A Deep Dive into South American E&P Argentina: Change is in the wind

Transcription

1 A Deep Dive into South American E&P Argentina: Change is in the wind Anish Kapadia Matt Portillo Shola Labinjo Hubert van der Heijden May 2011 **IMPORTANT DISCLOSURES BEGIN ON PAGE 35 OF THIS REPORT**

2 Contents Argentina: The Investment Case... 3 Who should you buy?... 4 Map of Key Basins... 4 The Neuquén is heating up... 5 Enhanced recovery... 6 Don t write off conventional exploration... 6 Neuquén Basin Geology... 8 Shale Oil Economics Shale Gas Economics Tight Gas Potential Key Unconventional Wells to Watch Price Controls Pipeline infrastructure Argentina: Key Pipelines Oilfield Services Refining Our view: Prices are going higher!!!! Recent M&A Activity Other Basins & Potential Shale Plays Golfo San Jorge Stratigraphy Austral Magallanes Stratigraphy Parana Chaco Stratigraphy Company Exposure YPF S.A. (YPF: US $17B market cap B): Apache Corporation (APA: US $50B market cap A): Gran Tierra (GTE: US $2B market cap B): Madalena Ventures Inc. (MVN: CN $183MM market cap NR): Total S.A. (FP: FP $150B market cap NR): Exxon Mobil (XOM: US $419B market cap NR): Americas Petrogas (BOE: CN $321MM market cap NR): Petrobras Argentina S.A. (PZE: US $2B market cap NR): Antrim Energy (AEN: CN & AEY: LN $173MM market cap NR): APCO Oil and Gas (APAGF: US $2.5B market cap NR) Crown Point Ventures Ltd (CWV: CN $113MM market cap NR): Arpetrol (RPT: CN $73MM market cap NR): Azabache Energy Inc. (AZA: CN $31MM market cap NR) Other private operators Appendix: Booming Buenos Aires & more macro Important Disclosures: Page 2

3 Source: BP, TPH Argentina: The Investment Case Why Argentina and why now? We believe the Argentine oil and gas industry is in the midst of a multiyear transformation that is fundamentally altering pricing for both oil and natural gas in country. Price caps have created an unsustainable situation that makes the country a significant oil and gas importer over the next decade. Slowly rising prices of refined products have allowed refiners to bid up prices for crude and industrial buyers are in some cases permitted to pay above market prices for gas. This leads to our thesis that the future should bring more favourable pricing to E&Ps. The government s persistent intervention in the local oil and gas market has made Argentina s energy sector uncompetitive and as a result, hydrocarbon production has not kept up with demand growth. Decade long price controls and restrictions on hydrocarbon exports have discouraged energy companies from investing in exploration and in some cases development (gas), causing reserves and production to fall. When the country began its price cap policy in 2001, the situation was manageable, as Argentina was a significant net exporter of crude (>400mbopd) and natural gas (0.5 bcfd). Furthermore, prices for both products on the international market were lower than they are today (rising costs have magnified subsidies for imports). For a while the country was able to meet export commitments for gas (primarily to Chile) and was self-sufficient for refined products. With strong economic growth forecast, the country s thirst for hydrocarbons is unlikely to weaken, even in a steadily rising commodity environment. Based on our forecast, oil consumption will outstrip domestic production by ~33mbopd in 2014 and by ~360mbopd in Equally important is that Argentina is already short of key refined products. Although the country currently produces ~676mbopd and has a refining capacity of 635mbopd (operating at >80% utilisation), only 85% of the crude produced locally is consumed by the domestic refineries, suggesting that the refineries are not sufficiently complex to process lower quality crude slates produced locally. As a consequence, Argentina must export lower quality crudes and import certain refined products, such as diesel; notably, in 2010 Argentina became a net gasoline importer. In 2003, Argentina s net exports of diesel amounted to 23mbblpd, by 2010, the country imported 25mbblpd of diesel to augment domestic supply. In our view, Argentina reached the tipping point in 2009 as the country became a net importer of natural gas and saw a rising need for diesel imports. As imports have continued to increase, pricing for both commodities has already begun to rise. Over the last two years, oil prices have risen from a capped price of $42/bbl to a current market price of $58/bbl but assets still look cheap and the story is still underfollowed creating an ideal opportunity for investment. Argentina: Oil Imbalance Argentina: Gas Imbalance Oil Consumption (mbopd) Forecast Consumption (mbopd) Gas Consumption (bcfd) Forecast Consumption (bcfd) Oil Production (mbopd) Forecast Production (mbopd) Gas Production (bcfd) Forecast Production (bcfd) Page 3

