Production picks up at Argentina's Vaca Muerta shale deposit

Below the dry rocky earth of Neuquén Province lies one of the world’s most exciting energy prospects. The Vaca Muerta rock formation is found at depths of 1000-3000 metres, and covers an area of 30,000 sq km – similar in size to Belgium. The formation was given its name in 1931 by a geologist from the US who discovered its hydrocarbons content, but the technology required to exploit it would be unavailable for 80 years.

In 2011, during a boom in non-conventional oil production in Texas, the US Energy Information Administration (EIA) published its first report on global shale rock resources. Argentina, largely thanks to Vaca Muerta, was estimated to have the third-largest resource volume behind the US and China. In May of the same year a consortium of national oil firm Yacimientos Petrolíferos Fiscales (YPF) and Repsol of Spain announced a major discovery at Vaca Muerta. This began a process of exploration, production and infrastructure development that would revolutionise Argentina’s energy matrix.

Resources

Since 2011 Argentina’s shale resource estimates have been revised upwards. In 2013 the country was estimated by the EIA to hold 801.5trn cu feet of wet shale gas and 27bn barrels of tight oil – the two principle forms of non-conventional hydrocarbons – placing it above the US and second only to China. The size of these resources would not only ease the pressure on Argentina’s declining conventional oilfields, but they would be capable of meeting the country’s current energy demand for well over a century.

In October 2015 YPF announced it had discovered a “super well” with an initial production of 1630 barrels per day (bpd) of crude oil, and in August 2017 a consortium of regional oil and gas company GeoPark and Wintershall of Germany announced a significant discovery in its CN-V block in Mendoza. According to a May 2017 report by international consultancy Wood Mackenzie, production from Vaca Muerta was set to hit 77,000 barrels of oil equivalent per day (boepd) in 2017 – a 43% increase on the previous year’s figure – and reach 113,000 boepd in 2018. This output comes from just 8% of the deposit’s total acreage. By 2031 the basin could produce anywhere from 700,000 boepd to 1.25m boepd, according to Wood Mackenzie.

Due to its potential, the government has placed the development of Vaca Muerta at the centre of its energy policy and economic planning. In January 2017 the country extended the Gas Plan scheme introduced in 2013, under which non-conventional gas produced in 2017 received a guaranteed price of $7.50 per million British thermal units (Btu). That price falls by $0.50 each calendar year to $6 per million Btu in 2020. “The Gas Plan acts as an attractive government subsidy for oil firms,” Alberto Calsiano, head of the energy department at the Argentina Industrial Union, told OBG. “In comparison, wellhead gas in the US costs between $3 and $4 per million Btu. The government has tended to give energy policies security and stability, and the proof of that is in the huge investments being made in Vaca Muerta.”

Investment

Following a relatively slow start, local and international energy companies have taken a large interest in Vaca Muerta. Between 2011 and 2014 total investment in the deposit reached an estimated $3.7bn. However, in 2017 alone companies announced investments of between $6bn and $8bn, and in 2018 that figure could approach $15bn, according to government estimates. In July 2017 a consortium of YPF and local subsidiaries of BP, Total and Wintershall announced they would spend $1.15bn over the next five years to drill 60 wells in the Aguada Pinchada region of Vaca Muerta. Local firm Techint will also invest $1bn to develop its Fortín de Piedra concession over the course of 2018.

“Argentina’s gas industry has a wide range of attractive opportunities due to little investment over the past decades,” María Tettamanti, director-general of local distribution firm Camuzzi Gas, told OBG. “Now we are seeing positive steps from the government to encourage investments from gas companies, such as guaranteeing an initial purchase price. The potential of Vaca Muerta is higher than initially imagined, and its impact on the economy will likely be very significant.”

Labour

Despite rising investments at Vaca Muerta, the hydrocarbons sector has faced a number of country-specific factors that push up production expenses. “In other countries labour is around 30% of the total costs of the production chain, but in Argentina they account for around two-thirds of total costs,” Luis Anaya, commercial manager of Kerui Petroleum, a Chinese oilfield service firm, told OBG. “The government has made positive steps through the negotiation of agreements with oil unions, but labour costs associated with transportation need to come down.”

Indeed, since 2016 President Mauricio Macri has negotiated agreements with unions on a sector-by-sector basis and in January 2017 he proclaimed a “new era” for the hydrocarbons industry following a deal with oil unions. Under the agreement, some of the most generous and commonly exploited labour legislation – such as including transport time to and from the rig as working hours – were phased out in return for investment guarantees and the continuation of the Gas Plan. According to Miguel Angel Gutiérrez, president of the YPF, without this agreement, operators’ investment commitments would have been reduced by 30%. “This demonstrates what we can achieve as an industry when we all work together,” he told local press in early 2017.

