Argentina’s flagship shale project would need billions of dollars of subsidies

The largest shale project in the world outside the North America, in the Vaca Muerta basin in Argentina, is not viable under current market conditions and stated assumptions – unless the government of Argentina is prepared to maintain oil and gas subsidies of up to $9 billion.

That is the leading result of the model developed by OpenOil with Andres Knobel, a lawyer and representative of Tax Justice Network in Buenos Aires.

The project was developed by Chevron and YPF in 2013, when the oil price was over $100. Three years later, it looks unviable under the original stated assumptions without massive subsidies.

This outlook on the largest shale project in Argentina is bound to affect market perception of other shale plays outside North America. Argentina has the second largest shale gas reserves in the world and is the only other country apart from China to have significant shale production outside North America.

Vaca Muerta is a fascinating case of how energy policy and viability can seem to coincide at one point, only to collide at another.

Successive Argentinian governments have long sought energy security. Interestingly, in a country which has often known severe ideological divisions, it has been a long standing policy as much of the left as of the right. Energy imports, including a lot of gas from neighbouring Bolivia, have had significant impact on the peso because of the large amounts of US dollars needed to buy them.

So the announcement by the US Energy Information Administration of its estimates of shale gas and oil resources in the Vaca Muerta region galvanised energy policy. As the narrative accompanying the model shows, Chevron and YPF carried out a pilot project in the region which itself cost over a billion dollars. Based on that, they declared a massive project: $16 billion of investment, 1,500 new wells, production of 750 million barrels of oil equivalent and royalties into Neuquén province of $8.5 billion.

Then the market crashed.

The original agreement had locked in fixed prices on both gas and oil. In the case of oil, that was $65 per barrel, meaning currently a subsidy of $15 for every barrel produced out of the field. Add a $4 billion gas subsidy and it turns out that the subsidies would account for most of the positive cash flows the project would garner.

Of course there are many uncertainties. Prices could rise, although nobody is holding their breath, and they would need to rise by a considerable amount. There is talk of the companies being able to hit the same levels of production with cuts in both capital and operating costs of 25% or more from the 2013 estimates. Technologies for shale, this argument runs, are constantly improving. From the investor perspective, there will always be debate about what discount rate is applicable. We have modelled 10 percent here for the most part, based on broad industry norms, but Wood Mackenzie recently used 12.5% in a similar project in the region. The higher the discount on future revenues, to account for market and political risk, the lower the guaranteed profitability from projected future cash flows.

And, as Andres has highlighted in his blog, the model has been produced with very little hard data, only a single page press release by the companies in 2013. But it has been presented – twice – to the Argentinian state oil company YPF, who have not contested its conclusions. We believe it to be fairly robust, but of course continue to invite all interested parties to comment on the model and its conclusions and provide better data.

Above all we hope this work will contribute to the current discussion of fossil fuel subsidies in Argentina. OpenOil’s work is technical, not political. It is not our function to support or oppose a policy such as energy subsidies, which is essentially grounded in the priorities of an elected government, and Argentinian society as a whole. But it is the job of financial analysis to attempt to cost policies and contract negotiations – to put numbers on them. There is a lively debate in Argentina right now around energy subsidies in all its dimensions – affordability, climate change, free market or protectionism. But no firm numbers as far as we have seen. We hope the Vaca Muerta model will be the first in a series of analyses that help ground and inform that debate.

The financial model and narrative report are available here.

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