4 Source: Apache Corporation Who should you buy? Our preferred investment in country is YPF (YPF US), on which we have a $57 price target. Currently the stock is trading at a discount to our 1P NAV ($46/sh), has significant leverage to rising domestic crude prices ($1/bbl increase NAV by $1/sh), a high dividend yield (2011 TPHe 8%), solid upside potential, driven by improved oil recovery on mature fields, and conventional exploration. However, the biggest near term catalyst will come from the company s 3mm (net) acres in the Neuquén basin an area which is highly prospective for unconventional oil and gas exploration. Map of Key Basins Page 4

5 Source: Americas Petrogas Source: Instituto Argentino del Petroleo y del Gas The Neuquén is heating up Located in the central-western part of Argentina, the Neuquén Basin spans an area of 30mm acres and is the main hydrocarbon producing 1,800 1,600 1,400 region in Argentina with 1,200 activity dating back ~100 1,000 years. Total oil and gas 800 production from the basin was mboepd in 2009 versus 200 1,431mboepd for Argentina as 0 a whole. From a reserves perspective, the basin has suffered a pretty serious Austral Cuyana G. San Jorge Neuquén Noroeste relative decline over the past decade, and as of 2009, the Neuquén basin held only 25% of the oil resources or 33% of the combined oil and gas resources in the country (implying steeper potential decline in production unless reserve replacement ratios increase). Reserves stood at 1.6Bboe in Neuquén and 4.8Bboe in Argentina, at the end of Operators in the basin Argentina Oil & Gas Production (mboepd) Based on data from Argentina s BDIH 1, it appears that acreage holdings in the Neuquén basin are skewed toward a few companies that operate the majority of the basin. Out of a 25mm acre area available for concessions, a 10mm acre area appears to be un-leased or does not have data on the operator available. Public operators on the remaining acreage include YPF (4.2mm gross acres), Petrobras Argentina (2.0mm acres), Apache (1.7mm acres), Americas Petrogas, through Midas S.A., (1.3mm acres), TOTAL (0.87mm acres), Chevron (0.46mm acres) and Azabache Energia, through Argenta Energia, (0.21mm acres). These seven firms operate approximately 60% of the Neuquén acreage currently under contract. Other public companies that have a stake 2 in concessions in Neuquén are: Crown Point Ventures (0.56mm gross acres), Antrim Energy (0.31mm acres) and Madalena Ventures (0.28mm acres). 1 Banco de Datos Integral de Hidrocarburos de la Republica Argentina 2 Based on company data Page 5

6 Enhanced recovery Century long exploitation of oil and gas resources in Argentina s hydrocarbon provinces has left the country with a diminishing production base. Further, oilfield surveillance including reservoir simulation, waterflood surveillance and maintenance, and enhanced oil recovery is years behind the US. While not sexy work, the returns can be some of the best in the business. Opportunities to workover existing wells abound including installing and optimizing artificial lift and optimizing ongoing waterfloods. Simple blocking and tackling production and reservoir engineering should enable companies to increase recoveries. For example, YPF likely owns assets with 24BBoe original oil in place and we model our recovery factor at 22%. Waterflood maintenance, looking for bypassed oil, squeezing off thief zones and polymer injection can increase recoveries by 6-8%. If the industry can arrest declines by only a few percentage points, Argentina can add tens of thousands of barrels per day of production and could potentially see a 1x-2x uplift in reserves. The next phase of surveillance is enhanced oil recovery projects including Alkali Surfactant Polymer and CO2 floods which are currently being piloted in several fields. In aggregate, the successful adoption of enhanced oil recovery techniques suggests that there is an opportunity for companies to stem declines and generate value by exploiting some of the, hitherto overlooked or abandoned, conventional resources. Unsurprisingly, YPF, the country s largest producer, has been a leader in this regard. YPF has a long history of rejuvenating declining fields; in the 1950 s the company successfully executed water flooding programmes in the Golfo San Jorge basin. This was followed by the adoption of polymer flooding techniques in the 1970 s and 1980 s. More recently, the company has been drilling infill wells on the El Medanito field, in Neuquén basin, with a view to initiating a second generation water flooding programme. YPF estimates that water floods can improve recovery factors by 6%-8%. In the Golfo San Jorge basin, YPF has developed plans to carry out polymer and surfactant injection pilots at the Grimbeek II and the Sur Manantiales Behr areas. The area, with 22oAPI and 100cP oil, provides an ideal geological setting for polymerisation supported recovery. YPF believes that polymer and surfactant injection techniques could improve recovery rates by 12%-16%, double recovery rate achievable with water flooding. The upside potential created by the adoption of enhanced recovery techniques in Argentina is validated by YPF s 100% reserve replacement in 2010, achieved entirely through enhanced recovery projects. Don t write off conventional exploration We believe there is material conventional exploration upside for both oil and gas in country given the lack of capital investment over the last 10 years. By constraining realized prices and allowing service and wage costs to rise, the government effectively squeezed margins on operators and reduced incentives to spend capital outside of maintenance capex; hence production and reserves are falling. As prices have started to rise over the last two years, margins are expanding and prices are high enough (on the oil side) to incentivize capital reinvestment into exploration. The industry has started to bring in modern drilling and seismic equipment. The recent use of 3D seismic has improved success rates and horizontal drilling is allowing companies to access bypassed/thinner pay zones on both exploration and mature assets. However, much of the 3D shot in Argentina has been over existing fields to better understand the reservoirs. Apache and other operators are shooting 3D in known hydrocarbon basins; this should result in new field discoveries. Perhaps the greatest potential to unlock resource is being driven by the use of fracture stimulation. Because many of the wells have been drilled to deeper producing reservoirs there is good well control for shallower exploration on bypassed horizons. Page 6

