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Argentine Energy Sector -- Kirchner is not a Chavez in the making! (Issue: 6)

The emergence of Latin America?s left leaning leaders such as Venezuela?s Hugo Chavez and Bolivia?s Evo Morales and their belligerent acquisition of oil & gas assets has prompted investors to view the region with suspicion. The Bolivarian revolution, as Mr. Chavez calls it, is meant to form a grand alliance amongst the Latin American brethren. No one begrudges such noble thoughts. It is the uncertainty over foreign investments in the energy sector including arbitrary acquisitions that has become a matter of concern. Both Mr. Chavez and Mr. Morales have actually implemented new laws and acquired foreign assets. Will Argentina be the next?

Mr. Chavez is at the extreme end of the expropriation spectrum. Venezuela?s Hydrocarbon policy changed former service Contracts to Joint Ventures (JV) leading to higher taxes and considerably reduced ownerships. Refusal to sign new agreements by France?s Total and Italy?s ENI resulted in the seizure of their Jusepín and Dación fields by Venezuelan troops. The fields produce approximately 33,000 and 50,000 barrels/day. Now the state owns 60% of all Venezuelan energy projects through Petroleos de Venezuela S.A. (PdVSA). 

Matters are no different in Bolivia. New Hydrocarbons Law in Bolivia has resulted in steep tax hikes for upstream companies as well as acquisitions. Ecuador?s confiscation of Occidental Petroleum?s assets and victories by Socialist governments elsewhere in the region which have clear alliances with Mr. Chavez have prompted investors to reconsider their investments in companies with exposure to Latin America.

Against this milieu, muted interest in the Argentine oil and gas sector amongst investors comes as no surprise. The president, Mr. Nestor Kirchner has maintained cordial relations with Mr. Chavez. Occasionally, Mr. Kirchner even accuses the International Monetary Fund and the World Bank for its past economic woes. Plans are currently underway to construct a gas pipeline from Venezuela to Argentina and Brazil, and Mr. Kirchner signed an agreement to build a joint natural gas refinery in Bolivia, sealing the friendship with Mr. Chavez and Mr. Morales. So is Argentina?s Enarsa a PdVSA in the making?
 
When the Argentine government formed a new, state-owned oil company called ?Enarsa? in October 2004, many interpreted it to be the Argentine version of PdVSA. Enarsa currently has few employees and no production assets. Its role has remained subdued and appears to play the role of an energy agency that monitor and sign exploration agreements with foreign oil companies. Enarsa is merely a bureaucratic arm and not a state oil company like PdVSA and its comparison with the latter makes little sense!

Argentina has always been for western style reforms
At the beginning of 1990s, Argentina was one of the first Latin American countries to implement IMF austerity plan which led to the privatisation of state enterprises including electricity, gas and telecommunication. Petroleum sector reforms were guided by the Plan Argentina - Decree 2178 (1991) and the Hydrocarbons Federalisation Law - Decree 24145 (1992). The former outlines the basis of today's petroleum and fiscal regulatory regime. It also led to the privatisation of Yacimientos Petroliferos Fiscales (YPF) (now Repsol-YPF). Provisions under the two decrees include the replacement of service contracts with concession tax/royalty contracts, withdrawal of YPF?s automatic right to participate in petroleum ventures and the grant of the right to sell crude oil to the market of the developer?s choice.

Additional changes have since followed the Plan Argentina - Decree 2178 (1991) and the Hydrocarbons Federalisation Law - Decree 24145. The most significant reform is the gradual transfer of oil and gas reserves ownership to provincial authorities including offshore areas up to 12 nautical miles from the coastline. Other changes include the limitation of initial exploration period for 2 to 3 years for onshore and 4 years for offshore projects, limitation of concession acreage to 10,000 km2 onshore and 15,000 km2 offshore and 12% Federal royalty payable on the wellhead value. Given below are the detailed provisions:

• Plan Argentina - Decree nº0 2178 (1991) :
  • Core of the deregulating legislation applicable to the petroleum industry.
  • Basis of today's petroleum and fiscal regulatory regime.
  • Old risk service contract replaced by concession tax/royalty contract.
  • YPF has no automatic right to participate in any venture.
  • The contractor has the right to dispose the crude at will.
  • Almost all the existing licenses were converted to the new scheme.

