Argentina Will Not Become Venezuela

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Chevron (NYSE: CVX) is in advanced negotiations with Argentinean state owned YPF (NYSE: YPF) to develop Vaca Muerta basin, considered by Chevron the second largest reservoir of unconventional oil in the world. This looks like a potentially huge opportunity, but the risks are also enormous. It looks like Chevron may be making a bet on the Argentinean political and institutional outlook with this decision.

The opportunity

According to the US Energy Information Administration, Argentina owns the third largest shale gas reservoirs in the world behind China and the U.S., and Chevron estimates it may be even bigger when it comes to shale oil. Ali Moshiri, Chevron’s head of Latin America, Middle East and Africa, told reporters in Buenos Aires that the company calculates that after the U.S., Vaca Muerta holds the largest shale oil in terms of reserves.

The specific terms of the agreement are not yet disclosed, but Chevron is expected to start with $1.5 billion in the first phase, and the total investment could reach as much as $15 billion over the next years.  According to press reports, Chevron will be drilling nearly 100 wells in 12 months; in addition to that, 25 exploratory wells in both the Vaca Muerta and the Cacheuta formations will be drilled.

YPF is working on a similar deal with Bridas, an oil company owned by Argentine billionaires Carlos and Alejandro Bulgheroni and China’s CNOOC, to invest another $1.5 billion to develop around 130 wells of nonconventional oil.

It´s easy to see why global corporations may be interested in investing in Argentina´s shale reservoirs, we are talking about huge assets in strategic area of the energy business. Besides, since competition is limited due to economic and legal uncertainty, those willing to run the risks may be able to obtain some remarkably favorable conditions.

The risks

Oil companies are used to investing in the most uncertain scenarios, dictatorships, military conflicts and all kind of erratic economic policies are usually very tangible risks in areas where global oil companies operate. If the risks are worth taking, these corporations are willing to assume them, and in the case of YPF and Vaca Muerta, the potential return is certainly compelling.

In Argentina, though, there is one risk which may be particularly important. The government has implemented a strict capital control system, which means that no corporation has any guarantee of being able to bring its money back home once it´s invested in the country. When it comes to taking your money out of Argentina, it ultimately depends on a discretionary decision by government officials.

Speaking about this potential problem with Bloomberg, Moshiri sounds quite confident:

 “Chevron will continue reinvesting all the money it makes in Argentina,” Moshiri said, declining to elaborate how the company will avoid having its funds seized. “At the end of the day the right decision will be made by the people in Argentina, the government and the judiciary system.”

Chevron knows that it will need to continue reinvesting for a long time, and when the time comes to bring its profits back home, the company believes that it will be able to work out a solution with authorities, or at least find its way out via legal litigation.

This is of course, unless Argentina becomes more like Venezuela, where the Chávez administration seized the assets of US oil corporations like Exxon and ConocoPhillips, and the local judiciary system – completely under government control – is of no help at all to U.S. corporations.

Argentina vs. Venezuela

The similarities between Argentina and Venezuela have been growing over the last years, both when it comes to economic policy and the institutional environment.

On the economic front, and to name a few examples, both countries have severe capital control systems which have led to “parallel” or illegal foreign currency markets, inflation rates above 20%, restrictions on imports, abundant government intervention in different sectors of the economy, price controls and growing government spending, not only on social welfare but also in many other areas.

On the political and institutional aspect, the Kirchner administration has taken an aggressive turn since it won the elections in 2011; there is a project to implement a judicial reform which would make judges more dependent on the executive branch of the government, and the government is immersed in a harsh political and legal fight against the biggest media group in the country, which opposes its policies.

Considering that YPF itself was expropriated form Spanish Repsol in April of 2012, Chevron could have reasons to feel concerned about the future of its assets in Argentina, especially if the country continues on the Venezuela way. Fortunately for the company, and especially more for the Argentinean people, I don´t think that’s the most likely scenario.

Economic growth has stagnated over the last years, which combined with rampant inflation paints quite a dire economic picture. The government has been losing support, particularly from the middle class, which is not only asphyxiated by inflation by also deeply concerned about issues like personal security, government corruption and institutional instability.

Middle class votes are still crucial in the Argentinean electoral map, while in Venezuela the lower income sectors - deeply aligned with the government - are more dominant. Some important labor union leaders are now opposing the government in Argentina, and this is another stark contrast with the political situation in Venezuela.

While in Venezuela both the media and the judicial system are strictly aligned with the government, there is big opposition from private media groups in Argentina, and the Supreme Court of Justice is considered prestigious and independent of the political powers.

Like if this weren´t enough, things in Venezuela have been turning from bad to worse lately, and this should provide a good reminder about the perils of going down that road, both to Argentinean voters and to all kinds of political and social leaders in the country.

Bottom line

When Chevron evaluated the risks of investing in Argentina, it must have considered not only the economical but also the political and institutional environment. It looks like the company believes Argentina won´t become Venezuela, and it´s an intelligent assumption.

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Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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