Argentina – What has Wall Street missed this time ?

The last six months has seen a continued level of strong investments in the Argentine Oil and Gas sector, seemingly in defiance of the global trend and at odds to the drop in commodity prices. What many people have failed to see that in addition to these investments being a bet on political change that is expected in the forthcoming national election, this change has slowly been building over the last four years. The current government, with the baggage it carries from debt default issues, the nationalization or "forced purchase" of YPF and other issues which have created a situation in which financial investors are leery about the country as a whole. Despite this major oil and gas companies continue to announce major investments in the market.

So what do the oil companies see that Wall Street seems to have missed?

Argentina has a number of things going for it. Most importantly it has a world class resource potential. It has the third largest gas reserves in the world, and massive potential in conventional and unconventional oil. Many of the majors missed out on the shale boom in North America, and they don’t want to make the same mistake in Argentina. The country also boasts high quality infrastructure and a well-trained labor force. Historic problems with the oil and gas unions persist to a certain extent, but the growth in the industry has moved employment levels up to historic highs, calming the strongest complaints of the unions. But most importantly, the government has been forced to implement pragmatic, more industry friendly tactics over the last few years. The latest case in point is maintaining local oil and gas prices well above international standards. This may seem like market manipulation, but it is actually a very pragmatic approach by the government – it is better for the country to incentivize local production then it is to import energy at an even higher price point. Some say that this requirement was driven by the harsh reality of the government now being the owner of YPF. This may indeed be a factor, but what is even more important is the recognition by the government that it makes no sense to import energy when domestic resources are of a world class potential and the geographic position and distance from any other suppliers makes importing energy costly, complicated and unreliable. With fifteen to thirty percent of the production revenue coming back to the government in taxes of some form or another, the higher sales price also has a direct impact on local tax revenues.

Argentina is likely to see a political change this October. The candidates that are contesting for the presidential post are considered to be slightly or substantially more investor and business friendly than the previous government. This may turn some heads in Wall Street, but the oil companies know that Argentina is presenting a once in a lifetime opportunity for those who have the stomach to think long term. A world class resource play, in an existing oil and gas basin where infrastructure and people are readily available, in a market where energy demand is outstripping supply all make the opportunity sound attractive. But when you factor in that fact that the lack of pure financial investment dollars available to Argentina is seeing oil and gas blocks selling at a fraction of what they cost in North America you realize what the big oil companies do: in the short term there will be challenges to work in Argentina, but over the long run the returns will be difficult to beat.

Warren Levy – April 2015