 

• Hydrocarbons Federalisation Law - Decree nº0 24145 (1992)
  • YPF was privatised.
  • YPF kept many of its exploration + production permits.

• Licensing
  • Concession type: tax/royalty
  • Exploration permit
    • Initial exploration period for 2 to 3 years for onshore and 4 years for offshore.
    • At the end of initial period, if commitments have been fulfilled the contractor has the right to enter into a second exploration period which is one year less than the initial period.
    • A third period can be possible; the duration will be 2 years less than the first phase.
    • An extension of up to 1 year may be applied at the end of the second period and up to 3 years at the end of the third period.
    • At the end of each period, 50% of the remaining acreage must be relinquished.
  • Area
    • No contract may exceed 10,000 km2 onshore and 15,000 km2 offshore.
    • A company may hold control in up to 5 permits.
    • The maximum area in the case of production concession is 250 km2.
  • Work obligation
    • A minimum work commitment and minimum expenditure programme is negotiated prior to the signing of the agreement.
    • The work commitment is expressed in work units worth $5000 each (a minimum of 150 units must be offered).
    • The contractor must commit to the drilling of one well in the second and one well in the third phase of exploration.
  • Development Lease
    • In the event of a discovery, the licence holder has the right to transform the Exploration Permit into a Production Concession for 25 years. A 10 year extension can be negotiated with the relevant authorities.
  • Surface rentals (?Canons?)
    • Exploration period:
      • first: $ 10.56 /km2/year.
      • second: $ 21.12/km2/year.
      • third: $ 31.68/km2/year.
    • For Production Concessions, the rate is AR$400/km/year.

 

• Taxation
  • Producers of oil and gas are subject to the generally acceptable tax regime, whether federal, provincial or municipal. The Argentine economic crisis in 2002 prompted the government to introduce a series of emergency taxes which included an additional 20%+ tax on oil exports for a period of five years, effective 1 March 2002.
  • The Tierra del Fuego province is exempt from Export Tax ? an extension of the exemption from Income Tax.

• Royalty
  • 12% Federal royalty payable on the wellhead value (15% if produced from an Exploration Permit).
  • Crude oil deductions:
    • Pipeline transport costs from stock tanks to the point of sale are deductible.
    • Other transport costs are deducted on the same basis of processing costs (max. of 3.5% of gross revenues).
  • Gas deductions:
    • Some compression and processing costs can be deducted, as well as transportation costs from processing plant to main pipeline.
  • Royalty is deductible for the purposes of calculating profits for Income Tax and Provincial Sales Tax.
• Provincial Sales Tax
  • 1-2% provincial tax on gross revenues after royalty (does not apply for exports).
• Corporate Tax
  • 35% corporation tax (losses can be carried over for 5 years).
  • Deductions include operating costs, depreciated capital costs, abandonment costs, royalty and provincial taxes.
  • Dry exploration wells and seismic costs are expensed.
  • Successful exploration costs should be depreciated on a pre-unit basis (cost/expected lifetime project units multiplied by units produced during the year).
  • Other capital costs (including development costs) are depreciated on a 7-year straight line basis.

Courtesy: GP Energy
Sources for verification: Energy Information and Administration, Economist Intelligence Unit,

Argentine Energy Sector

Implications of these changes are best understood if they are analysed in the context of similar changes in other countries. It is important to highlight however that none of the changes have provisions for government expropriations. Nor do they stipulate a minimum government ownership of assets. Provisions are clearly in strict contrast with the regulatory framework in Venezuela which requires 60% government ownership. They are also in contrast with those in Bolivia which have also sought government ownerships and expropriations.

Comparing with provisions in the UK, the fulfilment of exploration commitments within a 2 ? 3 year period is similar to the ?develop or lose? provision by the Department of Trade and Industry (DTI) on the North Sea oil projects. However, the North Sea exploration projects leave the developer with just two years while the Argentine Hydrocarbon Federalization law offers 2 to 3 years and 4 years offshore. In addition, only 50% of the remaining acreage must be relinquished at the end of each period and is therefore less stringent compared to the North Sea exploration projects.

