Argentina’s Re-Nationalization of the Energy Industry and What it Means
Argentina could be one of the world’s richest new energy frontiers, both in terms of natural gas and oil. It has vast amount of shale reserves – second only to the U.S. and China. However, years of unfavorable terms for producers and low energy prices for consumers have made Argentina a net oil importer in 2011.
The government of Cristina Fern’andez de Kirchner recently re-nationalized YPF, Argentina’s largest oil producer from the Spanish firm Repsol, which had held a majority share since 1999, roughly six years after YPF was privatized. The development of Argentina’s vast unconventional resources will require significant investment in infrastructure; Kirchner justified the expropriation by claiming that YPF was under-investing in Argentina’s oil and gas sector.
The five-year plan released by YPF in August states that its immediate goals are to reverse years of production decline and increase oil and gas output at an annual improvement of six percent. However, Argentina does not have the expertise, money, or access to credit to develop its energy wealth alone. Argentina needs outside financing, given the $37 billion dollars it hopes to raise to achieve its five-year goals, but the Argentine government continues to signal that it is not a reliable partner for existing or potential international energy investors who require a partnership that affords a transparent and stable market-based regulatory framework. Moreover, YPF’s estimate of the amount of investment needed to develop its unconventional resources is unrealistically low and overly optimistic. Just to develop gas wells alone, YPF would require an investment upwards of $250 billion, a gigantic amount considering Argentina’s current GDP is roughly $450 billion.
However useful Ms. Fern’andez’s energy policies are to getting reelected, her populist policies are also a guaranteed recipe for creating fear among investors, as recent history in Venezuela illustrates. After more than 13 years under the watch of President Hugo Ch’avez, national oil company PDVSA has been unable to recover production to pre-revolutionary highs, following the implementation of increasingly unfavorable terms for international oil companies. Now in Argentina, even Chinese companies (traditionally more willing to play long with resource nationalism in Latin America) are balking. Sinopec, the country’s third largest operator, has threatened to halt production. Argentina’s strategy is nonsensical: while the government pays domestic gas producers around $2.10 per million BTU, it pays around $11 per million BTU for gas from Bolivia, and around $17 for LNG – all to compensate for a growing domestic energy shortfall.
Argentina will not be able to reverse years of oil production decline, and it risks becoming a net gas importer in the future, unless it pays back its debts to private creditors, reverses its protectionist policies, liberalizes price controls, and honors its commitments under international law. Only then will international investors be truly assured.
Argentina’s Vaca Meurta is such a vast, undeveloped resource that international energy concerns cannot ignore it. Indeed, as we go to press, YPF announced a tentative agreement with Chevron to develop shale oilfields, although details remain sketchy as to the extent of Chevron’s play. Nevertheless, Chevron will have to keep its eyes wide open, lest it sink billions of dollars into infrastructure – only to see a crisis come along where the Argentine government finds another pretext for nationalization and expropriation.”
Early this month, we saw the almost predictable announcement that Argentina’s “state controlled YPF energy company had reached a strategic accord with Russia’s Gazprom.” The announcement “lacked specifics.” Gazprom, the battering ram of Vladimir Putin’s policies, is repeating similar past maneuvers in former Soviet satellite nations, Libya and Israel. Gazprom’s strategy has nothing to do with helping Argentina produce more gas, let alone export it. Throwing the government a life-saving bone, Gazprom’s interests would be to prevent Argentina’s development as a producer and thus, thwart any chance of its becoming a global competitor.
Argentina’s Energy Fundamentals
Argentina’s energy industry has been in trouble for the past fifteen years, despite having significant natural resources. The figures in the chart below show problems in both oil and gas production. Oil production has declined from over 900,000 barrels per day to about 650,000, compelling the country to be a net importer of oil. Natural gas, which was exported from 1999 to 2008, has reversed course and production levels have fallen significantly below consumption levels. Currently, the country is an importer of natural gas at highly elevated prices compared to the regulated, depressed, prices allowed for its producers.
