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Argentina and Mexico: Energy reformers

Published:Friday | November 28, 2014 | 12:00 AM

Argentina and Mexico: Energy reformers

Energy reforms have recently been at the top of the Argentine and Mexican political agendas, and they will have an important impact on their economic development.

Although both countries have ageing hydrocarbon fields that sorely need investment, the shale revolution is the driver behind the changes.

Argentina used to have the third largest shale oil/gas deposits in the world, with Vaca Muerta ranking as its largest formation. However, the publication of Russian geological data pushed it into fourth place - the Russians now have the biggest-known deposits.

A few thousand kilometres to the north of Vaca Muerta, Mexico's Burgos formation is its largest shale field. The country ranks eighth globally, and the Burgos formation is actually an extension of the Eagle Ford basin that has been so successful in Texas.

Both Argentina and Mexico introduced legislation to change decade-old laws. The new norms will allow foreign investors to bring in fresh capital to develop these unconventional resources. Although they provide generous incentives, both countries have a long legacy of revising the rules once their fields enter production. This creates a sense of anxiety among the multinational community.

The Argentine energy reforms had two main objectives. The first was the creation of a national framework to allow more efficient investment. Under the Argentine Constitution, the provinces own all subsoil mineral rights.

The issue of ownership has been the subject of intense debate since the country's independence, but it was affirmed during the constitutional reforms of 1994. This created a great deal of problems that complicated foreign investment, given that each province could establish individual rules to manage their industries.

However, the Fernandez de Kirchner Administration negotiated an agreement with the 10 leading oil producing provinces to establish a national framework that establishes a common set of concessions and royalties. The second objective was to establish generous terms that would attract the multinationals.

Exploitation concessions for non-conventional resources were extended to 35 years, while off-shore concessions were pushed out to 30 years. At the same time, royalties were dropped to 18 per cent. As a result, Argentina could transform itself into a very attractive destination for oil producers.

The changes also provide an enormous windfall to YPF. Although the government is the majority shareholder of the company, the remaining shares are privately held. The result will be a generous transfer of resources to shareholders.

A parallel process is taking place in Mexico. Its situation was slightly different. Ever since the end of the Mexican Revolution, foreigners were not allowed to invest in its oil sector. The government permitted performance-based contracts, which provided incentives if goals were exceeded.

The upside was limited. The energy reforms changed this by introducing three new commercial formats: profit-sharing contracts, production-sharing contracts and licenses. The latter two were extremely attractive for foreign investors, since they allowed future production to be accounted as reserves. As a result, they could be used as assets in balance sheet operations to obtain better financing terms.

The Mexican energy reforms will be a game changer. Prior to the reforms, the US Energy Information Administration expected annual production to fall to 1.8 million barrels of oil per day (bpd) by 2025. Now, it forecasts an increase to 3.2 million bpd, with 3.7 million bpd by 2040.

One of the main objectives of the reforms is to provide a legal venue to allow the swarm of small fracking operators in Texas to cross the border. The bounty of natural gas that will be produced will be a boon to Mexican industry, which is struggling with energy costs that are three to four times higher than those found north of the border.

While there is a great deal of excitement about the energy reforms in Argentina and Mexico, there is also trepidation about the recent decline in energy prices. Operating costs in many of these exploratory areas are high, and the projects are unviable if prices continue to decline. It is unlikely that they will remain low for long.

Many fracking operators in the US are being squeezed. The Russians could also be dumping oil on the market in order to generate some of the liquidity that was lost because of the sanctions.

Last of all, the Saudis could be trying to squeeze some of the radical elements in Syria and Iraq from generating financial gains by selling pilfered oil.

All of these effects are transitory, and we should stabilise at much higher oil prices. As a result, the projects in Argentina and Mexico should be able to move ahead.

• Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.