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Argentina’s Sucker Punch

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The Bandwagon

Argentina is in the news again, and not in a good way. Having already ratcheted up tension with Great Britain earlier this year over the status of the Falkland Islands (or Islas Malvinas), Argentina is now picking a fight with Spain over the oil field concessions granted to YPF-Repsol (1).

Tomorrow, the governor of Rio Negro province will announce the rescission of three concessions to YPF-Repsol. Mr. Alberto Weretilneck bases his actions on the terms of the 2007 amendment to the 1967 Hydrocarbons Law (2), which provides for the termination of exploration and production concessions for “substantial and unjustifiable failure to comply with specified production, conservation, investment, work or other obligations”.

Alberto Weretilneck (left) and Juan Manuel Urtubey (right)

Rio Negro’s announcement follows hard on the heels of Salta province’s Governer, Juan Manuel Urtubey, who announced yesterday that he was revoking YPF-Repsol’s concession to the Tartagal Oeste oil field, also due to lack of investment in the area. In his statement, the governor has declared: “In order to increase the number of areas open to investment, fields without production activity will be reclaimed in order to open them to a bidding process. This stage has commenced with the reversion of Tartagal Oeste….concession to YPF.” (3)

This is not the first rescission. Rio Negro and Salta join their sister provinces of Chubut, Santa Cruz, Neuquén and Mendoza. In total, 14 hydrocarbon fields have been reclaimed by the provincial governments from YPF-Repsol due to lack of production or investment. What makes the Tartagal decision particularly ominous is the importance of Salta province: it produces 25% of the oil and 16% of the natural gas of the whole country, and sits atop the second largest natural gas field in Argentina. (4)

Credit agencies are listening. Both Fitch and Moodys had already downgraded Repsol from BBB+ to BBB, following the decisions of Chubut and Santa Cruz, and a vote to pay the 2012 dividend in stock rather than cash.

Argentina’s Sucker Punch

Repsol and the Spanish government have been taken by surprise by these developments. There was considerable fear as late as last month that the newly elected government of Cristina Fernández de Kirchner would move to quickly nationalize the Argentina subsidiary of the Spanish oil major, a move she had threatened on a number of occasions during her reelection campaign. Mrs.Fernández has repeatedly accused the oil company of deliberately holding back production, thus forcing Argentina to import more energy from abroad and worsening an already declining current account surplus.

So quickly did relations degenerate, that a high-level meeting was called between the two governments to resolve the situation. During these meetings, Mrs. Fernández promised that her government would not nationalize the company (5), which seemed to put an end to the crisis.

Apparently, Mrs. Fernández had other plans.

Working through Argentina’s powerful, and autonomous, governors (6) has allowed the Federal government to avoid responsibility for an outright privatization, which would have required compensation to be paid to Repsol with funds that Argentina does not have. This strategy not only reclaims the most important assets – which are the hydrocarbon fields themselves – it also reduces the net worth of YPF.

If these actions are part of a deliberate strategy, and not merely the unpredictability which often characterizes Argentine politics, then it might play out in two ways:

  • Renationalization: Argentina may continue to grab concessions in an effort to pressure Repsol into a sale while reducing YPF’s market value, thus making a nationalization bid substantially cheaper;
  • Transfer to ENARSA: The reclaimed concessions may be given to ENARSA, the new Argentine state energy company (formed in 2004 by Nestor Kirchner). A material portion of YPF-Repsol’s remaining concessions are due to expire in 2017 – these would not be renewed and would thus be available for transference to ENARSA as well. This would be nationalization “on the cheap”, though it would take much longer. YPF-Repsol has substantial concessions in Argentina until 2025.

Counterpunch

YPF-Repsol denies the allegations and has promised legal action. Given the lack of political independence of Argentina’s courts, that action promises to be symbolic at best, and to go against the oil company at worst. The company points to a recent decision to reinvest US$1.3 billion in retained earnings to the Argentine subsidiary, as well as planned expenditures of US$3.4 billion this year, which would be a record for the company. (7)

The Spanish government is also sure to take action to pressure Argentina. Mariano Rajoy’s government cannot afford to allow Repsol to be undercut in this manner. For one thing, Repsol is one of the few “crisis resistant” Spanish companies and a major employer and source of revenue for Spain. A nationalization of YPF, which still represents a significant percentage of the group’s assets, would be disastrous. In 2011, YPF represented 35% of Repsol’s consolidated EBITDA, and the 2011 cash dividend was worth approximately US$800 million.(8) We can expect more telephone conversations between the Spanish king and Mrs. Fernández.

The most successful Spanish companies depend on their Latin American subsidiaries for much of their profitability and international projection. Banks like Santander and BBVA, telecommunications giant Telefónica, as well as Repsol, all have major exposure to Latin America, and an YPF renationalization could set an ugly precedent for these companies. 

And Yet…

There is nevertheless substance to Argentina’s arguments. This year, Argentina became a net importer of energy after 22 years of self-subsistence, to the tune of US$3 billion. (9) The Provincial Hydrocarbons Committee (10) further warned of two key negative trends:

  • Proven reserves of hydrocarbons have fallen dramatically in the period 2002 to 2010;
  • Investment in exploration and discovery of new fields has also fallen in the same period.

Much of the fall in production is attributable to the uncertainty and variability of Argentina’s regulatory framework. The government’s constant changes in legislation, have discouraged energy majors, while investors remain wary of Argentina’s history of default, as well of a highly rent-seeking tax regime. If Argentina were to provide long-term regulatory continuity, a more flexible pricing mechanism for exports of oil and gas, and a more favorable tax rate, investments and production would undoubtedly rise. That, however, is unlikely. It is easier for the government to blame the foreign oil companies and to play the nationalism card.

