An analysis of Argentina’s Vaca Muerta shale reserves, outlining the current state of affairs events that act as disincentive to investment as well as discussion of the country’s underlying infrastructure needs and weaknesses that need to be addressed before shale can be extracted in an economic manner.
Invited Contributors: Alexander Robart and Caldwell Bailey co-authored this piece exclusively for The Review. Alexander is a principal with PacWest Consulting Partners with more than a decade of strategy consulting experience across multiple industries including oil and gas, energy, industrials, and resources.
The US Energy Information Administration (EIA) estimates that Argentina possesses the world’s third-largest reserves of shale gas, as well as significant deposits of shale and tight oil in the Vaca Muerta and other formations. However, commercial scale and economically viable development of these abundant unconventional oil and gas resources has been stymied. Most oil and gas professionals in Argentina resoundingly agree that economic interventionism by the administration of President Cristina Fernández de Kirchner is largely to blame for activity falling shorting of expectations. International exploration and production companies (E&Ps), oilfield service (OFS) providers, and investors alike have been reluctant to deploy capital in Argentina due to myriad political-economic factors including the re-nationalization of YPF in April 2012, price ceilings on natural gas sales, soaring inflation coupled with foreign exchange restrictions, and general regulatory uncertainty, combined with labor challenges and high well costs. The Fernández government appears to be simultaneously courting and spurning the international oil and gas community.
This situation is unfortunate, as the oil and gas discoveries have come as Argentina finds itself importing increasing — and increasingly expensive — quantities of natural gas and refined oil products to meet rising domestic demand. Macroeconomic fundamentals should dictate a concerted effort to develop the resources as fast as possible. However, even if political and economic challenges were to vanish tomorrow and the Fernández administration were to suddenly change its approach to its dealings with the oil and gas industry, the country still faces significant hurdles to commercial scale development of its unconventional resources.
Extraction of Argentina’s enormous hydrocarbon resources — 774 trillion cubic feet (Tcf) of natural gas and 22.8 billion barrels of tight and shale oil according to EIA and YPF estimates — will require a shift in its development approach. Unconventional oil and gas development requires a significantly larger number of wells over a longer period of time, compared to conventional onshore development, due to the steeper production decline curves typical of unconventional wells. Each well requires a greater input of products and services, but more importantly, more capital investment. Given the larger number of higher-cost wells over a long period of time, reducing per well costs through a combination of robust infrastructure, efficient supply chain and logistics, and operations management employing a ‘manufacturing’ approach is critical to making unconventional projects profitable.
In Argentina, unconventional activity to date has primarily involved vertical wells, due to the thickness of the Vaca Muerta shale’s payzone and comparable lower costs for vertical wells compared to horizontal wells. However, even if unconventional development in Argentina were to be carried out largely through the development of vertical wells, supply needs would still be massive, given that more total wells will be required to achieve comparable production.
Argentina’s current ability to support the unconventional oil and gas development needs without significant investment is questionable. The country has limited transport options to Neuquén province (where most of the Vaca Muerta formation is located) from ports on its east coast on the southern Atlantic. Domestic proppant and chemical production capacity and storage facilities are almost non-existent. While water sourcing and wastewater disposal capacity is sufficient for current activity levels, it will likely become a challenge as activity increases in the future.
Given the level of political-economic uncertainty in Argentina today and the central role that state-owned YPF will play in driving activity increases, PacWest has developed two scenarios to forecast unconventional activity and subsequent demand for oilfield services and supporting supply chain and logistics capacity: Base Case and Upside Case.
In both scenarios, PacWest expects activity to increase year-on-year. YPF, which today accounts for roughly 80% of unconventional activity in Argentina, has announced an ambitious five-year development plan to see nearly 2,500 unconventional wells drilled by 2017. PacWest estimates are not as optimistic (see Figure 1), forecasting 1,125 unconventional wells drilled in the Base Case over the 5-year period 2013-2017, with 140 and 375 wells drilled in 2013 and 2017, respectively. However, the Base Case still represents a meaningful increase from the 92 unconventional wells drilled in 2012, a credit to YPF given its capital raising challenges. In the Upside Case, PacWest forecasts a total of 1,662 wells over the same period, with 177 and 550 wells drilled in 2013 and 2017, respectively.
One common obstacle to increasing unconventional activity is the amount of hydraulic fracturing capacity (generally measured in hydraulic horsepower or HHP, an indirect measure of the number of frac trucks and fleets available to stimulate or ‘complete’ wells). So far, Argentina’s in-country capacity is about 279,750 HHP or 119 trucks (see Figure 2), as compared with the US, which at year end 2013 will have an estimated 6,400 frac trucks with greater average hydraulic horsepower per truck than those deployed in Argentina. Our frac demand forecast assumes that the number of frac trucks required per well remains constant (based on conversations with industry sources, we assume average fleet size today to be 10 trucks) The service providers with frac capacity available in Argentina (which at the end of 1Q2013 included, in order of in-country capacity, Schlumberger, Halliburton, Weatherford, Baker Hughes and Calfrac) would need to increase frac capacity 12 times to meet completion requirements for the number of wells fractured in PacWest’s relatively conservative Base Case scenario projections.
In order to make unconventional development activity economic, significant efforts will need to be undertaken to reduce capital investment per well. Currently, unconventional well costs in Argentina average approximately $10 million for a vertical well and $18 million for a horizontal well. This is driven by inefficiencies across the supply chain due to the limited current scale of activity, labor restrictions, and limited supply chain and logistics infrastructure, among others. Each of these factors is intrinsically related to the others, creating a cycle of escalating costs.