The EIA estimates that Argentina’s technically recoverable shale gas amounts to a mammoth 774-trillion cubic feet (Tcf). That puts the country third in rank behind only the United States (862 Tcf) and China (1,265 Tcf).
Before receiving the “Order of the Boot” in April, Repsol estimated that it would take an investment of around $250 billion over a decade to make Patagonia’s Vaca Muerta shale gas development viable; money Argentina doesn’t have.
Keep in mind that borrowing is no small feat for Argentina, which has yet to return to the global credit markets after its almost $100 billion debt default in 2001 – at the time, the largest sovereign debt default in history. In 2011, the country’s energy trade balance went into the red for the first time, with YPF having to import gas to make up what is a growing national shortfall. Kirchner cited the need to increase productivity as the chief reason for ousting Repsol.
Meanwhile Argentina’s shrinking monetary reserves, according to Bloomberg, stand at $47.3 billion. Barclays notes that with government plans to expand production costing around $40 billion, that leaves Argentina almost exclusively dependent on massive foreign investment.
On April 16, 2012, after weeks of rumors, Argentina’s President Cristina Fern’andez de Kirchner decreed the government was taking “temporary” control of the country’s biggest oil company, YPF, and announced its intention to expropriate a 51 percent share held by Spanish oil company Repsol.
The Argentinian Congress approved the government bill authorizing the expropriation on May 3, and in the process changed Argentina’s laws that, in effect, give the executive branch overarching powers over the country’s hydrocarbon sector.
Almost two months later, the government of Argentina presented the dubious Mosconi Report, which provided “evidence of the underinvestment and internal market shortages, strategies implemented by Repsol after taking control of YPF in 1999.” The Mosconi Report was to “substantiate the reasons… to recover the control over the main oil company” of Argentina, and establish how “Repsol’s strategy was for the progressive liquidation of companies and international assets held by YPF.” (Newsletter, Embassy of Argentina, Washington D.C., July 16, 2012.)
Investing in a capitalist enterprise is one thing, investing in a state-nationalized enterprise is quite another – as Argentina’s increasingly Chavez-esque President Cristina Fern’andez de Kirchner is about to find out. Strong-arming Spanish Repsol out of its YPF assets, as the president did in April, is useful to boost slumping popularity polls, but it’s also a failproof recipe for scaring away investors from its energy sector.
President Kirchner’s increasingly volatile and state-centric regulatory policies, including the imposition of price controls, export tariffs and consumer subsidies, have already had the combined impact of slowing to a crawl investment in the country’s energy sector.
Fern’andez de Kirchner justified Argentina’s re-nationalization of YPF after accusing Repsol of being responsible for Argentina’s declining production that made it a net importer for the first time in 17 years.
Since 2000, Argentina’s oil production has decreased by an average of 3 percent annually, reaching 650,000 barrels per day in 2010, down from 815,000 bpd in 2000, according to the International Energy Agency. Demand is now fast increasing at 8.5 percent annually. In 2011, the country imported $9.4 billion in fuel. Worse still, gas output has fallen 25 percent, according to a government audit.
Argentina justified its renationalization of YPF because of falling oil production of nearly 40 percent since Repsol acquired it for $15 billion. Repsol maintained that it invested $20 billion while it controlled the company, but the Mosconi Report claimed that only $3.7 billion was net investment, the rest of it amortization.
That said, Repsol has for some time struggled with Argentina’s neo-populist policies, both with Ms. Fernandez, and with her deceased husband Nestor Kirchner. Throughout the Kirchner tenure, the government has sought to regulate domestic energy prices and to limit corporate profit.
Repsol has argued that the nationalization was discriminatory. And in fact, the company has so far been the biggest long-term victim of the government’s counterproductive populism. As early as 2006, it revised its proven reserves downward 25 percent, in large part due to the unprofitability of developing some of Argentina’s oil and gas reserves given existing prices controls. An operating maxim is that proven reserves can only be booked if they can be developed under market conditions.