7 Source: Apache Corporation Neuquén Stratigraphy Page 7

8 Source: Madalena Ventures Inc. Neuquén Basin Geology The basin comprises a Late Triassic-Early Cenozoic formation, as well as marine and continental siliciclatics, carbonates and evaporates with the majority of the 4000m infill occurring during the Early Jurrasic-Cretaceous time frame. It is part of an active tectonic system and the final phase of the Andean tectonic movements produced a series of fold and thrust belts against the western portion of the basin. Historically, conventional oil and gas exploration has been focused on the eastern and southern portion of the Neuquén. 3 The source rock for most of the conventional oil and gas opportunities in the Neuquén is the Vaca Muerta and Los Molles shale. These Jurassic age rocks are thick deepwater marine sequences and are prospective throughout most of the basin however the primary target for shale exploration currently is the Vaca Muerta. This organic rich, black and dark grey marine shale was deposited in a reduced oxygen environment and contains Type II Kerogen. 4 The figure below is a cross section, from west to east, of the basin showing depth and thickness changes for various horizons. The deeper targets can reach 16,000ft in the western portion of the play (gas) and moves to a shallower depth of 8,000ft in the eastern portion (oil). Focusing on the unconventional potential, the Vaca Muerta thickness varies significantly along the same cross section from ~1,500ft to ~150ft. The gas window makes up the thickest portion of the play and transitions to gas condensate and oil toward the basin high. There are multiple horizons which are productive for oil and gas. The Sierras Blancas (oil and gas), Troncoso, Avilé and Agrio (oil) are the main producing conventional horizons, the Mulichinco and Lajas are tight gas prone and the Vaca Muerta is the primary shale target. Even though this is one of 3 The Neuquen basin: an overview; John A. Howell, World Shale Gas Resources: An Initial Assessment Page 8

9 Source: EIA Source: TPH Argentina s most prolific and mature hydrocarbon basins, it still holds significant exploration upside as the introduction of modern technology (3D seismic, horizontal wells and fracture stimulation) is unlocking new play types. According to data from YPF s drilling activities in the Neuquén, the Vaca Muerta has reasonably high permeability due to presence of interbedded sands with porosity ranges between 6% and 10% (slightly better than the Bakken and similar to the Eagle Ford). With total organic content between 2% and 9%, OOIP is currently estimated at 8-25mmbbls per section, and all important parameters appear to be very close to known US shales. While we are cognisant that the play is in its infancy, our confidence is boosted by the hundreds of wells that have penetrated the formation, recent vertical wells that yielded bopd IP rates and a few historical analogues that have been completed in the Vaca Muerta. Again this is very preliminary analysis, as several more wells need be drilled to delineate the play. Vaca Muerta Bakken Barnett Eagle Ford Gas Window Eagle Ford Oil Window Haynesville Marcellus Hydrocarbon Oil/Gas Oil Gas Gas Oil Gas Gas Age Jurassic/Cretaceous Upper Devonian Mississippian Cretaceous Cretaceous Jurassic Devonian Depth (TVD ft) 8,000-11,000 8,000-11,000 6,000-9,000 11,000-12,000 5,000-11,000 10,000-14,000 5,000-8,500 Thickness (ft) 150-1,000+ < Porosity (%) EUR (mboe) , , TOC (%) Looking at Vitrinite Reflectance (Ro %) profile of the basin (diagram on the right), we hope to gain an idea of where oil, wet or dry gas prospects are likely to be situated. The dark red and lighter red areas each have a Ro of 1.3 and above, indicating a likelihood of dry gas. Further to the south and east, the transitioning area (in yellow) is expected to yield wet gas and NGL (natural gas liquids); the shallowest part of the basin (in green) is highly prospective for oil. When stepping out further to the west, we believe the thrust below the Andes Mountains has reached a depth which has caused over maturation and to the extreme east, the shallower depth has not reached thermal maturity (plus the shale thins out). Like most shale plays, the Neuquén basin will likely have sweet spots but it is far too early to make any assumptions on the potential location. Page 9

