Argentine deal with holdouts crucial for nation’s shale gas

Focus story by Al Greenwood

HOUSTON (ICIS)–If Argentina can reach a settlement with its hold-out creditors, the country would not only avoid another default.

It could also speed up the development of its vast reserves of shale gas, reducing the country’s energy shortage.

That, in turn, could end the annual winter-time cuts in natural-gas supplies that Argentina imposes on petrochemical and other industrial companies.

However, none of this will come about any time soon if Argentina and the holdouts fail to settle. Argentina has until 30 July to reach some kind of deal.

After that, the country would face its second default in 13 years.

That earlier default − then the largest in the world − laid the foundations for both Argentina’s energy shortage and its dispute with the holdout bondholders.

Following that default, Argentina offered the creditors restructured bonds worth 25-29 cents on the dollar.

It was quite an unfavourable deal for the creditors, said Doug Doetsch, a partner with Mayer Brown.

Argentina made such an offer because it had no other practical way to pay the creditors − in 2001, the amount in default was $81bn.

However, another reason Argentina made such an offer was the nature of the country’s administration, Doetsch said.

“They had a very populist government,” he said. “It was easy to blame the foreign creditors for the problems.”

Argentina told the creditors that its offer was the only one they would get. If the creditors rejected it, they would get nothing from Argentina.

In all, Argentina managed to restructure more than 91% of its foreign debt. Since then, it has continued to make regular payments to these restructured bondholders.

Those who rejected the restructured debt held out for the full payment of their bonds. One group of holdouts, led by NML Capital, sued Argentina in US court and prevailed.

The judge ruled that the next time that Argentina makes a payment to the restructured bondholders, it must also pay the hold-outs.

The next payment to the restructured bondholders is due on 30 July. If Argentina refuses to pay the holdouts by 30 July, then − by the judge’s ruling − it cannot pay the restructured bondholders.

If Argentina misses the payment to the restructured bondholders, then it would be found in default.

The dispute with the hold-out creditors is not the only relic of Argentina’s 2001 default. Its energy shortage can also trace its roots to policies the government adopted in response to the 2001 default.

To provide Argentines with relief during the economic fallout from the default, it capped energy prices.

The price caps were another strand of Argentina’s populist policies, Doetsch said.

“You hold down utility costs so that the electorate has relatively low-priced electricity and other charges,” he said. “That’s an attempt to favour consumers over producers.”

The government maintained the price caps even after the country’s economy recovered. The low prices caused energy demand to spike.

Because prices were so low, it gave energy producers no economic incentive to explore and develop new reserves.

Demand gradually exceeded supply, and Argentina is now an energy importer.

The imports are ruinous to the country’s foreign reserves, since the country is buying liquefied natural gas (LNG) at $15-18/MMBtu and selling it to consumers at massively discounted prices.

Normally, a country would replenish its reserves by raising foreign debt. This would provide Argentina with the US dollars it needs to import LNG and to continue subsidising it for consumers.

However, Argentina has been locked out of foreign markets since the 2001 default.

Its main source of US dollars is its trade surplus. That surplus has been shrinking because of rising energy imports.

Argentina’s overall trade surplus fell to $9.02bn in 2013, down more than 27% from $12.4bn in 2012, according to INDEC, the country’s statistical institute.

Earlier this year, Argentine foreign reserves became so low, the country devalued the peso.

The low reserves are presenting Argentina with another problem. It is making it more difficult for the country to reach a settlement with the hold-out creditors who sued the country.

Argentina does not owe these holdouts a lot of money. The amount is $1.65bn. On 30 July, it will owe the restructured bondholders $900m, another sum that is well within the country’s means to pay.

Instead, Doetsch of Mayer Brown said the problem for Argentina is the amount it owes to the other hold-out creditors who did not take part in the NML lawsuit.

These holdouts may also decide to sue Argentina to collect the full value of their bonds. Argentina owes the rest of these holdouts an amount estimated to exceed $10bn.