Since the renationalization, YPF quickly announced plans to revamp production. Miguel Galuccio, the ex-Schlumberger executive and recently appointed CEO of the re-nationalized YPF wrote in an article, published by, among others, the newsletter of the Argentinian Embassy in Washington, that YPF expects to invest $3.5 billion in 2013, drill 1000 wells and increase production by 6 percent. This level of productivity is something to be repeated and accelerated for 5 years for a total of $35 billion of investment. Galuccio admitted that the investment “will be largely auto-financed by the operations’ own cash flow.”
Under the new plan, YPF will achieve a 6 percent average annual growth in gas and oil production, mostly from unconventional oil and gas sources, expanding to nearly 600,000 bpd in 2017, from 450,000 bpd in 2012. We think that these goals are utterly unrealistic and unlikely to be achieved with the levels of investment that YPF alone can muster.
Moreover, YPF estimates its unconventional resources are equivalent to 22.8 billion barrels — quite a leap from the estimate of 927 million barrels in 2011. The company earmarked almost $1.4 billion to test unconventional techniques, plus another $12 billion to develop them. Further, YPF contends that mature wells will also be rehabilitated and refining capacity will be expanded as much as 20 percent.
The Potential Future of Argentinean Oil and Gas
Argentina has vast oil deposits, but higher investment levels are required for greater development. YPF’s CEO Galuccio has recently stated that the company can achieve a 6 percent annual increase, which translates to about 27,000 barrels per day from YPF’s current production of about 450,000. Adding a minimum of 20 percent annual decline which needs to be replaced, the total new production per year should be about 117,000 barrels per day, which means that average production for each new well would be 120 barrels of oil per day. This is highly optimistic, based on recent experiences. Assuming that 50 percent of the $3.5 billion is generously allocated to the construction of new wells, each would still only be allocated $1.75 million (compared to a more realistic cost of $4 million) and a very low activation index of $15,000 per barrel per day, one of the best in the world. Wells that cost less than half the average amount and production costs as low as the best oil producers in the world are highly unrealistic. YPF cannot attain the postulated production increases with such low investment levels. Even the most technically advanced U.S. oil producers would not state such optimistic projections.
First, the good news is that there are significant shale gas deposits: The 774 Tcf of shale gas at 20 percent ultimate recovery, as now presumed in some US shale plays such as the Marcellus, means 155 Tcf of commercially recoverable natural gas. At a low $2 per thousand standard cubic feet this implies a resource value over $300 billion; at $5 it translates to $750 billion. This is larger than the country’s GDP of about $450 billion.
Let’s hypothesize a shale gas production rate in Argentina of 1 Bcf/d. If the activation index for the Marcellus shale were to hold ($3,000/Mcf, i.e., $10 million per well with 3 million cubic feet – 3,000 Mcf – of stabilized production) then the required investment would be $3 billion. Such number would be for the mature, well known and established US shale plays. For Argentina, a far more likely amount would be at least twice as large, $6 billion. This is for a modest national production increase, to allow the country to become a net exporter again. YPF cannot do this alone.
To develop the country’s shale gas potential, the total investment, using ultimate value of $750 billion would be of the order of $250 billion, over the next 15 to 20 years, a figure impossible to envision in today’s Argentinian predicament. Clearly, the government should try to become a magnet of investment not a raider of the already existing investors. The table below shows incremental natural gas production, investment, number of wells, and expected income – assuming highly regulated price ($2/MMBtu) and market (unregulated) price (e.g., $8/MMBtu).
It’s hard to separate the nationalization of YPF from the Repsol discovery in 2011 of the Vaca Muerta shale formation in west-central Argentina, one of the biggest unconventional fields in the world. The magnitude of the discovery at Vaca Muerta (estimated at 774 Tcf) is staggering, approximately 60 times the total current gas reserves assigned to Argentina (13.4 Tcf, according to the Oil & Gas Journal, a 50 percent decline from the figures reported a decade ago.) Repsol had also estimated that 77 percent of Vaca Muerta holds oil, with the remaining containing dry and wet gas. This would make Vaca Muerta perhaps the most valuable shale formation in the world. With current price disparity (oil sells for about $100 per barrel, gas sells anywhere from $2 to $8 per MMBtu, translating to $12 to $48 per barrel oil in energy equivalency) Vaca Muerta would be more attractive than the gas-dominated Marcellus or Haynesville shales in the United States and at par with the Bakken and Eagle Ford shales.