10 Source: Madalena Ventures Inc. Source: Madalena Ventures Inc. While there are very few wells tested to date, there have been hundreds of wells drilled into and through the Vaca Muerta as companies have targeted deeper formations in the Sierras Blancas. A few of these wells have even produced from the Vaca Muerta under openhole completion. The well depicted on the right initially flowed almost 500bopd and has produced 720mbls to date. We believe natural fracturing in the region provided enough permeability for the well to flow naturally and then the application of fracture stimulation at a later date helped boost well performance. Given significant basin-wide faulting we believe it is possible that there will be improved permeability in field sweet spots of the Vaca Muerta due to natural fracturing. There is also a substantial amount of tight gas potential in the Mulichinco, which is shallower than the Vaca Muerta and the much deeper Lajas formation. YPF announced the potential 4.5tcf tight gas Lajas discovery and the Mulichinco has produced some of Argentina s largest gas fields at Sierra Chata (1tcf) and Aguada Pichanca (2tcf). Gross thickness on these formations can reach a couple hundred meters with 4-6% porosity. Historically wells drilled into the formations have not been productive but the introduction of vertical fracture stimulation has opened up a new horizon type in Argentina. *This is an example of a log in the Vaca Muerta taken while drilling a deeper formation in the Sierras Blancas by Madalena Ventures in the Neuquén basin Page 10

11 Gas price IP rate Production cost Prospectivity Source: TPH Shale Oil Economics We have created shale oil models to evaluate the feasibility of the resource play in Argentina, based on a low GOR analogue from our US coverage of the Eagle Ford. Our analysis suggests shale oil projects are currently more viable than unconventional gas projects, as spot market pricing can justify development while gas needs higher contracted prices (~$5/mcf) to work. We model an initial flow rate of 900bbl/d for horizontal wells (3x the uplift from midpoint on vertical results) with 160/acre lateral spacing and 20% prospectivity. Estimates are based on a long term oil price of $60/boe, individual well costs of $5-9mm (depends on depth and number of fracs) and operating costs of $8/bbl. Our base case valuation is $1,400/acre. The tables below contain sensitivity analysis on value per acre basis (highly dependent on drilling schedule). $'000/acre valuation sensitivity to number of wells drilled &IP rate Wells per annum at peak $'000/acre valuation sensitivity to lateral spacing & prospectivity Spacing $ $ ($0.9) ($1.2) ($1.4) ($1.5) 20% $2.0 $1.4 $1.0 $ $0.2 $0.3 $0.3 $0.3 40% $1.9 $2.0 $1.6 $1.4 1,000 $1.4 $1.8 $2.1 $2.2 80% $0.9 $1.9 $2.2 $2.0 1,259 $2.6 $3.5 $3.9 $ % $0.8 $1.5 $2.2 $2.2 $'000/acre valuation sensitivity to long term oil & gas prices $'000/acre valuation sensitivity to well & production costs Oil price Well cost $1.4 $50.00 $65.00 $80.00 $95.00 $0.0 $6.00 $8.00 $10.00 $12.00 $3.00 $0.1 $1.8 $3.6 $5.3 $7.00 $3.2 $2.1 $1.0 ($0.1) $5.00 $0.2 $1.9 $3.6 $5.4 $8.00 $3.0 $1.9 $0.8 ($0.3) $7.00 $0.2 $2.0 $3.7 $5.5 $9.00 $2.9 $1.8 $0.7 ($0.4) $9.00 $0.3 $2.1 $3.8 $5.6 $10.00 $2.7 $1.6 $0.5 ($0.6) Page 11

