Publish in Perspectives - Wednesday, September 20, 2017
The Vaca Muerta field in Argentine, which is estimated to hold the third largest shale gas reserves in theworld. (Photo: YPF)
Argentina’s oil & gas sector ahead of the mid-term elections in October.
BY THOMAZ FAVARO
AND MATTHEW MCCOLLUM
If there is one takeaway from the results of the August 13 party primaries (known locally as PASO), it is that Argentine President Mauricio Macri’s ruling Cambiemos coalition is well-placed to secure additional congressional seats in the upcoming mid-term elections in October, when half of the Chamber of Deputies and a third of the Senate will be up for reelection. Should the PASO result be repeated, the Cambiemos coalition would secure an additional 17 seats in the lower house and seven in the upper house. This would provide Macri, whose ambitious pro-market reform agenda had been curbed by the coalition’s minority status in Congress, with some relief – though Cambiemos would still fall short of a majority.
These political developments are especially important for the development of Argentina’s oil and gas industry and its most prized asset: the Vaca Muerta formation located in Neuquén province in Patagonia, a Belgium-size shale play that is estimated to contain about 308 trillion cubic feet of shale gas as well as 16.2 billion barrels of shale oil, the third largest globally. Meeting the field’s production potential would reduce Argentina’s dependence on energy imports – which currently account for a quarter of its energy needs – and reduce its recurring trade and fiscal deficits. Foreign investors, however, have been wary of investing in the field due to regulatory restrictions, macroeconomic risks and high production costs – factors that are ultimately tied to Cambiemos’ electoral performance.
POSITIVE STEPS SO FAR
After taking office in December 2015, Macri surprised many with the pace of his liberalizing and business-oriented agenda, including the end of currency controls, the removal of energy subsidies, and the debt settlement that paved the way for Argentina’s long-awaited return to international financial markets. Despite Cambiemos’ minority status in Congress, the president pushed such reforms by leaning heavily on his executive powers, and by keeping a cooperative relationship with moderate opposition lawmakers and local political powerbrokers. Macri has also been successful in bringing some positive changes to the oil and gas sector, lifting export taxes and bringing local energy prices closer to international prices. In January, Macri announced a deal between trade unions and energy companies to agree to more flexible working conditions in hope of spurring additional investments. The agreement was predicated on an extended government subsidy that guarantees a price of USD 7.50/MMBtu on produced gas, though that price is set to decrease annually until 2022 to encourage companies to invest now rather than later. To address restrictions on equipment imports, Macri signed a decree on August 10 that eliminated foreign equipment bans and reduced the maximum import tariff from 28 percent to 7 percent.
Energy companies have not been oblivious to these changes. This year, Chevron, ExxonMobil, Total, Shell, Wintershall and BP, among others, have signed deals to boost investment. Approximately $6 billion to $8 billion in investments have been confirmed for 2017 according to Energy and Mining Minister Juan José Aranguren. However, total investment has consistently fallen short of the nearly $20 billion per year that the government claims is required to fully develop the region. Future investments are contingent on whether Macri’s agenda stands to the electoral test. Despite Macri’s initial success, macroeconomic stability remains far from assured in Argentina. Inflation remains high – 40 percent in 2016 – and, although it is on a downward trend, all available evidence indicates that it will remain above the government’s target in 2017. Furthermore, the government needs to continue to rebalance the public finances more broadly. In this regard, Macri has an ambitious post-election agenda, which includes plans for major revamps of the country’s tax, labor and pension systems.
Although an increase of allies in Congress will help advance Macri’s reform platform, the Cambiemos coalition is still expected to remain a minority in Congress. This means that even in the most optimistic outcome, Macri will continue to maintain a strategy that involves horse-trading with moderate opposition members and provincial governors – who hold considerable sway over federal lawmakers from their provinces – to support his proposals. But if Cambiemos does improve its standing in the legislature, the Macri administration will be able to negotiate from a position of strength, greatly improving its odds of success.
Furthermore, a divided opposition is likely to improve Macri’s odds. Although the PASO results demonstrated that former president Cristina Fernández (2007-15) is all but certain to secure a seat in Senate, the electoral campaign has also indicated that she remains a controversial and divisive figure among the Peronist movement, particularly given the damaging corruption allegations against her and her former allies in government. Her return to politics will likely translate into a more vocal opposition against Macri, though her new political movement (Citizens’ Unity) is unlikely to be able to block Macri from moving forward with his agenda in the legislature.
Macri’s reform agenda is undoubtedly welcomed by investors: all these measures would help to curb the high production costs and general political uncertainty that currently concern investors in the oil and gas sector, and significantly improve the attractiveness of assets such as Vaca Muerta. But the reform agenda needs to stand the electoral test if it is to become a reality. As it stands, the two-year outlook for Macri’s reform agenda is cautiously optimistic for oil and gas companies and investors; the sector will be watching closely to see if that optimism is more fully justified after October’s elections.
Thomaz Favaro is an Associate Director for Brazil & Southern Cone and Matthew McCollum is part of the political risks analysis team at Control Risks.