Taxation on oil projects is at the Argentine corporate tax rate of 35%. The emergency tax imposed by the government was only for a five-year period which is expected to have ended 1 March 2007. Similarly, royalty rate of 12% remains on par with that in other jurisdictions such as Colombia which has a sliding scale royalty schedule starting from 8% on smaller fields. Larger fields attract higher royalty rates in Colombia. Royalty rates in Kazakhstan vary between 2 - 12%. Not surprisingly, Venezuela has the highest royalty rate in the world at a staggering 33.3%!

Similar to other jurisdictions however, the Argentine regulatory framework also has provision for higher taxes. In February 2002, the Government imposed a surtax 25% on oil and oil derivatives exports (Except in Tierra del Fuego province) in response to an economic crisis. This was changed in April 2004, to establish a framework for variable retentions with an export tax of 25% when the WTI oil price is less than or equal to US$32 per barrel. The export tax increases as the WTI exceeds US$32 per barrel according to the table below:

WTI price                                             (US$/barrel) Additional tax (%)
32.01 ? 34.99                                                                3%
35.00 ? 36.99                                                                6%
37.00 ? 38.99                                                                9%
39.00 ? 40.99                                                                12%
41.00 ? 42.99                                                                15%
43.00 ? 44.99                                                                18%
45.00 ? and over                                                            20%

Export taxes linked to WTI prices ring the same tone as ?Excess Profit Taxes? by countries such as Venezuela, Algeria and Bolivia. While such uncertainties offer little support to the investment case of oil companies with assets in those countries it is important to note that EPT have been imposed in many other jurisdictions as well. EPT were introduced in the US in 1980 (President Jimmy Carter?s time) to prevent oil companies profiting too much from high oil prices, which was later repealed in 1987. In largely investor friendly Kazakhstan, the government has an EPT regime in place which is linked to the WTI price. The DTI increased tax on the North Sea oil companies to 50% in December 2005. Similar to those in other jurisdictions EPT affects company earnings and remains a sour point amongst oil companies in Argentina. 

Given that uncertainties related to tax regimes are widespread and common to all jurisdictions it is time to take a closer look at the Argentina oil and gas sector. Amongst Latin American countries, Argentina has the fourth largest crude oil resources after Venezuela, Brazil, and Ecuador and the third largest natural gas resources after Venezuela and Bolivia. Despite some notable economic hiccups, the country has a stable political environment and also a favourable business environment. Even though Colombia offers the most favourable regulatory environment for foreign oil companies, that in Argentina by no means is unfriendly and clearly has better terms than many other jurisdictions.

	Crude oil (Billion bbl)	Natural Gas (Tcf)
Argentina	2.32	18.90
Brazil	11.24	11.51
Ecuador	4.63	0.35
Bolivia	79.70	151.40
Energy Information and Administration (EIA), Oil and Gas Journal (OGJ)

Argentina ? oil and gas sector

According to Oil and Gas Journal (OGJ), Argentina has 2.5 billion barrels of proven oil reserves and 16.1 trillion cubic feet (Tcf) as of January 2007. Crude oil has represented over 90% of output with lease condensates, natural gas liquids, and refinery gains accounting for the remainder. Argentina?s fields are considered to be largely mature and the industry has seen little additional capacity. Consequently, production has been declining from its peak of 916,000bbl/d in 1998. Argentina is a net petroleum exporter with Chile and Brazil accounting for most of its energy exports.

Two onshore basins, namely Neugina and Golfo San Jorge account for much of Argentine hydrocarbon resources and currently produce approximately 90 percent of Argentina's oil output. Apart from these two basins, there is a growing interest to explore offshore oil resources and Petrobras is currently engaged in the development of two blocks located off the country?s central-east coast. Enarsa has control over all offshore concessions not already licensed to private companies.

With its 16.1 Tcf of natural gas Argentina has the third-largest natural gas resources in Latin America after Bolivia and Venezuela. Its reserves have been falling and the government is keen to develop its gas resources. In line with this increase in production, Argentina's natural gas consumption has also risen significantly in the past decade and is now the country?s dominant energy source, accounting for 45 percent of primary energy consumption. The development of Argentine natural gas resources with the help of foreign companies has therefore become a priority.