12 Sweden Ukraine Bolivia Pakistan Paraguay India Chile Norway France Poland Brazil Algeria Libya Canada South Africa Mexico Argentina United States China Source: EIA Source: TPH Shale Gas Economics While the gas market deficit continues to rise, spot market pricing does not justify development of unconventional resources. Rather we believe operators need access to Gas Plus contracts to push forward development. Over time, we feel comfortable that operators will be able to continue to push gas prices higher for industrial users (current contracts being negotiated at ~$5.5/mcf). With Argentina: Relative Shale Opportunity by Country (Tcf) that in mind we have created a model for shale gas development. Using a 10mmcfd IP rate, 6bcfe EUR per well, 160 acre space with 20% prospectivity and a gas plus price of $6/mcf we obtain a risked NAV per mcf of $0.22, or ~$1,399/acre, for the full development. Page 12

13 Source: Pampas Energia, Antrim, YPF Tight Gas Potential We believe there is a significant amount of running room for tight gas Argentina: Natural Gas Prices by Segment ($/mmbtu) development in the Neuquén. There are two targeted horizons in the region which are highly prospective for exploration; the Mulichinco and Lajas. The Lajas recently grabbed YPF & VALE MOU Apache & Pampa Energia MOU Power Plants Distributors industry headlines in 2010, as YPF Compressed Natural Gas successfully drilled 4 vertical exploration wells into the tight gas Domestic Customers formation, southwest of the Lomo La $0.0 $1.0 $2.0 $3.0 $4.0 $5.0 $6.0 $7.0 $8.0 Lata field. YPF estimates the discovery contains ~4.5tcf. The wells flowed 3.5mmcfd on vertical completion, with 6 stage fracturing; we expect to see a greater uplift in production potential through horizontal completion. YPF has entered into a joint venture agreement with Vale to initially co-produce up to 55mmcfd as part of the Gas Plus scheme from the tight gas formation to supply Vale s potash projects. We estimate a total development capex of $1B for the initial stage of the project, as production ramps up to 55mmcfd by 2017 at a growth rate of around 10% per year. Using YPF s development plan, we obtain an NAV per mcf of $0.54 for the initial phase of the project, based on a gas plus price of $7/mcf (price agreed upon for development). Perhaps the best analogue in the US could be Jonah/Pinedale fields in the US. Key Unconventional Wells to Watch Basin Block Well Participant(s) Horizon Well Type Status Neuquén - - Apache (100%) Los Molles Shale Gas Horizontal In Progress Neuquén Neuquén Neuquén Neuquén Lomo La Lata Lomo La Lata Loma Campana Cortadera LLLK.x-2 YPF (100%) Vaca Muerta Shale Gas Horizontal In Progress Los Gusanos x-2 YPF (100%) Quintuco Tight Oil Vertical Testing SOil.X-1 YPF (100%) Vaca Muerta Shale Oil Horizontal In Progress A.E.A Nq. CorS x-1 Madalena (40%), Apache (60%), Gas y Petroleo de Neuquén (10%) Mulichinco Tight Gas Vaca Muerta Shale Gas Vertical Rig en route to location Neuquén Huacalera Huax-1 Americas Petrogas (19.5%), Apache (51%), Energicon (19.5%), Gas y Petroleo de Neuquén (10%) Vaca Muerta Shale Gas Mulichinco Tight Gas Vertical In Progress *HIDENSA, will be carried during the exploration phase Page 13

14 Source: Companies Price Controls Gas prices in Argentina are explicitly regulated by the authorities. The government divides the market into three segments the Households & Small Retailers, Compressed Natural Gas, Industrial/Power Plants and Export. Each segment, with the exception of the export segment, has regulated a price and producers can only export gas after internal demand has been satisfied. Historically, the domestic gas price ceiling has been set at ~$2.5/mcf. Furthermore, producers are mandated to sell a pre-determined proportion of their total production to Argentina: Reported Oil & Gas Price Realisations Antrim Madalena YPF Arpetrol Apache Apco Americas Petrogas Oil Price ($/bbl) Blended Gas Price ($/bbl) households and small retailers a segment of the market which pays between ~$0.3/mcf and $0.5/mcf for gas. Larger and industrial offtakers pay between $0.5/mcf and $2.5/mcf for gas. Unlike it is with gas prices, the government does not formally control oil prices in Argentina. Rather, authorities utilise informal mechanisms to maintain control over oil prices, often engaging in a game of brinkmanship with oil producers and refiners. The shortage of gasoline and diesel in Argentina has led to an increase in the demand for crude, causing refiners to drive up crude prices. Periodically, the refiners pass on the crude price increases to consumers by raising pump prices. Depending on the political situation, the government may allow the refiners to maintain the price increase or may head to the courts to get an injunction compelling the refiners to freeze the prices. In February 2011, Shell was forced by the Courts to roll back the 2.6% fuel price increase it had instituted a month earlier. It is notable that in an election year, the government opted to challenge the price hike, although similar price increases had been tolerated in the past. Page 14

