Argentina: Out of Gas on the Road to Recovery


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Abstract:
Fighting its way out of crushing debt, Argentina has fallen into a trap of its own making--it has oversold its natural gas resources.

Analysis:
This past year, Argentina enjoyed economic growth (GDP) in excess of 8 percent. Its inflation level was below 3 percent, and it booked a fiscal surplus. This is very good news in a country which showed a decline in GDP between 1999 and 2002 of 20 percent and defaulted on $88 billion in private sector debt in 2001. Analysts who follow the country believe it makes a very good start toward a sustained recovery for the country.

Now the country needs to start restructuring the $88 billion debt and repair the broken natural gas industry.

The debt restructuring is by far the more problematic of the two. The country owes the $88 billion mainly to bondholders. And it owes $13.1 billion to the International Monetary Fund which provided the money on an emergency basis while Argentina worked out the $88 billion problem. Argentina recently made a payment of $3.1 billion to the IMF and agreed to pursue good faith negotiations with private holders of the $88 billion who have already balked at an offer of 25 cents on the dollar. These are difficult international financial dealings that will play out in the near future. As Argentina attempts to cope with them, it must keep its economic prosperity going, and that means it must first deal with the crisis in natural gas.

Bargain-Basement Gas
Argentina has large reserves of natural gas. More than 27 trillion cubic feet proven with another 10.8 tcf probable. The country has steadily increased production of these reserves, from about 0.6 tcf in 1991 to 1.31 tcf in 2001. making it the fourth largest Latin American producer following Venezuela, Bolivia, and Mexico. Beginning about 1998, the country became an exporter of gas, chiefly to neighboring Chile.

But then in 2002, the government made one of the big mistakes that got it into trouble: It allowed the peso to float, freeing it from value related to the U.S. dollar. But when it did, it converted natural gas prices into pesos on a one-to-one basis and froze prices so companies could not increase them. This made natural gas available at a fraction of the cost of other fuels and led to rapid and large switches to natural gas by transport and industry alike. Sharp increases in gas consumption resulted. More than 1.3 million vehicles, more than in any other country, have been converted from gasoline. Entire industries have switched--some from coal, others from oil.

Gas companies and the E&P sector, on the other hand, virtually quit developing gas reserves. The current Argentine boom has further boosted demand for gas and electricity. Gas production may be up as much as 30 percent. It is widely agreed to be at maximum output, but it is still short of demand. The power industry has tried to meet demand, converting to fuel oil and gas oil. But liquid fuels go at international prices that are now six to eight times more than gas. A drought affecting Argentina's hydroelectric power plants, which generate close to half the country's electrical power, has aggravated the situation. Also, Argentina faces a crisis this coming winter because, with public utility rates frozen for the last two years, virtually no new supplies have been developed.

Argentina thus found itself out of gas on the road to recovery. Facing this situation, the country last month dropped the voltage on its electric power grid and on April 1 limited its natural gas exports to 2003 levels.

The power drop seriously limits manufacturers and threatens the economic growth that the country so badly needs. The export limit mainly affects Chile, which fuels many power plants with the gas.

Argentina has prevailed upon Brazil to send more natural gas south. Bolivia, too, indicated it would send more gas--provided it did not end up in Chile. These two countries have been at odds ever since Chile captured Bolivia's coastline in 1883.

On April 5th, Chile complained of the Argentine cut in supplies and then on April 7th sent a diplomatic letter of complaint that the decision ignored export treaty commitments.

On April 6th, some light appeared to shine on the plight of natural gas producers. The Argentine government and natural gas producers YPF-Repsol, Total, and Petrobras agreed on a wholesale price increase of 40 percent. In return for the increase, the producers will supply 80 million cubic meters per day to the domestic market. It includes provisions for meeting expanded demands.

The Argentine government has criticized the gas companies for not investing in exploration and infrastructure. However, the freezing of rates and the 2002 peso devaluation clearly turned the business nonprofitable.

A Tough Job
Argentina faces more tough times as the country moves to sustain a growing economy. Improved natural gas supplies will certainly help that along--though the modest added returns from a 40 percent price increase are far from the greatest of stimulants for investment. Solving its energy supply needs may not be nearly as critical as finding a way to repay or settle its crushing debt, of course. But the energy problem has to be solved first. Without that solution, there is no motive power and no recovery.

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