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Argentinian shale suffers further setbacks

The government was relying on Vaca Muerta to solve its financial problems. But another default looms as Covid-19 disrupts growth plans

Argentina’s shale industry, like its US counterpart, is facing possible financial ruin. Plunging oil prices have reduced production in the Vaca Muerta basin to a trickle, while lockdown of facility workers is further slowing operations.

And the threat of widespread job losses and potential bankruptcies is disastrous timing for a government desperately needing oil revenues to stave off a ninth national default.

State oil company YPF is particularly feeling the effects. The firm has been the leading driver of growth in the Vaca Muerta basin, working in collaboration with several international joint partners including Malaysian state oil firm Petronas and Chevron.

Diminished physical demand, resulting from the Covid-19 pandemic, is compounding low oil prices and forcing YPF into significant production cuts. “YPF has slashed its budget and activity in order to preserve cash,” says Muhammed Ghulam, senior associate at US bank Raymond James. “The company has started to shut-in production, including a 50pc cut at its flagship Loma Campana project.”

YPF’s refinery utilisation has plummeted by around 30-40pc. The economic lockdown is destroying fuel demand, which in turn is forcing YPF to shun crude purchases from other producers. “Almost all producers are shutting down wells and fields,” says Santiago Wesenack, head of equity research at Argentinian broker AR Partners. “Some spot sales are down at $18-20/bl, and at that price the full-scale development of Vaca Muerta becomes a question mark.”

Stumbling blocks

The economic impact is also raising concerns over YPF’s ability to meet debt repayments. Over the next 12 months, large debt maturities are due, which, if the downturn persists, could force YPF into further capex cuts to conserve cash.

And it could be a vicious circle—subsequent lower activity would then hurt revenues and make it even tougher to meet the debt payments. YPF might even have to go its state owner with cap in hand, while Argentina is already struggling to repay its own record sovereign debts.

“The full-scale development of Vaca Muerta becomes a question mark” Wesenack, AR Partners

One option the government is considering is a return to price controls. To protect the domestic oil sector and stave off bankruptcies, local crude at the pump would be set at $45/bl, rather than pegging crude to the standard price of Brent.

Successive governments previously implemented this tactic to help subsidise the growth of the Vaca Muerta and encourage foreign investment. “Provinces are asking the government for a minimum price for crude,” says Lisa Viscidi, director of the energy, climate change and extractive industries programme at US think-tank Inter-American Dialogue. “Subsidies would mean companies stay, hoping that the oil price recovers.”

But the spread between an artificial domestic price and the international market could be significant until global demand recovers substantially, raising question marks over the government’s ability to fund such a policy. Argentina failed to make a $503mn payment on 22 April after bondholders rejected a government proposal, made just days before, to restructure $83bn in total foreign debt. The development leaves the country on the verge of another default, just months after the IMF issued a record $57bn bailout loan.  

Argentina’s financial uncertainty, together with perceived political risk—following the return to government of ex-president Cristina Kirchner—will significantly affect investor interest. And producers already operating in the shale patch may face material bankruptcy risk. “The smaller E&Ps need to go into survival mode and do their best to ride this out,” says Ruaraidh Montgomery, director at Latin American research consultancy Welligence Analytics.

Chasing rainbows

Argentina’s financial recovery was always contingent on the growth of the domestic oil and gas sector. The government ultimately hoped to target the LNG market with more gas evacuation capacity and a new LNG terminal for exports.

But that ambition will almost certainly be delayed, and potentially pushed back years, with bottomed out prices and little investor interest in hefty upfront costs. “The biggest challenge is financing, and that will only get tougher,” says Montgomery. “Argentina has the gas resource to support large-scale LNG exports, but its history of macroeconomic volatility, political instability, and frequent market intervention will make it difficult to secure financing.”

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