This brings our focus to individual companies with operations in Argentina. Most of them operate in the prolific Neuquen Basin, which accounts for much of Argentina?s petroleum reserves and production. There have been several significant new light oil discoveries in this basin and currently has a combined daily production of 262,000 barrels of oil and 2,727 MMcf of gas. Total remaining reserves are estimated to be 1,212 million barrels of oil (35% of the country?s reserves) and 14 Tcf of gas (47%). Rising oil prices however have led to the development of many other provinces as well. Petrolifera Petroleum (PDP.TO), Antrim Energy (AEN. TO), Apco Argentina (APAGF-NASDAQ) and Petro Andina (PAR.TO) are some of the leading operators in Argentina with some producing assets. Pine Cliff (PNE.TO), GP Energy (GPE.V), Pluris Energy (PEYG ? NASDAQ), Gran Tierra (GTRE.OB), Trefoil (TREF ? OSLO) and Argenta Oil & Gas Inc (AZA.V) are some notable exploration companies with exposure to Argentina.
 
Antrim Energy holds interest in five production licences: Puesto Guardian (1), Tierra del Fuego (3) and Medianera (1) and one exploration permit (Capricorn) with some 496,000 acres net to the company in Argentina. Its assets are located in prolific hydrocarbon regions with well developed infrastructure. Antrim has ongoing production in Argentina and has drilled several new pools leading to the successful discovery of significant new reserves. In addition to its exploration endeavours the company is currently engaged in the expansion of gas processing facilities and installation of a pipeline in Tierra del Fuego. Antrim and partners have also initiated a renewed investment programme at Puesto Guardian and Capricorn exploration licences.

In addition to Argentine assets Antrim has considerable exposure to the North Sea and much of its value appears to be reflecting the North Sea operations. Antrim however is a leading energy player in Argentina and provides exposure to the Argentine energy sector. In addition to it?s Toronto listing, Antrim is also listed on the London Alternative Investment Market (AIM).

Petrolifera?s Argentine operation started in its 100% owned Puesto Morales/Rinconada Concession in the Neuquen Basin. Its Argentine operation was boosted by a subsequent addition (100% interest) in the Rinconada concession. The company has an established production at Puesto Morales/Rinconada with some 11,000 bbl/day oil sales and 2.3 mmcf/day natural gas sales in 1Q2007. At Rinconada, Petrolifera?s first well tested 670 bbl/d oil with a stabilized rate of 250-275 bbl/d. The company believes that there is significant oil potential at shallow depths. Other non-producing acreage includes Vaca Mahuida (100%WI), Gobernador Ayala II (100%WI) and Salinas Grande I (50%WI Pending). The Neuquen Basin is the main oil producing basin currently in Argentina.

Petrolifera also has assets and exploration properties in Peru and Colombia. Its Peruvian operations are at Maranon Block 106 and Ucayali Block 107 while the Colombian operations are at Sierra Nevada and Turpial. Oerations in Argentina however are advanced stage projects and appear to underpin much of Petrolifera?s valuations.

Argentine Energy Sector

Apco Argentina Inc is an oil and gas exploration company with interests in six oil and gas concessions and one exploration permit in Argentina. Apco?s flagship project is Entre Lomas concession (52.8% interest) located in the provinces of Rio Negro and Neuquén and has 350 active oil wells and 23 active gas wells and covers 294,000 acres. Entre Lomas is JV development with Petrolera Entre Lomas S.A. (Petrolera) and Petrobras Energia S.A. Its 81.82% working interest Canadon Ramirez concession (Chubut province) is being co-developed under a joint venture with CanAmericas Energy, which provides the latter the right to earn a 49% interest. Within its 92,000 acres, the concession has 2 active oil wells. Apco?s 25.72% interest CA-12 Rio Cullen, CA-13 Las Violetas and CA-14 Angostura concessions (Tierra del Fuego) with 19 active oil wells and 17 active gas wells within its 437,000 acres. Apco?s 1.5% interest in Acambuco concession also adds active oil wells and 4 active gas wells to its fold. The company also has an interest in the Yacimiento Norte 1/B Block also known as the Capricorn license, an exploration licence in some 900,000 acres which it shares 50-50 ownership with Antrim.

