Energy South America

While the world credit crisis shakes up all the major countries in the world, there are a few small corners where business is not too bad. One example is the oil and gas business in Argentina. It seems to have a pretty good future for the next few years at least, due to several factors:

• The benchmark price in Argentina has been around $42 a barrel for years, and it is due to rise to around $60 very soon. Prices are set by the government, and the higher the price, the more royalties they get, and the more investment there is in exploration and production.
  
• The internal market currently absorbs all the crude production, and gas has to be imported. Even with the local economy slowing, as it is, the demand for motor fuels and natural gas have stayed high. If the demand drops, that will leave some to export at world prices, which are currently just a little higher than the local price.
  
• There is still strong demand in Chile for all forms of energy, as there is in Brasil. If gas ever gets back into surplus production, there are two ready markets, especially with Bolivia constantly shooting itself in the foot in the energy policy area.
  
  In an informal survey of about a dozen private oil and gas producing companies in Argentina which I did this week, all but one company interviewed was planning to go ahead with major exploration projects as planned, for this year and next. The one company which was scaling back on exploration was a US-based company, whose revenue is tied to the world price, which has dropped more than 50%. They were cutting back on outsourcing and planning to do only what they can do in-house. Everyone else was going full speed ahead.

Money is pouring into Tierra del Fuego from overseas. A couple of months ago the provincial government announced a half-billion dollar gas-to-liquids plant, to be constructed by Franklin Mining and Synfuels Corp., both of the US. Yesterday Tierra del Fuego Energía y Química S.A., a Chinese company, signed a memorandum with the provincial government to build a methanol plant using Tierra del Fuego gas as the feedstock, with first-stage production of 700,000 tonds of methanol. This will be the second large methanol installation in the Magallanes region. Methanex has two plants on the Chile side, on the mainland.

Several important gas discoveries have been made during the last few months, and intense exploration is under way, by both local and foreign companies, on both the Chilean and Argentine sides of the island, and on the Chilean mainland.

The ambassadors of Kuwait, Algeria, Morocco, Lebanon, Palestine and the Arab League met last Friday with officials of the government of San Juan province to express their interest in investing in the province. Their primary interest was the oil business, but the Lebanese ambassador also stated that his country has large technically competent companies who would be interested in getting involved in the anticipated tunnel through the Andes to Chile, an important link in the so-called “Two Ocean Corridor” which will supposedly connect Atlantic ports with Chilean ports.

The ambassadors of Kuwait and Algeria expressed concrete interest in the petroleum industry by their respective state oil companies, KOC and Sonatrach. The Algerian ambassador, a very good guy I have met a couple of times, pointed out, in his excellent Spanish, that Sonatrach is one of the ten largest oil companies in the world, and has already invested $500 million in Peru. In my personal experience, Sonatrach is a pretty good company when you consider the enormous challenges they have had to overcome, ranging from French sabotage at the end of the revolution, to terrorism, to cultural challenges, to one of the harshest climates in the world.

The ambassador pointed out that in order to interest Sonatrach in specific projects, the province will have to present a portfolio (“well done”) to Sonatrach, with very clearly defined requirements. Setting up an attractive investment climate is not necessarily Argentina's strong point, but on the provincial level it may be easier to achieve than on the national level.

The ambassadors from the oil producing countries stated that they do not expect the global economic crisis to have much of an effect on their economies, because most of their income is from petroleum extraction, even moderate oil and gas price drops will not affect them substantially.

This story from San Juan is part of the trend of the provinces moving ahead in the oil business after being more or less liberated by the Kirchners. Provinces now compete for investment money, and they are getting more for themselves than they did under the old federal system. In this case the market works.

Repsol YPF is on the move in Argentina. The country's largest producer, refiner and marketer by far, apparently sees a bright future in the country.

- There is a strong rumor that Shell and Total in Europe are trying to buy the 20% of Repsol shares owned by a Spanish group. Both companies are strong in offshore E&P, and Total has a large offshore field off Tierra del Fuego, with plans to further exploration in that area. Both are also experienced in working in difficult third-world environments. They would both be a good match.

- YPF is preparing to drill offshore Argentina for the first time in 30 years. That has caused some excitement in the local industry. If they are successful, there will be a boom.

- The Argentine office of YPF has just issued an additional $150 million in long term bonds, as part of the $1 billion investment package announced earlier this year, to be spent on increasing reserves and production in Argentina.

- The Peterson Group, who just raked in a very tasty net profit of $715 million for the first half of this year, up 6.62% over last year, is actively seeking as many additional shares of YPF as they can get.

- YPF is carrying out large seismic programs in several provinces, with many more planned for the coming summer. The majority of the work is high density 3D.

- They have also signed recently a long-term renewal of their concessions in Neuquen, the heart of the Argentina oil industry. It will be subject to approval by YPF directors and the provincial legislature, but it will go through.

An oil boom is just getting underway in Argentina. Even though a recession is probably around the corner, the oil business should be good in Argentina, no matter what happens. Some of the reasons are:

- Declining local production. Crude production is down more than 200,000 barrels per day since its peak in the 1990's. One aspect of the “economic model” of the Kirchner government is to minimize imports and maintain self-sufficiency in important resources wherever possible. This is especially important to them when the Argentine benchmark crude price is $42.00 and the world price is around $100.00. When the government is forced to import oil to supply the local refineries, the current trade surplus will turn into a deficit.