The supply and transport of frac consumables, particularly proppant and stimulation chemicals, is one of the largest drivers of logistics infrastructure capacity requirements and costs. In the Base Case development scenario, PacWest estimates total proppant demand will reach 467,000 metric tons (MT) by 2017, up from 71,000 MT in 2012 (see Figure 3). While most of the current supply of proppant is higher-cost ceramic proppant sourced from the Brazilian Curimbaba Group, US players CARBO and Santrol have also sold ceramics and resin-coated sand manufactured in China and Mexico, respectively, into the Argentine market. Badger and Unimin have also provided lower-cost, but still high-quality Northern White sand from the US, but at lower volumes. With local sourcing options in Argentina in early stages of exploration, global logistics and supply chain will remain a concern during this period of growth.
A similar situation exists for stimulation chemicals. While Argentinian unconventional wells will require similar volumes of chemicals per well to the US, it has virtually no in-country production capability today, though efforts are underway to begin development of local production capacity. PacWest expects that in the period to 2017, demand for stimulation chemicals could rise to as much as 16,000 MT, from total demand of 2,000 MT in 2012 (see Figure 4) in the Base Case. An eight-fold increase in demand will put strains on chemical supply chains.
Argentina’s ability to invest in the required infrastructure to alleviate logistical challenges is also in question, beginning at the Port of Buenos Aires, which is the primary port of entry for oilfield goods into Argentina and South America’s largest cargo port. However, the port faces major efficiency and capacity challenges that will, by all indications, persist as frac activity and supply needs ramp up. Adding to this congestion, complications with trade financing have required operators to divide purchases into smaller orders and spread them across multiple suppliers and supply chains, eliminating economies of scale. Lastly, reports from industry and government sources indicate that equipment imports are often held in Customs for more than six months, creating additional bottlenecks.
A more attractive import alternative lies to the south at the Port of Bahía Blanca. That port handles about half the tonnage of Buenos Aires, and is only 20 years old. While it is unclear what, if any, upgrades may be needed to handle increased tonnage, there appears to be sufficient room for expansion of capacity. Bahía Blanca’s greater proximity to Neuquén (approximately 550 km, compared to 1,100 km from Buenos Aires) would also decrease total travel time and cost for delivery of consumables. The mode of delivery of these products to Neuquén presents another potential roadblock.
One of the greatest sources of efficiency in the US unconventional oil and gas supply chain has been the ability to transport oilfield products by rail. The US has an extensive rail network totaling approximately 140,000 miles and reaching areas throughout the country. As unconventional oil and gas development activity has increased, rail operators have been close behind expanding rail networks to support oilfield logistics requirements. In contrast, Argentina’s rail network totals only 29,000 miles of track and is severely fragmented, with the government owning the rails and multiple licensees operating various portions of the network. Today, a single rail line, run by FerroSur Roca SA, serves Neuquén province, running from Bahía Blanca to Zapala, though most of FerroSur’s capacity is already booked by long-term customers. One private resources company, Vale, considered an investment to expand rail infrastructure in Neuquén, but abandoned plans to do so in March 2013.
Left without a good alternative, most oilfield goods will be transported via truck, which is the least cost efficient alternative. Basic truck transportation costs are over 25% higher than equivalent shipping via freight rail and double to triple those in the US. In addition, the use of truck shipping exposes the industry to Argentina’s truckers’ union, the country’s most powerful labor group. The union has used strikes to garner wage concessions in the past from oil and gas companies, and an attempt to shift increasing freight traffic to rail would likely draw their ire and further complicate logistics to Neuquén’s wellsites. Slowing supplies down further, the majority of roads in Neuquén Province that serve oilfield locations are currently unpaved, which will likely necessitate investment in this infrastructure as well.
Attracting the amount of investment required to overcome these constraints will not be easy. Given the government’s lack of access to international financial markets, its ability to finance multiple large infrastructure projects is likely limited. Additionally, foreign investors are weary of committing capital to the Argentine market, given the government’s policies and history of antagonizing industry. E&P companies are unlikely to make meaningful logistics infrastructure investments without some direct participation or allowances (in the form of tax easements) from the government in Buenos Aires.
The unconventional oil and gas story will continue to evolve in Argentina. Although the country’s confounding politics are sure to remain the headline story in the international press, the logistical challenges to development should be a major point of concern for serious analysts of the Argentinian shale development story worldwide.
© Latin American Energy Review 2013
About the Author:
Alexander Robart is a Principal with PacWest Consulting Partners. He has more than a decade of strategy consulting experience across multiple industries including oil and gas, energy, industrials, and resources. He has focused primarily on working with upstream oil and gas clients, including Super Majors, independent E&Ps, oilfield services companies, equipment manufacturers, and financials, both in North America and internationally.
Mr. Robart has led most of PacWest’s consulting engagements involving unconventional oil/gas market analysis and strategy development in key North American basins as well as emerging international unconventional basins. His experience covers the entire breadth of oilfield services and equipment, ranging from drilling, completion, to production, but he has developed particular expertise in the oilfield water management and hydraulic fracturing markets through numerous projects. He has also led much of PacWest’s international hydraulic fracturing market analysis and forecasting efforts and has spent time on-the-ground in most of the emerging unconventional plays.
Mr. Robart holds an engineering degree from the University of Virginia and an MBA from the University of Michigan.