15 Source: Global Data (2009) Source: Instituto Argentino del Petroleo y del Gas Pipeline infrastructure Another side effect of a decade of underinvestment is a considerable drop in pipeline utilization. For instance, country-wide oil production is down 24% from a peak of 890mbopd in Similarly, Argentina s gas production is down 16% from a peak of 4.5bcfd in While, the degree of infrastructure underutilisation would vary across the country s producing basins, the decline in output Argentina: Neuquén Basin Production History Oil Production (mbopd) Total Gas Production (mboepd) suggests that there is sufficient capacity in the system to accommodate near term incremental production and new project developments. In the Neuquén basin, an area that has witnessed increased exploration activity in the past year and is likely to deliver production growth going forward, oil production is down 35% from its 1999 pre-crisis level of 410mbopd; similarly, gas production is down ~19% from its 2004 peak of 3bcfd (511mboepd). Today, Argentina has an aggregate pipeline length of 23,082km and contributes 19.3% to South and Central America s total transmission pipeline network length 5. The country s pipeline network comprises 3,198km of crude oil pipelines, 2,512km of petroleum product pipelines and 17,372km of natural gas pipelines. The largest pipeline operators in the country are Transportadora de Gas del Sur S.A (TGS), Transportadora de Gas del Norte S.A (TGN) and YPF S.A. The table below contains a summary of Argentina s pipeline network. Gas Pipeline Systems Operator Start Point End Point Location Length (Km) Capacity (mmcfd) Transportadora de Gas del Sur S.A. Pipeline (TGS) Transportadora de Gas del Sur S.A San Sebastian Bahía Blanca Onshore 7,089 2,600 TGN North Pipeline System Transportadora de Gas del Norte S.A San Jeronima Buenos Aires Onshore 3, TGN Centro Oeste Pipeline Transportadora de Gas del Norte S.A Beazley San Jeronimo Onshore 2,176 1,125 GasAtacama Holding Pipeline System GasAtacama S.A Coronel Cornejo Taltal, Chile Onshore 1, Carina- Aries Pipeline System Total S.A. Aries Caoadon Alfa Both Tierra del Fuego Pipeline Bridas Corporation San Sebastian Bandurrias, Chile Both Methanex SIP Pipeline Sociedad Internacional Petrolera S.A. Cabo Virgenes Dungeness, Chile Both Gas Andes pipeline Gas Andes S.A La Mora Santiago, Chile Onshore Parana- Uruguayana Pipeline Transportadora de Gas de Mercosur S.A Parana Paso De Los Libres Onshore Gasoducto Cruz del Sur Main Pipeline System Gasoducto Cruz del Sur S.A. Punta Lara Montevideo, Uruguay Both Oil Pipeline Systems Operator Start Point End Point Location Length (Km) Capacity (mbopd) Oldelval Oil Pipeline System Oleoductos del Valle S.A. Allen Medanito Onshore 1, Repsol Oil Pipeline System "Argentina" Repsol YPF, S.A. Lujan de Cuyo Medanito Onshore 1, Oleoducto Trasandino Pipeline A&C Pipeline Holding Company Puesto Hernandez Concepcion, Chile Onshore Brandsen- Campana Pipeline Repsol YPF, S.A. Brandsen Campana Onshore Prodcut Pipeline Systems Operator Start Point End Point Location Length (Km) Capacity (mbopd) Dock Sud- La Matanza Pipeline Repsol YPF, S.A. Dock Sud La Matanza Onshore 34 n.a La Plata- Dock Sud Pipeline Repsol YPF, S.A. La Plata Dock Sud Onshore Lujan de Cuyo- Montecristo Pipeline Repsol YPF, S.A. Lujan de Cuyo Monte Cristo Onshore Villa Mercedes- La Matanza Pipeline Repsol YPF, S.A. Villa Mercedes La Matanza Pipeline Onshore Campo Duran- San Lorenzo Pipeline Refinor S.A. Campo Duran San Lorenzo Onshore 1, Global Data, Argentina Oil Markets, May 2010 Page 15