YPF holds 40 percent interest in Vaca Muerta. Exxon, Apache, EOG, and others also have acreage. Chevron and Total are seeking entry, according to Argentinean press, and as we go to press, Chevron has signed a memorandum of understanding, The conventional wisdom in the industry, however, is that any concrete, ongoing partnership with Argentina will take a very long time to establish.
Vaca Muerta and the promise of exports is indeed a big prize and could be enough to attract investment, namely from China. Sinopec is already Argentina’s third largest oil producer, trailing BP in second and of course YPF.
It is possible that now that the government controls YPF, it will seek to liberalize prices, the biggest bottleneck to investment in Argentina. There are a myriad of incentives it could offer, including more access to Vaca Muerta.
But the Argentinean government has not signaled its willingness to budge, at least so far. It remains to be seen which way the Argentine action will go. It is a stunning and traumatic experience to the free market.
In a scathing warning following the YPF expropriation, the IEA stated:
“Fernandez has said that the expropriation was necessary due to a lack of investment of 3 percent per year over the last decade. Producers must pay a tax on exports, and refinery utilization rates suffered kind for some of its fuel supplies from Venezuela with farm and manufactured products, and the country became the problem this year, with key fuel supplier YPF saying the changes could mean it will face problems in importing the funds and renationalized airline Aerolineas Argentinas, which had been privatized in the 1990s. The government believes that by reining in this private capital it will aid Argentina’s rising fiscal deficit and deteriorating economic situation.
“The government’s political interventions are unlikely to reduce the country’s import needs, and it faces a steep challenge in achieving a short-term reduction in imports. The decision to expropriate Repsol’s share, rather than taking a part in the investment is bound to negatively influence foreign investors’ decisions in Argentina. Looking forward, Argentina will need continued investment and an improved regulatory framework to turn resources into reserves. YPF in particular will face higher borrowing costs from a downgraded Moody’s rating. The government may claim production is showing short term gains; however, higher state influence is bound to direct capital higher borrowing costs, and a tight rig market is likely to make exploration and development in the Vaca Muerta costly for YPF and other players.”
Foreign companies have asked for a clear playing field. Many investors will seek refuge from Argentina not only because of the potential of profitability, but also because of the lack of a transparent regulatory environment. Fitch Ratings wrote in April that the expropriation adds another layer of economic uncertainty: “Many foreign companies with long-standing investments in Argentina have navigated an often-challenging regulatory environment in recent years, particularly in resource sectors where government pressure to boost investment and production has been most direct. Still, this week”s move to nationalize YPF, formerly majority-owned by Repsol of Spain, introduces another layer of uncertainty for foreign companies contemplating investment in Argentina. Foreign firms already face big hurdles related to foreign exchange controls and restrictions on dividend payments.”
Indeed, Argentina is fast moving to pariah status among Western investors, following Venezuela’s footsteps, or perhaps worse. Argentina has no access to international credit markets since the country’s nearly $100 billion 2001 debt default, and is facing slowing growth and 23 percent inflation. Further, the country is beginning to demonstrate itself as a government without regard to the rule of law and essentially an outlier to many of its resource bountiful neighbors.
Fernandez in 2008 also seized $24 billion in private pension funds and is tapping central bank reserves to pay for them. Borrowing costs since Fernandez’s reelection a year ago have increased to more than 12 percent, even more than Venezuela’s, and are now the highest in Latin America. She has also increased import restrictions to protect local industry. As a result, in the first half of 2011, FDI decreased 30 percent from 2010, according to the UN’s Economic Commission for Latin America and the Caribbean. In the first half of 2011, Argentina received $2.4 billion in foreign investment, compared with Brazil’s $44 billion, Mexico’s $10.6 billion and Colombia’s $7 billion.
