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Matthew Smith

Matthew Smith

Matthew Smith is Oilprice.com's Latin-America correspondent. Matthew is a veteran investor and investment management professional. He obtained a Master of Law degree and is currently located…

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Argentina’s Huge Vaca Muerta Shale Could Become A Stranded Asset

Sharply weaker oil prices, growing threats to oil demand and the imminent arrival of peak oil demand could unleash a wave of stranded oil assets in South America. Among the most vulnerable is Argentina’s Vaca Muerta shale play. There were already significant headwinds impacting operations and investment in the shale oil and gas play before the March 2020 price crash and outbreak of the COVID-19 pandemic. Rising uncertainty sparked by the poor outlook for crude oil coupled with high breakeven costs and rising unease with Peronist Alberto Fernandez winning the presidency weighed on investment in the Vaca Muerta toward the end of 2019. This was amplified by Fernandez’s appointment of former President Cristina Fernández de Kirchner, the architect of the nationalization of YPF in 2012, as his vice president. Growing uncertainty surrounding Argentina’s oil industry was further magnified by the country’s latest economic crisis, which saw Buenos Aires default on its sovereign debt in May 2020, for the second time since 2000. A key problem for attracting investment in the Vaca Muerta is the high breakeven costs associated with new projects. It is estimated that they are over $50 per barrel for new projects and between $45 to $50 a barrel for existing operations. That makes the shale formation, which is ranked as the second-largest non-conventional natural gas play in the world, a loss-making proposition in the current environment where Brent is trading at around $43 a barrel. Such high breakeven costs mean that international energy companies will look elsewhere for assets that have lower breakeven costs, such as offshore Guyana where production breaks even at $35 Brent.

Measures taken by the Fernandez administration to bolster activity in the Vaca Muerta and attract further investment appear to have little chance of success. His administration pegged the domestic oil price, for what is known as the criollo barrel, at a minimum of $45 per barrel for as long as the international Brent benchmark stayed below $45 per barrel. The local crude oil reference price is abandoned if Brent exceeds $45 per barrel for 10 consecutive days. It is difficult to see how that will substantially promote investment in the Vaca Muerta, especially by foreign energy companies, when it is still below the breakeven costs for new projects in the vast shale formation. There are several jurisdictions in South America that have significantly lower breakeven costs and less political risk, notably offshore Guyana and Brazil. Those subsidies are a costly measure for a fiscally fragile Buenos Aires. The national government is battling a deep economic contraction, with the IMF forecasting that GDP will shrink by a devastating 12% during 2020. Fernandez’s planned $5.1 billion of oil industry subsidies aimed at reinvigorating activity in the Vaca Muerta will further impact Buenos Aires’ extremely weak finances. It is difficult to see those measures giving drilling activity in the Vaca Muerta a sustained lift. By the end of October, according to Baker Hughes, there were 21 active drilling rigs which were five higher than a month earlier but still less than half of the 55 active rigs for the equivalent period in 2019.   Related: What Biden’s Victory Means For Middle East Oil

Source: Argentina Ministry of Economy and U.S. EIA.

That increase in active rigs is primarily because of the state-owned oil company YPF ramping up activity at the behest of Buenos Aires rather than further investment from international energy companies.

Many foreign energy companies operating in the Vaca Muerta have made it clear that their ongoing participation in developing the massive shale play is contingent upon government subsidies making it profitable. While President Fernandez has committed to generous financial support for Argentina’s oil industry it is difficult to see how the deeply fiscally challenged government can meet those obligations. The economy is expected to contract by 11.8% because of the COVID-19 pandemic and the deficit has ballooned out to a whopping 10% of gross domestic product. That will sharply impact fiscal income at a time when there is renewed pressure from foreign creditors on Buenos Aires to meet its financial obligations. It is difficult to see how Buenos Aires can engage in substantial spending to promote activity in the Vaca Muerta while meeting debt repayments to creditors when public debt is at 110% of GDP and the economy as well as fiscal income is declining. The headwinds facing Argentina’s economy and their considerable potential impact on government spending are magnified by Buenos Aires lack of access to capital. Argentina’s long history of credit defaults means that Fernandez’s administration cannot tap global financial markets for capital while the domestic financial system and capital markets are small, further heavily constraining government spending. Related: A Major Oil Rally Could Be On The Horizon

Peak oil demand, where the adoption of electric vehicles and growing pressure to decarbonize the global economy will eventually cause oil demand growth to decline, is expected to occur in roughly a decade. That means there is a very real danger of oil prices eventually going into terminal decline, making riskier jurisdictions with high breakeven costs unattractive for international energy companies. For this reason, Buenos Aires only has a limited window to tap the considerable hydrocarbon potential of the Vaca Muerta. For as long as the Vaca Muerta’s breakeven costs remain high and exceed the international Brent price Buenos Aires will struggle to attract the required capital and technology transfers needed to exploit the shale formation.

Bearing in mind the considerable fallout from the COVID-19 pandemic and the significant financial pressures on Buenos Aires, including the latest sovereign debt default, it is difficult to see Argentina’s government fully funding the planned subsidies. Those conditions along with existing concerns relating to a leftist Peronist government being in power and public resistance to IMF policies are magnifying uncertainty for international oil companies acting as a major deterrent for the vital investment required to develop the Vaca Muerta. A plethora of other issues including poor energy infrastructure, environmental opposition, the fragile ecology of Patagonia, campaigns for indigenous rights, and unstable domestic energy markets are further impeding investment. The arrival of peak oil demand is only amplifying those headwinds. For these reasons, it is unlikely that the Vaca Muerta’s full hydrocarbon potential will ever be tapped and the national government’s goals appear overly optimistic, meaning that it could become a stranded asset.

By Matthew Smith for Oilprice.com 

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Leave a comment
  • George Doolittle on November 18 2020 said:
    Argentina has massive copper reserves so hardly a need to be bearish in that regard. Plus it has food security unlike all of the rest of Latin and Central America let alone Mexico.

    As for being a major player in shale oil definitely much more economic than offshore oil drilling insofar as domestic demand being met.

    Certainly North Dakota continues to pump out in excess of 1 million barrels of oil a day anyways.

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