16 Source: Global Data (2009) Argentina: Key Pipelines Page 16

17 Q1'05 Q2'05 Q3'05 Q4'05 Q1'06 Q2'06 Q3'06 Q4'06 Q1'07 Q2'07 Q3'07 Q4'07 Q1'08 Q2'08 Q3'08 Q4'08 Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Source: M-I SWACO, TPH Oilfield Services Whereas pipeline infrastructure is immobile once installed, service equipment and qualified personnel have had a chance to go elsewhere, leading to a service industry that has dulled over the past decade. Argentina has kept up a moderate rate of activity and still is one of the largest consumers of oil field services in Latin America but has been surpassed in importance by countries like Colombia (which has gone from 23 rigs in 2005 to 110 rigs as of March 2011). The country currently has ~80 rigs running or ~17% of the Argentina: Historical Rig Count continent s activity. Through conversations with local operators, it is our understanding that there is plentiful supply of skilled labour, older drilling equipment and logging/drilling services for conventional oil and gas exploration. The pinch point on supply arises as unconventional and horizontal drilling pick up. Rigs with top drives are in high demand and there is scarcely any frac equipment in country. In the Neuquén basin, pressure pumping capacity is in extremely short supply. We believe there is ~75k horsepower currently in place with additional HP being brought in by Halliburton and new entrants potentially looking to expand in country. However, if we look to the Eagle Ford as an analogue, the potential growth for service demand could be enormous and would take years to build out. TPH estimates the Eagle Ford currently has ~40 frac spreads and 160 rigs running across the play. At 30K HP per frac spread that would be ~1.2mm HP pressure pumping capacity. As the Eagle Ford reaches full development we could see this number double to 2mm HP. To be clear, we do not envision the amount of demand reaching these levels in Argentina, but if the Neuquén proves to be successful, it would not be inconceivable to see demand for newer spec rigs and pressure pumping equipment increase multiple times over. The other big hurdle for smaller operators is the learning curve that many US corporations have had to overcome during the last five years of drilling unconventional resource plays in the states. The entrance of APA, EOG and a number majors should help accelerate the development process if the play proves successful find it and they will come. We believe it is important for smaller operators who lack unconventional drilling experience to partner with one of these larger producers (as many have done). Page 17

18 Source: YPF Refining YPF is the leading refiner in Argentina with ~333mbopd of processing capacity compared to a market total of 635mbopd. In 2010, YPF s refinery utilisation was 93%; we estimate a country-wide utilisation of 82% in 2010, with diesel and gasoline accounting for 40% and 20% of refining yield respectively. Other notable refiners are Shell (110mbopd) and Bridas YPF Refinery: Representative Product Yield Diesel fuel Gasoline Jet fuel Base oils LPG Fuel oil Asphalt Coke (85mbopd). The three companies account for a combined market share of 83%. The four largest refineries in country are La Plata (190mbopd), Capsa (110mbopd), Lujan de Cuyo (105mbopd) and Bridas Campana (85mbopd) which make up 77% of capacity. Crude oil refining activities are regulated by the Argentine Secretariat of Energy. In 2008, the government instructed companies to optimize their production in order to obtain maximum volumes from refining assets according to their capacity. The government further attempted to incentivise companies to invest in the downstream business through the Refining Plus act which entitles companies to receive export duty credits for investments made in new refineries, expansion of existing capacity or conversion of capacity. Currently companies are increasing their refining complexity to handle a greater range of crude slates but there has been minimal investment to date in expansion of existing or new capacity. The YPF La Plata refinery is the largest refinery in Argentina with a capacity of ~190mbopd and 8.2 on the Solomon index (moving towards 8.8). The refinery, located at the port in the city of La Plata, is ~60km from the Buenos Aires. In 2010, the refinery processed around 175mbopd; an implied utilisation of 93%. The feedstock for the refinery comes primarily from the Neuquén and Golfo San Jorge basins. The refinery is currently undergoing civil works to improve heavy processing capability by increasing coking capacity by 30% as well as adding a hydrotreater to reduce product sulphur content to less than 500ppm. The Shell Capsa refinery is the second largest refinery in Argentina with a capacity of ~110mbopd. The refinery, located in the Matanza basin, is only ~4km from the centre of Buenos Aires. The crude oil for this refinery is transported by sea from various fields across the country. While details are limited, it appears Shell has restricted investment (outside of environmental standards being met) in the asset over the past few years, a contentious issue with the government in the past. The YPF Lujan de Cuyo is the third largest refinery in Argentina with a nominal capacity of ~105mbopd and a complexity of 10.7 on the Solomon index (going to 11). Due to its location in the western province of Mendoza and proximity to infrastructure, it has become the primary supplier of refined products to the central provinces of Argentina. The refinery currently processes around ~101mbopd, an implied utilisation of 96%, and receives crude supplies from the Neuquén and Cuyo basins. The refinery is undergoing minor upgrades to increase capacity by ~2.5mbopd and also to reduce product sulphur content to less than 500ppm.Given that Argentina is now a net importer of both diesel and gasoline, we would expect the country to continue to run a high utilisation rate (>90%) going forward. As with other similar initiatives going on in Latin America, the government of Argentina is focused on reducing emissions from gasoline and diesel. The current legislation regulates the reduction of sulphur content to less than 500ppm in diesel through July Page 18

