s exit from Argentina also means that the company’s portfolio will be more heavily weighted towards OECD countries. That has been a long-term goal for the company and has driven recent asset acquisitions in the US and Russia.

Shareholders will welcome the shift towards reduced political risk in Repsol’s portfolio. The company has repeatedly seen its assets nationalised and contracts renegotiated as governments across Latin America – in Venezuela, Bolivia, Ecuador and Argentina in particular – have sought to exercise greater direct control over their resources. The company also saw its production hit by the unrest in Libya.

Repsol’s share of production from OECD countries will rise from 8% in 2011 to an estimated 22% by 2018, while its share of OECD plus Brazil production will rise to nearly 40% by 2018, according to Deutsche Bank. Meanwhile, production from Venezuela, Bolivia and Peru – countries seen posing higher political risks – will remain relatively flat at around 30% of total production.

The US will be a major source of growth for the company. Repsol is targeting around 90,000 barrels of oil equivalent (boe) of production from its Mississippi Lime shale project by 2020, up from just 3,000 boe/d in 2012. And the company acquired a significant acreage position in Alaska’s North Slope that it will look to develop.

Overall, the company has projects in the pipeline that could see production grow by more than 300,000 boe/d between 2012 and 2020, nearly doubling production from the first quarter of this year. And the company has exploration prospects from Angola to Russia to Brazil providing further potential.

Upstream growth, though, will come at a price over the short term. Heavy spending in the upstream unit will mean that if oil prices remain lower than $120 a barrel, it will not be able to fund itself through 2015, according to Deutsche Bank’s projections.

That means Repsol will rely on cash flow from its downstream portfolio and other parts of its business to fund upstream growth. Repsol recently completed significant upgrades to its Cartagena refinery in Spain, which should improve margins in the business. Nevertheless, the European refining sector is expected to remain weak as product demand across the continent continues its long-term decline.

Normally, the company would have room to raise debt in order to fund upstream growth. But post-YPF nationalisation, the company’s foremost concern will be to protect its investment-grade credit rating. But the company has been put on watch by the ratings agencies.

Deutsche Banks says that the company will have to cut as much as $3bn in debt to maintain that rating, assuming oil prices stay in the $80-100 a barrel range.

The company has options. The most straightforward route would be to sell a major asset. However, the company has already denied that it is in talks to sell its 30% stake in Spanish gas company Gas Natural. The company is also unlikely to sell one of its major upstream assets that it will be relying on to deliver growth.

Alternatively, the company holds 5% of its outstanding shares in treasury stock, which Deutsche Bank estimates are worth around $900m. The company could also choose to cut its dividend payment, or allow shareholders to take dividend payments in scrip – or in the form of shares as opposed to cash. Finally, the company could choose to issue new equity.

As none of these measures on their own are likely to be large enough to sufficiently cut the company’s debt, Deutsche Bank reckons the company will pursue a mix of all the options.

Investors have punished Repsol for its fallout with the Argentine government. The company’s shares are down more than 40% this year, from around €30 ($39.55) a share at the beginning of January to just €17 a share on 23 May and the company’s market cap has fallen to just above $20bn.

If the company is able to convince investors that it has a plan to maintain its investment grade rating and continue its upstream growth trajectory, it could still turn things around. And the 29 May strategy update will be crucial to winning over investors. But if the company’s strategy leaves investors wanting, the company’s share price is likely to remain weighed down by it ongoing conflict over YPF and the company could start to see the vultures circling.

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