Subsidy bill for Argentina’s Vaca Muerta decision could reach billions of dollars

Argentina’s agreement with oil companies to extend subsidies on natural gas production in the Vaca Muerta basin will cost hundreds of millions of dollars in the short-term, with the possibility that longer term the bill runs into many billions.

The agreement, announced this week, says that prices for gas will remain fixed at $7.50 per million BTU in 2017, as part of a deal with Chevron, Total and ExxonMobil to invest more into shale oil and gas production from the region. The subsidies were previously slated to end this year but will now run through at least to the end of 2020.

OpenOil’s model of the Loma Campana concession signed by Chevron and state oil company YPF, suggests the subsidy bill on gas production in this field alone could run at $290 million in the years 2017-20. This is based on the announcement that prices paid to producers would decline from $7.50 now to $6.50 by the end of 2020, a projected production profile of 170 billion cubic feet, and a modest rise in market price from $4.50 to $4.89 per million BTU.

The overall subsidy bill could be considerably higher for two reasons. First, the reserves stated by YPF and Chevron in Loma Campana represent a fraction of tight oil and shale gas reserves in Vaca Muerta, and the $5 billion investment announced for 2017 could involve increased production both there and across the entire basin. Second, even a decline in fixed price to $6.50 by 2020 could leave a substantial subsidy commitment in place longer term.

Everything would then depend on future price. If a fixed price of $6.50 per million BTU were maintained, gas subsidies for Loma Campana alone could total $2 billion over the life of the project, even in a scenario where market prices appreciated modestly from current levels.

The OpenOil model clearly shows the project is not profitable at current market prices without subsidies on both oil and gas. There is an open question about whether that could be changed by an ability to cut costs significantly. One scenario shows Loma Campana could be profitable if YPF and Chevron could cut both capital and operating costs by 25% from estimates they made going into the project in 2013.

In late 2016, YPF announced it had reduced development costs to $17 per barrel, which it said was a reduction of 47% on 2015. The OpenOil model suggests that if that figure related only to oil, and covered only development costs, significant further savings would need to be made to achieve profitability. Another area of uncertainty exists over political and other risks, which could lead investors to demand a higher discount rate to be applied to future revenue streams.

There is little information about development plans for the Loma Campana concession, or other fields in the Vaca Muerta region. In general, though, it is worth noting that shale projects often have more flexible capital expenditure structures, with more wells and shorter lead times and life of well making investment decisions more granular than in conventional oil and gas production. It is possible, in other words, that the companies could have agreed to investment $5 billion this year, as announced, while still effectively “sitting on the fence” with regard to longer term investment plans. Descriptions of subsequent rounds of investment remain sketchy, despite much media attention.

Such higher investment levels would simply lead to a bigger subsidy bill yet, unless there is either a significant rise in market prices, which would have the effect of reducing the subsidy needed to maintain a fixed price, or considerable project efficiencies, or both.

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