Apco is a producing company with a well-diversified inventory of assets and prospects with a current daily production of 10,300 boe. The strategy appears to be to develop its assets through JV agreements or farm-outs. During the year ended December 31, 2006 its oil sales volumes totalled 2.403 million barrels, gas sales volumes totalled 6.7 billion cubic feet (bcf) and LPG sales volumes totalled 20,000 tons net to the company?s consolidated and equity interests. It reported gross revenues of USD $58 million for 2006. Apco is 69% owned by Williams Companies Inc.
 
Petro Andina Resources Inc has been active in Argentina since March 2004 with the acquisition of CNQ-7/A and CNQ-7 Blocks located in the Northeast Platform portion of the Neuquén Basin. The Company added further acreage to its assets with the 100% acquisition of the CN-VI A/B Concession from Petrolera del Comahue S.A. in September 2005. Petro Andina also has a 50% interest in the 271,000 acre CNQ-7/A Block in partnership with Repsol-YPF and is the operator of this block. Its other interests include 47.48% interest in the 65,000 acre CNQ-7 Block operated by Petrobras Energia S.A. and 7.5% interest in the Cerro Hamaca Norte (CHN) enclave within the CNQ-7 Block with Petrobras (52.86%) and Repsol-YPF (39.64%).

During its relatively short period of operation Petro Andina has made considerable progress. During 2Q2007, production reached 5,625 boe per day, representing a 49% QoQ increase (474% YoY increase).  The company has drilled 35 (17.5 net) wells with a 91 percent success rate during the same period. In addition, Petro Andina has completed the construction of the 15,000 barrels per day gross oil processing facility at El Corcobo Norte.

GP Energy is an oil and gas exploration company with exposure to Argentina through a farm-in on the Capricorn Block held by Antrim and APCO. At Capricorn the Company?s farm-in agreement allows it to earn a 25% interest in portions of the Yacimiento Norte 1/B Block, in Salta Province by paying 50% of certain seismic and drilling costs. The Capricorn License is strategically located along an oil producing trend of five fields that have estimated ultimate reserves of 22.0 MMBO.

Development activities are currently underway at Capricorn. A drill rig has been contracted to drill two exploratory wells on the Capricorn License in October. The Company's strategy is to utilize 3-D seismic to guide a drilling program in search of any extensions of the hydrocarbon bearing Yacoraite sandstone. Apart from its Argentine assets, GP Energy has interests in two major projects with a total of 118,000 acres in South Dakota. The Company is also in the development stage of another project called Saddle Butte, which currently contains an additional 5,400 acres of leasehold. All of the acreage is strategically located in close proximity to existing oil and gas production.

Argentine Energy Sector

Gran Tierra Energy Inc has producing and prospective assets in Argentina, Colombia and Peru. In Argentina it holds interests in 8 properties and is the operator in a majority of these properties. The Palmar Lago (14% interest), El Chivil (100% interest), El Vinalar (50%) and Nacatimbay (100%) blocks are producing assets while Ipaguazu (100%), Surubi (100%), Valle Morado (93%) and Santa Victoria (100%) are exploration assets.

The Palmar Largo joint venture encompasses several producing oil fields in the Noroeste Basin of Argentina. Approximately 39 million barrels of oil (gross before royalties) have been recovered from the area since 1984. The Palmar Largo project is characterised by its high quality 42API light oil. There are 15 (gross) wells currently in production (306bbl/day net to Gran Tierra). At El Chivil, Gran Tierra?s daily production is 110bbl and complements current production base in the Noroeste region. Gran Tierra?s acquired its position in the El Vinalar block via farm-in and has a current production of 247bbls/day (net after royalty, Q1, 2007). The Nacatimbay meanwhile has a current production of 281mcf/d gas and 50bbls/d condensate (net after royalty 1Q2007).