In less than a year, Fernandez has also forced companies to repatriate export revenue and money invested abroad, limited imports and banned most purchases of foreign currency.
But no measure has been as painful as the suspension in February 2012 of the Petroleo Plus and Refino Plus program that paid a total of $2.3 billion to oil companies as compensation for lost revenue as a result of capped commodity prices. Argentina’s government caps oil exports at about $42 per barrel and keeps any profit above that price. What is more, despite the debt challenges of the government, Argentina continues to skirt fiduciary responsibility by turning a blind eye to decade old contracts.
Even Chinese companies, traditionally more willing to play along with resource nationalism in Latin America, are balking. Sinopec, the country’s third largest operator, has threatened to halt production. Sinopec is demanding $184 million and warned that “The situation will worsen dramatically in the coming weeks.” (This figure is based on the value of the export certificates of previous exports to compensate the difference between export parity and regulated domestic price.) The company also demanded that subsidies favoring domestic consumption at the expense of exports, amounting to almost $2 billion be eliminated.
The problem with the Petroleo Plus and Refino Plus program is far worse for Argentinean producer PAE. (PAE’s owners are 60 percent BP and 40 percent Bridas, but the Bridas interest is split 20 percent by the Bulgheroni family and 20 percent by China’s CNOOC.) PAE’s export certificates are of the order of four times the Sinopec figures. If the market is not in equilibrium because of Sinopec, and if PAE cannot receive their certificates, the majority of the surplus oil production from Patagonia must be exported at $28-30 per barrel (compared to $100 per barrel in international prices.) This is an extremely tough set of circumstances for international oil majors to accept.
While the government pays domestic gas producers around $2.10 per million BTU, it pays around $11 per million BTU for gas from Bolivia, and around $17 for LNG – all to compensate for a growing domestic energy shortfall. (Actually $2.10 per million BTU is an average price. The reality is an even worse mess. Domestic regulated price is $0.55; National Gas Company is $0.65; electric generators $2.50; industrial use: $4.20.) All in all, the situation is hardly an incentive for investors.
Creating an Image of an Outlaw
Dozens of corporations and investors are currently engaged in legal battles with the Argentine government. For example, Argentina holds the world record for the number of pending cases at the World Bank’s International Centre for the Settlement of Investment Disputes (ICSID): namely, 26.
Most recently, Repsol has sued Argentina in a New York court in an effort to recover $10.5 billion in expropriated assets equivalent to the value of its 51% stake in YPF. It also said it will seek compensation at the ICSID, once a requisite six-month negotiation period expires.
Repsol argues the expropriation was illegal and the result of a process of “intervention, occupation and expropriation” that constitutes “a flagrant violation of basic constitutional guarantees of the Argentine rule of law”.
The company sent out letters in May to its competitors, including ExxonMobil, Chevron and ConocoPhillips, warning that they would be sued if they attempted to invest in YPF or its assets creating further uncertainties within the marketplace, something that the Chevron’s attorneys must be acutely aware of. In the immediate aftermath of the take-over, trelations between Buenos Aires and Madrid were seriously ruptured.
The YPF Expropriation Act does more than simply sanction the seizure of assets. Essentially, it realigns Argentina’s energy sector by mandating maximum oil production, even at the expense of market-based profitability. That is, the new law gives the government broad authority to act as an “arbitrator” between public and private investors to make sure its gas and oil reserves are developed to the country’s best interest, which it defines as “self-sufficiency of hydrocarbons … with the goal of guaranteeing economic development with social justice.”
In retaliation, the European Union is threatening to revise preferential trade tariffs that Argentina currently benefits from to force Argentina to back down. Spain has also retaliated by limiting imports of Argentinean biofuel. Repsol still holds 12.4 percent of YPF, while Argentina’s central government has a majority 26 percent stake. Another 25 percent is owned by oil producing provinces and 17 percent is listed on the stock exchange.