Beyond the actions and motivations of the political elite, renationalization of YPF has overwhelming popular support. The 1999 sale to Repsol is widely viewed as a gigantic example of political corruption, for which Mr. Menem’s regime was infamous, as well as an unnecessary and harmful “gift” of the nation’s resources to a foreign company.

 There is evidence to support this assertion. What is irrefutable is that the sale of the government’s stake in YPF to Repsol was a disaster in the long-run for Argentina.

 

 

  • YPF has been used as a “cash cow” for private investors to the detriment of Argentina’s hydrocarbon industry. Production rose substantially at first, but exploration fell dramatically after privatization as well as after the sale to Repsol. (11) The policy at the YPF has been purely extractive and has led to declines in YPF production, which now stands at a lower level than in 1993.
Average number of exploratory wells drilled in period:  
–          As a state-owned company (1973 to 1991)

102

–          As a semi-public company (1992 to 1998)

46

–          As a privately held subsidiary of Repsol (1999 to 2008)

17

 

 

  • Sale to Repsol has not improved efficiency at YPF. Though state-owned YPF did have lower profit margins and lower worker efficiency (in terms of revenue per worker) than the post-privatization company, the sale to Repsol has not substantially improved performance. Additionally, we see that state-owned PEMEX generates roughly as much revenue per worker as YPF-Repsol in 2010 –while semi-public Petrobras (64% owned by Brazil) is more efficient on both profitability and efficiency measures.(12)
 

YPF (1998)

YPF (2010)

PEMEX (2009)

Petrobras (2011)

Revenues (US$)

$5.5 bn

$11.1 bn

$80.6 bn

$130.7 bn

Profit (US$)

$0.6 bn

$1.4 bn

$7.0 bn

$17.8 bn

Profit Margin

10.9%

12.6%

8.7%

13.6%

Employees

9,500

13,370

138,215

80,497

Rev/Emp

$0.6 mn

$0.8 mn

$0.6 mn

$1.6 mn

Furthermore, both Petrobras and PEMEX have been far more active in exploration than YPF, and as a result are in much stronger positions than their Argentine competitor.

  • Argentina has given up billions in income as well as control over a strategic resource. Based on the dividend stream paid out by YPF to shareholders from 2001 to 2011, the Federal and Provincial governments have foregone approximately US$4.5 billion in revenues. Most of that has gone to Repsol, which has extracted US$13.3 billion over the same period.(13) That is capital which has not returned to Argentina. Compare these figures with the roughly US$4 billion that Repsol paid to the government of Argentina between 1998 and 1999 to acquire the state’s share in the oil company (the total price of all shares was approximately $15 billion).Argentina retains a “golden share” that entitles it to one seat on the Board of Directors of the company. 
  • There was no fundamental reason for the government of Argentina to agree to the sale of YPF to Repsol.YPF played a key role in the Argentine energy industry, and was a key employer in remote areas of the country. At the time of the sale, the company had been pursuing a strategy of expansion through joint ventures to acquire technology and expertise from partners. The company had a low cost structure, strong management and excellent export potential for natural gas to Brazil. All of these advantages were thrown away by the corrupt Menem government.When one considers the evolution of oil prices over the last 13 years and the spectacular results of exploration of the shore of Brazil, it is clear that YPF should have been held as a strategic asset of the Argentine public.

Argentina should never have fully privatized YPF, much less to Repsol, which had been a state-owned Spanish enterprise until the year before it bought YPF. A more successful model would have been that of Brazil’s semi-public Petrobras, with a protected interest for the Federal and provincial governments, as well as the workers.

Next Steps

The 2004 law that created the new state-owned energy company, ENARSA, gave it the exclusive right to explore and exploit all offshore hydrocarbons deposits. Mrs. Fernandez’s government is also not in a position to compensate Repsol at fair market value for YPF. It therefore seems likely that Mrs. Fernández’s government will encourage provincial governors to continue their aggressive pursuit of idle YPF-Repsol assets.

Mrs. Fernández has ably cloaked herself as the defender of the Argentine people, through her dispute over the Falkland Islands (Islas Malvinas) and now through her actions against Repsol. As there is far less risk involved in taking over YPF than in invading the Falklands, Common Sense expects Mrs. Fernández to continue to pursue this fight.

Sources:

(1) Yacimientos Petrolíferos Fiscales, S.A., the Argentine oil company which now belongs to Spain’s Repsol
(2) Law No. 17,319 of 1967, amended by Law No. 26,197 of 2007.
(3) http://www.clarin.com/politica/Salta-embestida-YPF-quita-area_0_670732942.html (Spanish)
(4) Federal Institute of Municipal Affairs (IFAM), Ministry of Interior, Argentina (Spanish)
(5) http://www.ieco.clarin.com/economia/rio-negro-ypf_0_671333040.html (Spanish)
(6) The 2007 amendment to the Hydrocarbons Law devolved control of all hydrocarbon resources to the provinces, though the Congress still controls all regulations related to the industry.
(7) http://www.elconfidencial.com/economia/2012/03/26/la-provincia-argentina-de-salta-retira-a-ypf-la-licencia-para-operar-un-area-95027/
(8) http://articles.marketwatch.com/2012-03-23/markets/31227924_1_downgrades-fitch-ratings-cash-dividend
(9) http://www.ieco.clarin.com/economia/rio-negro-ypf_0_671333040.html
(10) Organización Federal de Provincias Productoras de Hidrocarburos
(11) Department of Energy Database, Government of Argentina (Spanish).
(12) Annual report data for respective companies and years.
(13) YPF 2010 Annual Report

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