Sector Challenges

Although labour costs have largely been addressed, pipeline capacity constraints and transport bottlenecks remain obstacles to unlocking Vaca Muerta’s energy potential. Shortages of technical upstream equipment and machinery, such as perforation towers and fracking sets, have also slowed development. Insufficient infrastructure has resulted in significant operational losses for gas companies in the past. For example, at the end of 2017 between 4m and 8m cu metres of gas was paralysed for several days due to low demand at the time, with no capacity to transport and store the excess gas. Shale oil companies operating at Vaca Muerta also encounter challenges, with oil pipelines reportedly nearing their full transport capacity and requiring extensions.

Large, diversified oil and gas companies with access to credit are better positioned to overcome these infrastructure gaps and compete, while smaller companies with limited access to finance have struggled to break into the market. “Argentina has always had great resources and Vaca Muerta is the current main attraction due to its size and quality,” Nicolás Mallo Huergo, chairman of Phoenix Global Resources, told OBG. “However, its full development will require large capital investments – which are available through multinational companies – and advanced technology in the next five to 10 years. Local industry should cooperate with those foreign firms that hold the capacity and capability to exploit Vaca Muerta to the fullest.”

State and private entities are taking steps to address these various bottlenecks and ease operations. In April 2018 Transportadora de Gas del Sur, a local private gas company, announced a commitment of $250m for 2018 and 2019 to expand its pipeline capacity at Vaca Muerta from 5m cu metres per day to 35m cu metres. The company also plans to build a conditioning plant to regulate the quality of gas before it is transported. Future pipeline extensions are expected to increase daily transport capacity to around 60m cu metres.

Plans are also in motion to redevelop the regional rail line and add 700 km of track in Neuquén Province. The railway is expected to transport 4m tonnes of frac sand per year, in addition to moving other inputs. “With the development of improved transport infrastructure, such as the train to Vaca Muerta, and reducing costs across the rest of the chain, I am betting that operators will one day be able to produce gas profitably at a price of $4 per million Btu,” Calsiano told OBG.

Indeed, the fracking process for non-conventional wells requires the injection of large quantities of water and sand into the target rock. While water is readily available in Neuquén Province, the cost of importing and transporting sand to site has traditionally been an additional cost to the local shale industry. However, in 2016 YPF opened a sand processing plant in Añelo, just 100 km from Neuquén, to provide suitable refined sands to frackers. YPF expects that using local sands will reduce the cost of drilling by around 10%.

Services

The development of a knowledgeable, high-tech service industry is the another piece of the puzzle that would allow operators to reduce costs and improve recovery rates. Specifically, hydrocarbons extraction in Argentina relies on the importation of second-hand equipment from the US, but the process that has been more easily facilitated under Macri. “The imports system has improved a lot. Tariffs have been largely reduced and the system is a lot more flexible now as you can import second-hand equipment as long as there is no local production of those products,” Anaya told OBG.

Nevertheless, the market for services remains illiquid and margins are thin for providers. “We are going through a similar phase as the one the US experienced about 10-15 years ago. Big service companies work with large operators and are ensured a high volume of work, while smaller operators have to wait months for equipment to become available,” Ayala added. “Meanwhile, the big operators are looking to drive prices down, meaning margins can be around 5% rather than 25% in the US. Still, the rewards for early market entrance could be huge and we expect a significant increase in demand for services in 2018.”

More efficient labour relations, infrastructure improvements and a growing service market are already having a positive effect on the cost of drilling. One example of this came in October 2017, when the Chevron-YPF consortium exploring its Loma Campana concession announced that it would add a third drill rig to the site following a 50% drop in drilling costs.

US Investment

As production picks up, the coming year will likely see greater investments by US oil and gas companies, and cooperation between the Argentine and US governments on projects at Vaca Muerta. In June 2018 Argentina hosted a G20 energy summit in Bariloche, bringing together ministers of energy from around the world. One result of the event was that the various ministers agreed to greater international cooperation on natural gas exploration and supply chain efficiency. In what could be a key development for Vaca Muerta’s natural gas operations, Rick Perry, secretary of the US Department of Energy, offered to facilitate technical partnerships between US companies and Argentine players. In a statement to local press, Perry suggested that US pipeline companies and natural gas processors could help expand infrastructure at Vaca Muerta by making the technology that powered the US shale gas revolution available in Argentina.

This followed several months of efforts by officials to educate US investors on Vaca Muerta’s potential. In April 2018 Juan José Aranguren, the then-minster of energy and mines, President Macri and Senator Guillermo Pereyra hosted a conference in Houston with over 200 US hydrocarbons investors, and held private meetings with a number of company executives.