The Argentine government says the amount is too much, given that the country’s current foreign reserves are at $29.7bn, according to the Argentine Central Bank.

Another hurdle preventing a settlement is the so-called rights-upon-future-offers (RUFO) clause that is governing the restructured debt. Under that clause, if Argentina voluntarily pays the holdouts the full value of their original bonds, then it would also have to pay the restructured bondholders the original value of their bonds.

That amount has been estimated at $120bn. This RUFO clause remains in effect until the end of this year.

So far, there are no signs that Argentina and the holdouts are close to an agreement. As the 30 July deadline approaches, it is becoming increasingly likely that Argentina could face another default.

Doetsch, though, pointed out that this could be a short-term default. The country could ultimately reach a settlement with the holdouts and pay whatever amount is owed to the restructured bondholders.

Though this would not be good, such a default would unlikely cause long-lasting harm to the country’s economy, Doetsch said.

In another scenario, Argentina could successfully request more time from the judge to settle with the holdouts. It could then pay the restructured bondholders by the 30 July deadline and continue to negotiate with the holdouts.

The judge, though, has already rejected earlier proposals for such delays.

Argentina could also both reach an agreement with the holdouts and meet the 30 July deadline to pay the restructured bondholders.

No matter how Argentina reaches a settlement, it would be one of the last major obstacles that is preventing the country from accessing foreign credit.

The country already has resolved past disputes.

This year, Argentina paid Repsol $5bn in compensation for the state expropriation of YPF.

Later in May, Argentina reached an agreement with Paris Club creditors to pay the group $9.7bn over the next five years.

“I think Argentina is definitely trying to regularise the situation,” Doetsch said. “It will have to go the market at some point.”

If Argentina could return to foreign credit markets, then it could remove some of its currency-exchange restrictions.

These restrictions were intended to keep dollars from leaving Argentina.

However, the restrictions also made it difficult for Argentine companies to get foreign financing, Doetsch said.

The restrictions also discouraged foreign companies from investing in the country. These companies would want to convert the peso they earned from their Argentine investments into their home currencies. Currency-exchange restrictions make such repatriation difficult.

A more orthodox currency-exchange regime would make it easier for foreign companies to convert pesos into their home currencies.

This would be of particular interest to foreign energy producers that are eager to develop Argentina’s large reserves of unconventional gas.

The country’s shale-gas reserves are estimated at 802 trillion cubic feet (802 tcf), the second largest in the world, according to Accenture, a consultancy.

If Argentina can develop its shale-gas reserves, then that should benefit its petrochemical industry in at least two ways.

First, Argentina could end the gas cut backs it imposes on industrial customers every winter.

Second, the increase in gas production could also increase supplies of ethane and other natural gas liquids (NGLs).

Unlike much of the world, Argentina cracks ethane to produce ethylene. This gives the country’s chemical industry a potential cost advantage against much of the world, which uses oil-based naphtha as a feedstock.

It is an advantage the US is already enjoying because of its shale-gas boom.

But even if Argentina can reach a settlement with the hold-out creditors, it will not immediately bring about a shale-gas boom.

The country will likely have to maintain its onerous currency-exchange restrictions, since it will need dollars to continue importing LNG, said Jorge Buhler-Vidal, director of Polyolefins Consulting.

“That is still going to be around for a while, default or no default,” Buhler-Vidal said.

In addition, a settlement will not immediately restore confidence in the peso, he said.

Without that confidence, those holding pesos − be it Argentine consumers or companies − will be desperate to exchange the Argentine currency for dollars. As a result, the government will need the currency-exchange restrictions.

Confidence could come from a new administration. President Cristina Kirchner will leave office at the end of 2015.

“All kinds of things can happen between now and then,” Buhler-Vidal said.

Argentina could reach a settlement with the holdouts and start taking steps to attract foreign investment into its shale-gas reserves.

The country could also default.