In Colombia Gran Tierra is operator and holds interests in 7 blocks with two producing assets (Santana and Guayuyaco) and four exploration projects (Rio Magdalena, Talora,  Mecaya and Azar). The Chaza Block is expected to begin production in Q3 2007.  In Peru, Gran Tierra holds a 100% interest and is operator of two license areas on the eastern flank of the Marañon Basin in northern Peru.

Pine Cliff Energy also has exploration and development interest in the Argentine energy space through its 93% owned subsidiary, CanAmericas Energy Ltd.
CanAmericas has been accumulating interest in several exploration blocks and concessions which are in prolific hydrocarbon areas including in the Neuquen Basin.  Its acquisition strategy continued in 2Q2007 as well the Company completed its third farm-in agreement.
 Pine Cliff will earn an interest in 11 gross townships (252,048 acres) (net 3 townships (63,012 acres)) of land. Pine Cliff is well positioned to proceed with aggressive exploration programs in the future.

In addition to its Argentine assets, Pine Cliff has a producing asset in Alberta. The Company has a 13.2% average working interest in 4,320 acres (572 net) and initially had two producing wells at the time of acquisition. Three more wells were subsequently drilled with all three wells being productive. Pine Cliff?s current production is approximately 3,150 Mcf/day gross (365 Mcf/day net).

Pluris Energy Group Inc has its presence in Argentina through the acquisition of rights to purchase 100% of the shares of San Enrique Petrolera, SA, a Buenos Aires based E&P company. San Enrique?s key assets are located the Neuquen and Austral basins and cover approximately 251,000 acres. San Enrique has a current net production of 1,000 boe per day and is expected to reach peak in 2008-2009 through the ongoing aggressive development programme. The San Enrique development interests include 3P reserves estimated at approximately 25 mmbbl of oil and 142bcf natural gas. Current producing reserves are approximately 4.3 mmboe.

In addition to the Argentine interests, Pluris has interests in the US as well. The Tiller Ranch Field consists of 822 acres located within the Tom Graham Field in Jim Wells County, TexasThe Tom Graham Field has produced in excess of 13bcf natural gas and 6.8mmboe, and is within the prolific Texas Gulf Coast Frio and Vicksburg formations. . In 1Q2006, Pluris commenced first production and natural gas sales from its TR#1 well.

Recently listed Argenta Oil & Gas also has three exploration properties in the Neuquen Basin. Its 100% owned Loma El Divisadero Block (81,000 net acres) was originally drilled by YPF in the 1960s-80s but never put in production even though at least three wells tested oil. Argenta has recently acquired 3D seismic which is currently being processed. The 100% owned Covunco Block (141,000 net acres) is located on the edge of the so-called dorsal area and thrust belt of the Neuquen Basin. The block had some gas discoveries which but never put in production. Although the area is considered gas-prone, there have been recent oil discoveries by Apache and Repsol in nearby blocks. The area already has 2D seismic and Argenta has recently shot 3D seismic which is currently being processed. The El Corte Block (71,670 net acres, 90% interest) is located south-west of Neuquen Province, immediately south of the Covunco Block. The area has scarce 2D seismic data and only three exploratory wells. However, the area hosts two source rocks (Los Molles and Vaca Muerta Jurassic formations) and many possible reservoirs (Lajas, Lotena, Tordillo and Mulichinco formations) most of which have not been tested yet.

In addition to Argentine assets, the company has an exploration licence (La Mona Block, 100% interest) in the lower Magdalena Basin, Colombia. The La Mona block comprises approximately 211,000 acres. Argenta owns and operates all its assets.

Oil and gas companies in Argentina have so far been able to operate freely with little government interventions. Enarsa continues to maintain its subdued role and is hardly a PdVSA. Mr. Kirchner continues his attempts to attract foreign investments to oil and gas and mining sectors and does not appear to be keen to form a grand alliance that would use heavy handed tactics against oil companies. Kr. Kirchner?s role is in strict contrast to that played by Mr. Chavez in Venezuela.

So what about Mr. Kirchner?s friendship with Mr. Chavez? Apart from selectively providing diplomatic support to Mr. Chavez and extracting political advantage at home with Venezuela?s generosity Mr. Kirchner does not appear to be exactly following his oil-rich, aggressive neighbour?s footsteps.

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