The YPF compensation will be determined by Argentina’s National Appraisal Tribunal, a government-controlled entity that acts as an arbitrator to determine what it considers fair value of assets. But the existence of the Tribunal, unfortunately does not imply that Argentina will pay.
The government has already said it will seek its own compensation from Repsol for environmental damages. “We are talking to the governors so that they apply-province by province-the environmental damages. We will be absolutely inflexible,” Argentine Planning Minister Julio De Vido said in April. The powerful Vice Minister of Economy Axel Kicillof also accused Repsol of “cannibalizing” YPF to pay for its own international expansion and said it “pillaged our environment.”
Repsol has also said it expects Argentina to seek environmental claims equal to the compensation sought by the Spanish company.
Argentina’s dealings with Repsol is not unusual and prior to the renationalization, in March 2012, the U.S. Government suspended Argentina from its preferential import duty program because it won’t pay $300 million of ICSID arbitration awards to U.S. firms Azurix Corp., a Houston-based wastewater service company, and Blue Ridge Investments LLC.
Exxon is still waiting, as is Unisys Corp, and for that matter so is every other company that has won a judgment against Argentina, because the government refuses to honor the awards. These legal questions continue to raise red flags to investors that the Argentine government does not respect the rule of law and is quite frankly an outlier in the region and not a place for investment.
The government’s handling of the YPF nationalization gives little investment incentives. Argentina shamefully ignores ICSID decisions; it blatantly tramples on globally accepted trade standards; it manipulates its own Constitution to fit its populist domestic political agenda, and it changes the regulatory framework several times a year. Under these circumstances, foreign investors simply have no way of securing the kind of long term profitability plan that the energy sector requires.
The YPF fallout
The government is in negotiations, at the request of regional authorities, to reinstate the Petroleo and Refino Plus programs, in a move likely motivated by the fallout of the YPF takeover. Nobody doubts Argentina’s oil and gas potential, but the rules keep changing and risk aversion is significant. This uncertainty alone will deter foreign investors.
Argentina has little option to attract foreign expertise to develop its unconventional resources, which will inevitably require U.S. companies. But it is not clear how the energy majors already active in Argentina, including Chevron, Total and Petrobras, will react to the YPF nationalization when it comes to committing further investment.
ExxonMobil is already developing known reserves in the Neuquen Basin, having committed $120 million last year. In September 2011, President Kirchner met the CEO of ExxonMobil in New York where she was informed that ExxonMobil, and its partner AES, planned to invest another $800 million to develop Argentina’s shale gas. It’s in this same Neuquen region of Western Argentina that YPF’s vast Vaca Muerta field holds the promise of significant shale gas wealth. Demands from Exxon that Argentina stop fumbling the rules for political expediency have grown louder as Exxon ponders whether to pursue even larger investments in Argentina.
Argentina’s ability to realize its potential will inevitably require serious reforms to its energy policy and regulatory structure. Argentina is ultimately betting that while some investors will shun its country, others will still be eager to invest. But it will be disappointed without major reforms.
Venezuela: Not a Model but a Warning
Argentina is following the path of Venezuela in nationalizing its largest hydrocarbon producer. Venezuela’s history should serve as a warning. Venezuela has had access to international credit markets, but it has still taken them years to compensate for the foregone invest in its hydrocarbon sector.
Ch’avez nationalized Venezuela’s oil industry in 2006, but he moved to increasingly control the company as soon as he came to power in 1999. Venezuela’s production under his mandate plummeted as low as 2.4 million bpd in 2009, down from 3.5 million bpd in 1998. It has recently recovered to around 3 million bpd, according to official data, although most international agencies estimate the figure is much lower.
Ch’avez has never been shut out of international credit markets, and indeed yields have been falling, despite rapidly increasing debt levels. PDVSA, Venezuela’s national oil company, is also now attracting foreign expertise, including Repsol’s, and other oil majors from around the world. Indeed, production has been increasing for a year, albeit slowly, as new output comes online.
The gradual turnaround required a more amiable Ch’avez. Moreover, Venezuela has paid for most expropriations, albeit often at its own undervalued terms, although it’s still facing claims in international tribunals. Furthermore, as the recent explosion in the Amuay refinery illustrates, mismanagement can also undermine FDI.
