Crude plunge ominous for Vaca Muerta export hopes

19th March 2020

By Fermín Koop

Crude plunge ominous for Vaca Muerta export hopes

The dream of turning Argentina into an oil exporting country is getting further from reality.

Just like US shale oil companies are at risk of going under as international oil prices plunge to levels in which shale extraction is no longer profitable, Argentina’s Vaca Muerta project could also be under threat.

At the very least, Alberto Fernández’s administration’s plans to develop the region’s shale gas and oil reservoir as a new source of exports will have to wait longer than expected, as crude prices reached their lowest levels in 18 years this week.

The weakest producers

The dispute between Russia and Saudi Arabia and the drop in demand triggered by travel cancellations amid the coronavirus pandemic made WTI crude reach US$20 per barrel yesterday, while Brent crude made a low of US$24 per barrel, a level at which oil and gas extraction is not profitable in Vaca Muerta, experts agree.

This will likely mean a delay in further investment in the area and a lower hydrocarbon production in Argentina, which is bad news at a time in which part of Alberto Fernández’s economic team was hoping to bring in more hard through these exports as it deals with a debt restructuring process.

“We are facing a big problem. Argentina was placing most of its future hopes on Vaca Muerta and now that’s under discussion,” Jorge Lapeña, former Energy secretary, said. “Companies will now have to study whether it’s convenient to produce gas and oil with these new conditions.”

The drop in prices is also highlighting some underlying weaknesses in the sector.

Shale oil techniques are more costly than traditional extraction, and have only been sustained through times of hardship via debt and subsidies.

Argentina spends significant amounts subsidizing the nascent activity in Vaca Muerta every year. Companies received 27.6 billion pesos in subsidies for shale gas production in 2019, a figure 2.81 times higher than 2018 and representing 12.1% of all the (already quite large) energy subsidies handed out by Argentina’s government.

Problems building up

Production in Vaca Muerta, one of the world’s main unconventional oil and gas reservoirs covering an area of 30,000 square kilometers, has been going through a period of uncertainty since the second half of 2019.

The country’s debt crisis and the freezing of fuel prices imposed in the late days of Mauricio Macri’s administration and continued by his successor Alberto Fernández, among other decisions, caused a sharp halt in investment.

The head of the consulting firm Abeceb Gustavo Perego said that “throughout the second half of last year there was a sustained drop in activity” in the reservoir that covers part of the provinces of Neuquén, Río Negro, La Pampa and Mendoza.

“Vaca Muerta isn’t affected only by the current price drop. If you look at the activity levels before and after the presidential primaries of last August, you already began to notice a process of deterioration,” said Perego.

This is reflected on the current production levels. In January, natural gas extraction grew 0.8% year-on-year and closed at 130.1 million cubic meters per day, well below the 144 million cubic meters per day that was reached in August 2019.

Break-even threshold

For Vaca Muerta to be considered profitable, experts agree the barrel of Brent crude should be above US$40, far from the current levels. The area now supplies 3% of the country’s gas needs and 19% of its oil, despite the fact that only 5% of its reserves are being exploited.

About 300 new wells per year need to be developed for growth in the area to be sustained, which would require between 5 billion and 7 billion dollars in yearly investment, according to Abeceb.

Although there are already several active companies in the region, including Shell, Equinor, Wintershall, and Pan American Energy, in addition to the state-controlled YPF, a greater injection of funds is needed to fully boost extractive activity.

“Vaca Muerta is now like a patient with a fever, we have to see the evolution of the international markets. If prices remain low, investments will be delayed and production will drop,” Gerardo Rabinovich, vice-president of the General Mosconi Energy Institute, told The Essential.

Fernández to the rescue?

During his State of the Union address earlier this month, Fernández said he would send a bill to stimulate “the development of the hydrocarbon sector” – a business-friendly framework that members of his team had been working on for the sector. The bill is now far from the priority, however, with the coronavirus outbreak jumping to the top of the government’s list.

Meanwhile, companies and oil-producing provinces are asking the national government to increase subsidies for the sector by establishing a local price for the barrel of crude, a mechanism already used in the past that could help keep Vaca Muerta afloat.

The scheme was used between 2007 and 2017 to give a floor to oil producers, as a drop below US$50 was seen as likely to affect investment and jobs. It was later eliminated by the Macri administration, which went back to using international crude prices as a reference. A floor for prices could help the sector at a time of trouble, but would mean a higher expense for the government while the economic crisis hits.

Neuquén has led calls for a differentiated crude price, as it “would help to give continuity to production, preserve jobs and investment,” according to provincial Energy Minister Alejandro Monteiro. Nevertheless, the decision has not been made by Alberto Fernández’s administration yet.

“Somebody has to pay the difference between the international and the subsidized crude prices. We have a lot of jobs on the line but such a move would cost the government a lot,” said Perego. “We should wait to see if values stabilize or not and then decide the best move next.”

In the subsidy for producers does not go forward, consumers could end up being benefited with lower prices of fuel. However, a decision will only be made if the downward trend continues, experts claimed. In practice, the Fernández administration has not hiked fuel prices since he took office and, since these are denominated in pesos, this has in real terms meant that they have gotten somewhat cheaper.

Fermín Koop

Fermín Koop is an economic and environmental journalist from Buenos Aires. He is editor at Diálogo Chino and co-founder of Claves 21.