- The Kirchners are in the oil business and stand to make money on more oil production. Several of the newer oil companies formed in Argentina are controlled by long-time Kirchner allies, and they have been winning a lot of exploration blocks, especially the Kirchner home ground of Santa Cruz province. Also, Enrique Ezkenazi, head of the Peterson group, is buying up as many shares of Repsol YPF as he can get his hands on. He bought 14.9% of the company earlier this year, and is advertising publicly for more shares. He is a VP of the company now, and a board member. As owner of the Banco Santa Cruz, where Kirchner was governor, he has been in business with the Kirchners a long time. YPF, the largest producer by far, needs to make money for Kirchner and his buddies to make money. When Repsol sold the 14.9% to Ezkenazi, it reflected their appreciation that it is much better to have Kirchner on the inside as a partner, than to have him picketing your gas stations and arresting your president, as he had done with Shell when they refused to sell out to Hugo Chavez. If an old buddy of Kirchner owns an oil company, you know the Nestor has a cut.

- Companies are increasing their exploration budgets onshore in the near certainty of a price increase in the near future. The price is set by the government, and there is a very strong rumor that it will be increased from $42.00 to $62.00, for “new production.” The natural gas price will be increased next year, probably after the midterm elections if the government can hold off that long. They are currently subsidizing gas imports from Bolivia in order to try to keep a lid on inflation, but the kitty is shrinking.

- Economic conditions will be favorable no matter what. If there is a recession in Argentina, as everyone believes, oil producers will be able to export more, both crude and refined products, at world prices, as local demand drops. In addition production costs will drop in dollars, as both labor and equipment and materials get cheaper, as the dollar rises against the peso; it is already rising, 3% over the past month. If the current high growth rate continues, not a likely scenario, local demand will continue to increase, and companies will be selling all the $62.00 oil they can produce. In Argentina you can count on the definition of “new production” being very flexible. At some point the world price may be close to that $62.00 again.

- Oil will be a source of export cash. With the prices of commodities like wheat, soy and corn dropping in world markets, and with a 100-year drought in large parts of Argentina, the government's income may soon be shrinking, if it is not already doing so. (There is no good way to know, since the Kirchners rigged the official statistics.) Taxes on oil exports would help to replace the lost income.

- For the first time in 30 years, there is new exploration offshore Argentina. A jackup rig arrived off Caleta Paula a couple of weeks ago and is now setting up to begin an initial 4-well exploration program. I have it from the someone who was instrumental in determining the program that it is a very good play. Currently an auction is in process for 11 additional offshore blocks, and the government plans to have the entire offshore area under license by 2010 (that remains to be seen, but that is the theory.)

- Planned seismic acquisition programs as of August 2008 total more than 30,000 square kilometers of high density 3D imaging, and 50,000 of 2D. In addition there aerial surveys planned for very large areas.

- Local companies are forming partnerships for ambitious exploration programs with foreign companies. Money and expertise are coming in from the US, Kuwait, Russia, China, and other places, some deals announced publicly and others still under wraps. For example, there was a report earlier this year the Moammar Khadaffi's son had flown into Mendoza to meet with a local media magnate who had recently set up an oil company. A US company, supposedly with Kuwaiti backing, has signed a deal with the province of Tierra del Fuego to build and operate a half-billion dollar gas to liquid plant in the province.

- With the provinces now running their own exploration auctions, there is much more latitude to make favorable deals than there was when the federal government ran everything. This has generated more interest in marginal areas than previously existed. Royalties and investment commitments vary widely.

- Last but not least, some of the new companies in the industry, such as Petro Andina, Geo Park and Gran Tierra are making new discoveries in non-traditional areas. There is nothing like an oil well to put dollar signs in your eyes.

Repsol YPF, the largest hydrocarbon producer in Argentina, has announced that its proven reserves have fallen by 20.3% since December 2005. It also announced that its total 2007 hydrocarbon production(oil, gas and gas liquids) fell by 4.1% compared to 2006. This reduction in both production and proven reserves means that new discoveries, both in existing fields and new areas, have not been sufficient to replace the depletion of existing reserves.

Local energy experts attribute this situation directly to the government's energy policy or lack thereof. Because of a lack of clear and consistent long-term policies and laws, most companies invest in short-term measures to increase current production. They do not tend to invest in long-term high-risk ventures such as offshore exploration, because there is no way to know what the government's policies and actions may be five years from now.

Brasil, in contrast, with a middle of the road government and stable energy policies, is experiencing a boom offshore, with some of the largest discoveries in the last 30 years in South America.

The President of Ecuador, Rafael Correa, announced today that ENARSA, the Argentine state energy company, will build the largest hydroelectric plant in the history of the country, with generating capacity greater than the total installed hydroelectric capacity to date. Why ENARSA is doing this is a mystery. ENARSA was formed during Nestor Kirchner's administration, which continues through the presidency of his wife, as a mechanism for the government to participate in any energy projects which seem attractive to the Kirchners, with no down side and plenty of up side. ENARSA has no experience in this type of project, which means that it will subcontract everything to companies which do.

The president of ENARSA is currently under a cloud because he chartered the Gulfstream jet which carried a bag full of illicit money destined for Cristina Kirchner's presidential campaign. The plane also carried executives of PDVSA. An Argentine judge is currently considering whether or not to issue an international arrest warrant for them; don't bet on the warrant. Odds are nothing will happen with any of this and business will go on as usual. The question is how much money will be available to be skimmed in Argentina and Ecuador. Will the project cost 25% more than it should, 50%, 100%?

The cornerstone of the project will be laid April 25 during Cristina Kirchner's visit to Ecuador.