Ch’avez will struggle to show foreign investors – and Venezuelans for that matter – that he can lead the kind of overhaul that PDVSA needs. Without investment, Ch’avez’s regime will inevitably fall along with the oil revenue. Indeed, laying claim to huge reserves is not enough to guarantee a growing industry. It must be accompanied by a sustainable business model, something that Ch’avez is struggling to put in place.
This is not a model for Argentina, but a warning. It took Ch’avez over a dozen years to recover even a semblance of energy stability. Furthermore, if it had managed its industry well, Venezuela would be producing at least 4 million bpd.
As the expropriation champion, some foreign investors are still coming in to Venezuela, although clearly the largest multi-nationals are shying away. The key throughout will be the reaction by the Chinese majors which have been very aggressive in encroaching Latin America, in spite of populist driven policies and rhetoric.
Indeed, resource nationalism is not a new phenomenon – even to Repsol. As one of Europe’s biggest integrated oil companies and biggest players in Latin America, Repsol chose to accept Chavez’s nationalization of the oil sector, even as Exxon and others chose to fight it.
Repsol renegotiated and was indirectly compensated with revised contracts. So did Chevron and many other European companies. The uncertainty clearly hurt Venezuela, but foreign companies -including Repsol- are still eagerly signing contracts under the new rules.
Venezuela is offering above market rates in some projects, and is aggressively investing in its oil production to attract even more foreign investment. Indications suggest that it is barely succeeding in this quest because the efficiency is extremely low and the oil service prices are incredibly high.
But if Fern’andez wants to become an oil exporter, she needs significant investment and foreign know-how, which Ch’avez has a lot more of. Fern’andez also needs to show that her government can be a good business partner, which it is clearly not. Venezuela’s model won’t work, certainly not in time for her to maintain the government’s costly populist policies.
A new Latin America or old populism?
Argentina’s expropriation had been expected for some time and fits into the country’s (indeed the region’s) resource nationalism and economic empowerment over the previous decade.
The more populist governments of Latin America, including Venezuela and Argentina, can be expected to continue walking a line between their populist and market practices. There is no guarantee that they will succeed but there is no evidence in sight that things will change.
Brazil is now acting as a regional overlord – making sure investment risks are controlled. Latin American countries, led by Brazil, underwent a formidable evolution from ragtag unstable countries to semi-stable global players. The shortlist of game changers includes Chile, Colombia, and Peru, albeit as counterweight to the more populist Venezuelan-led group.
Brazil, which rose to regional leadership status and displacing the US in the process, has the most at stake in Argentina’s expropriations. Not only are its companies among the biggest regional investors, but its own appeal as an investment destination could be hurt.
Argentina probably felt confident enough to re-expropriate YPF after years trying to bully Repsol to increase production, despite price controls that limit corporate profits. Repsol, which bought YPF in 1999, was the biggest symbol of Spain’s Reconquista, the nickname of the massive foreign investment drive during the 1990s and 2000s when Spanish companies bought up controlling stakes in the region’s banking, energy, and telecom industries. Spain was only second to the United States in terms of clout.
But five years of economic crisis changed Spain’s geopolitical and economic reality. Spain’s was the second biggest investor in Latin America during the 1990 and most of 2000s. Between 2006-2009, its share was 10 percent, behind the 25 percent of the US, and in 2010 it had decreased to 4 percent.
It was going to happen sooner or later in the context of 1) declining Western muscle 2) a crippling global economic crisis and 3) growing strength of developing countries rich in natural resources and emboldened by their economic growth. Latin America is starving for investment in its commodity sector to fuel its rapid economic growth and growing middle classes. Asian giants, led by China, are happy to fill the vacuum left by Western retrenchment.
Brazil is acting as a guarantor of stability. Its newly won status as a regional power is at stake as it steers a region still finding a balance between market economy and statist intervention. Moreover, Brazil’s economic muscle depends on its ability to reign-in unfriendly market policies in Argentina, which has clearly overestimated its position. Both nations lead Mercosur, one of the world’s biggest trade blocks, which recently admitted as a full member.
