MARKET OUTLOOK: Argentina deal could boost shale

The Chubut province in south Argentina is one of the country’s leading oil producers Sipa Press/REX/Shutterstock

Argentina president Mauricio Macri is encouraging business investment Pool Roma/REX/Shutterstock

The agreement that Argentina’s new president struck with hold-out creditors marks one more move that could attract the investment needed to develop the country’s substantial reserves of shale gas. If the agreement goes through, it would provide the Argentine government with direct access to foreign debt markets for the first time in 15 years.

Argentina’s new president, Mauricio Macri, has moved quickly since taking office in December 2015. He campaigned on a platform of market-friendly policies and defeated Daniel Scioli, successor of Peronist Cristina Fernandez.

During his first three months in office, Macri has removed the country’s restrictive foreign-exchange controls; lowered taxes on exports; reduced energy subsidies; and proposed a deal with hold-out creditors.

Monetary policy is now focused on reducing inflation, while fiscal policy is aimed at reducing the country’s deficit, said Erich Arispe, director in Fitch Ratings’ sovereign group. Last year, that deficit stood at 7% of GDP, high by any measure.

These are all much-needed steps if Argentina wishes to attract the investment needed to develop its reserves of shale gas, estimated to be the second largest in the world, according to the US Energy Information Administration (EIA).

More gas production could open vast potential for the country’s petrochemical industry. Unlike much of the world, Argentina relies on gas-based ethane for its feedstock, versus oil-based naphtha.

Despite the decline in oil prices, ethane cracking still holds a cost advantage against naphtha. Moreover, a lot of Argentina’s shale gas is in the energy-intensive Neuquen province, which already has plenty of infrastructure to support gas production.

NEW PETROCHEMICAL INVESTMENT?

During the recent CERAWeek energy conference, Dow Chemical CEO Andrew Liveris said Argentina represents one of the world’s biggest opportunities. The country could be the location for the next big petrochemical complex in Latin America.

In November 2015, at the Latin American Petrochemical Association (APLA) meeting, Fabian Gil, Latin America commercial vice president for Dow Performance Plastics, said Dow’s Bahia Blanca site “has a great opportunity to become the third big expansion area for Dow. It is already the most important petrochemical complex in Latin America.”

Dow already operates two crackers at Bahia Blanca of 425,000 tonnes/year and 275,000 tonnes/year, along with a 90,000 tonne/year low density polyethylene (LDPE), high density PE (HDPE) units of 120,000 tonnes/year and 150,000 tonnes/year, and a linear low density PE (LLDPE) plant of 290,000 tonnes/year, according to the ICIS plants and projects database. However, shortages of natural gas feedstock have often curtailed full production.

Whether or not Argentina experiences a chemical renaissance will depend not just on Macri’s reforms but also on the health of the global economy.

“We have to keep in mind that not only for Argentina, but for emerging markets, this is a very challenging environment,” said Arispe.

“There is no identifiable external factor that can provide you with momentum to recover, no tailwind so to speak from the international economy,” he added. “You have to pull yourself by your bootstraps.”

THE DEBT ISSUE

Many of Argentina’s problems stem from its default in 2001, then the largest in the world. Following that default, Argentina offered creditors restructured bonds worth 25-29 cents on the dollar. Most of the creditors accepted the offer. Others sold their bonds at a discount to other investors, who held out and demanded full payment. Because of the resulting dispute, Argentina lacked direct access to foreign debt.

This does not mean that Argentina was locked out of all access to credit. It could still attract US dollars by maintaining a trade surplus. Argentina could still issue domestic debt. However, the dispute with the hold-out creditors prevented Argentina from issuing foreign debt.

Without access to foreign debt markets, Argentina’s reserves of US dollars became precious. To preserve them, the country adopted a severe foreign-exchange regime, making it difficult for companies to import goods or repatriate pesos into their home currencies.

For companies eager to develop Argentina’s reserves of shale gas, these foreign-exchange controls made it difficult for them to import drilling equipment and fracking sand. Plastic converters had trouble importing the resin needed to make finished products.

Other policies also ensured that Argentina’s shale gas stayed underground. Following the default, Argentina pursued a very expansive fiscal policy. Essentially, the nation’s central bank started printing money to finance the government. This gave Argentina one of the highest inflation rates in the Western Hemisphere, second only to Venezuela.

The foreign-exchange controls did help Argentina control inflation, since it maintained the value of the peso against the dollar.

In another move, Argentina imposed price caps on energy and provided consumers with subsidies. The price controls made it difficult for energy companies to recover the costs of drilling new wells. The subsidies encouraged consumption. The result turned Argentina from a gas exporter to an importer.

During the coldest days of the Argentine winter, the country restricts gas supplies to industrial customers to ensure that homes have enough fuel to stay warm. These cutbacks have become so frequent, chemical companies schedule their maintenance in the winter to limit the disruptions caused by the gas curtailments.

Meanwhile, the dispute with the hold-out creditors continued. Some of the hold-outs, led by Paul Singer’s Elliott Management, sued Argentina in US court, demanding full payment of the bonds.

Before the deal with the hold-outs takes effect the Argentine legislators must pass laws that will allow the country to pay the hold-outs.Macri’s party has reached out to some of the opposition in Argentina’s legislature, increasing the likelihood that the two sides will cooperate on passing the necessary laws, Arispe said.

The dispute is affecting Argentina’s provinces as well as the federal government. Argentina’s ratings are holding down those for the provinces, making credit more expensive. A deal with the hold-out creditors could allow the provinces to obtain financing under more favourable terms. Hence, governors could pressure their legislators to cooperate with Macri and pass the laws needed to complete the deal with the hold-outs. The two sides have until 14 April to close the deal. If it goes through, the hold-outs would receive 75% of the outstanding amount.

The agreement caps what has so far been an ambitious reform programme that Macri undertook since becoming president. Shortly after Macri assumed office in December, Argentina removed its foreign-exchange controls. This resulted in a sharp devaluation of the Argentine peso, to pesos (Ps)14 from Ps9.78.

Despite the magnitude of the drop, the devaluation went smoothly, and so far, the government had avoided the danger of a runaway devaluation of the nation’s currency, Arispe said.

INFLATION CHALLENGE

Still, other challenges remain, Arispe said. Argentina’s inflation was already high. The devaluation of the peso and the removal of energy subsidies will add more pressure.

High inflation is already complicating the government’s salary negotiations with Argentina’s powerful unions. They are demanding rises to help offset the country’s high inflation.

Under the previous administration, Argentina’s state statistical agency, INDEC, published what many considered to be wildly inaccurate inflation figures – a move earning the censure of the International Monetary Fund (IMF). As a result, Macri will be negotiating union salaries without an official measurement for inflation, Arispe said.

Meanwhile, the peso has weakened further since the start of the year. It is now trading at over Ps14 to the dollar. The weakening of the Argentine peso is expected, given the performance of currencies in other emerging markets. That leads to another challenge for the country. The outlook for emerging markets in general has deteriorated, because of the slowdown in China and volatility in financial markets.

Even if Argentina overcomes these challenges, investment will not start flooding the country. Companies might want guarantees that the reforms Macri introduces will outlast his administration, Arispe said.

For projects that require a time horizon of several years, companies have just the first three months of Macri’s administration from which to gauge the risk of any investments.

“The work is just starting right now,” Arispe said. Even with pent-up demand for investment, there is still a lot to do.