But the EU has conditioned a trade pact with Mercosur demanding serious reforms in Argentina. The EU is lobbying to exclude Argentina from negotiations to pressure Brazil, which ultimately stands to lose the most – diplomatically and economically – in case of any delay. Argentina’s misbehavior threatens to spread trouble in countries that have behaved a lot better and far more transparent. Surely Brail cannot be happy. YPF’s expropriation will inevitably scare away many foreign investors from Argentina. Will they be replaced by others such as Chinese and Brazilian? That is the biggest question. Argentina can be expected to play up the size of its unconventional resources to attract investment, as Venezuela and Middle Eastern countries do, despite the political risk. But Fernandez must understand she is playing at a disadvantage by comparison.
Ch’avez’s rules are clear, and its energy sector regulation framework has been stable. The same can be said of countries like Iran, Iraq, and Libya. More importantly, these countries compensate their hostile policies with other forms of long term returns and offer huge export volumes to attract investors.
Argentina lacks just about all of these conditions. It lacks a stable regulatory framework and has changed the rules several times along the way. It is a net importer, and it lacks the money or technology altogether to contribute to the development of its resources. Since it can’t access credit markets because of shunning obligations to private lenders in the U.S. and elsewhere, and is depleting its international reserves, YPF will likely struggle to find long-term investors to pay for its share of developing Vaca Muerta and other fields.
Precisely as a result of its precarious situation, Chevron’s announcement, as well as Petrobras’ presence, could act as a resistance level for Argentina’s populist moves. YPF must show international investors it is ready to offer attractive terms. Disappointing companies already there, not to mention majors lining up, would be suicidal not only for Argentina’s energy plans, but for its macroeconomic stability.
Argentina is at a crossroads. While its fundamentals are adequate (e.g., a favorable GDP/debt ratio and the existence of abundant unconventional natural resources) the nation is on an economic collision course. It will, no doubt, eventually develop its huge hydrocarbon potential. Whether President Fernandez gets the credit is a different issue.
The re-nationalization of YPF could mark a tipping point in a downward economic spiral. The country’s macroeconomic stability has for years been hurting, but in the last year, government policies have confirmed some investors’ worst fears. Moreover, the image of Argentina cannot continue to be associated with populist thuggery.
Interestingly enough, it is up to President Fern’andez to decide her legacy. She doesn’t have a lot of time to show her citizens her strategy will work. In fact she must now quell an increasingly disgruntled populace who have taken to the streets in cities across the nation to display their displeasure. In order for this story to have a happy ending, it is urgent that her government attract foreign investment, especially in the energy field. To do so, it must honor its debts still pending after a decade since the Corralito. And it has to show investors it is willing to play by the rules. That includes lifting currency controls, import restrictions, along with other protectionist trade policies.
Fern’andez must understand that without these measures, she risks not simply scaring away American and European companies, but also regional concerns such as Petrobras, PDVSA, and most importantly, the deep-pocketed Sinopec.
To restore Argentina’s reputation as an acceptable investment risk, the government must effect a 180-degree policy turn-around, which could be accomplished by taking the following steps:
- Pay for the YPF expropriation and settle score with Repsol. Venezuela’s Ch’avez knew his revolution depended on foreign capital and expertise. Ch’avez has honored most of his debts, although many still await international arbitration. It’s to Argentina’s advantage to negotiate a quick settlement with Repsol, rather than drawing out the legal process.
- In order to clear a path to global markets and foreign direct investment, honor outstanding debts to private creditors along with all contractual obligations and arbitral awards issuing from U.S. and European courts.
- Honor commitments under international law, especially outstanding judgments stemming from the World Bank’s International Centre for the Settlement of Investment Disputes.
- Lay out a clear and transparent regulatory infrastructure.
- Reverse protectionist policies; and stop trampling on multiple international trade treaties.
- Liberalize price controls and capital flows.