19 Source: YPF Source: BP, TPH Our view: Prices are going higher!!!! Oil creeps to convergence The combination of increasing refined products demand and recent government initiatives, including the Petroleum Plus, Gas Plus, and Refining Plus programs, has made it possible for operators in Argentina to obtain higher prices for hydrocarbons. For instance, upstream oil price realisations have increased by ~$9/bbl since 2Q10, and were as high as ~$58/bbl in March 2011 (versus the capped price of $42/bbl). Further, limited domestic refining capacity, robust economic growth and the Energy Substitution Programme have led to an increase in demand for distillates (distillate demand +4% in 2010). As such, pump prices (ex-taxes) have risen from $54/bbl for diesel and $ $ $ $80.00 $60.00 $40.00 $20.00 $0.00 Argentina: YPF Oil Price Realisation vs. Brent Price Brent price ($/bbl) Argentina: Surplus to Deficit Oil Surplus to Deficit (mbopd) Gas Surplus to Deficit (mboepd) Average oil price - YPF Upstream ($/bbl) $49/bbl for gasoline in 2007 to over $73/bbl for both products in This has allowed domestic refiners to pay higher prices for crude oil, whilst maintaining their margins. As a consequence, crude realisation prices in Argentina have been rising. With international crude prices now well north of $100/bbl, it is reasonable to believe that pricing in Argentina could eventually reach $70/bbl. This would significantly increase the value of producing assets in country. Gas gets a lift Argentina is already a net importer of natural gas and based on forecasted growth demand will outstrip in-country production by ~5.2bcfd in To address the current supply shortfall in the local gas market, Argentina s government has resorted to importing gas from a variety of sources. Today, the measures include purchasing pipeline gas from Bolivia at >$7/mcf and LNG at ~$11/mcf. The gas is subsequently sold into the local market at ~$2/mcf. Argentina has also initiated the construction of a new pipeline to deliver gas to the country from Bolivia. The pipeline is expected to come on-stream in By 2017, Argentina expects to be importing 970mmcfd of natural gas from Bolivia, up from of ~163mmcfd (2009 est.) The gas subsidies, as well as other subsidies on diesel and NGL imports, and the pipeline project is costing the government money; in 2010, the IMF estimated that authorities in Argentina would spend ~1% of GDP on fuel subsidies by the year s end. This equates to ~$3B, or 40% of the country s projected fiscal deficit for the year (based on 2010 GDP estimates). The government s energy bill is expected to continue growing and it is estimated authorities will spend $4.3B on fuel imports in Export Development Canada, Argentina Country Overview, 2011 Page 19

20 Government Initiatives: In March 2008, the government of Argentina began introducing reforms to spur investment in the country s hydrocarbon industry. These include: Gas Plus: The Gas Plus initiative is designed to encourage natural gas production from new reserves, new fields and tight gas formations. Natural gas produced under the Gas Plus scheme is exempt from price controls, provided the producer has an agreement with an industrial offtaker. Under the scheme, producers can sell conventional natural gas at ~$5/mmbtu; natural gas produced from tight formations can be sold at up to ~$7/mmbtu. Although the mechanics of the program are bureaucracy at its best, the essence is quite straight forward. If newly discovered reserves, known unconventional resources or already depleted fields (enhanced recovery) are produced, a firm has the right to have that production admitted into the program. This is where bureaucrats take over. The E&P has to first apply to become part of Gas Plus as a company, then apply to have a specific field admitted and finally the government needs to determine the technical qualification for that field. Once done, individual wells need specific volumetric meters and monitoring systems and only that production can be used for Gas Plus. Now the E&P may have potential offtakers bid up the price for the gas; however the offtakers themselves need to go through a similar process to be allowed to participate in the scheme. Finally, there is still a price cap as under no circumstances may the price be higher than that of the prevailing rate on the Bolivian import pipeline. Bottom line, deals are getting done and the process is moving forward but slowly. Petroleum Plus: The Petroleum Plus initiative is a fiscal incentive created to encourage investments in E&P, with a view to increasing the domestic oil production and reserves. The program entitles companies which achieve pre-specified oil production and reserve increases to export duty credits. This allows production companies to export crude, provided internal demand has been satisfied, and receive a tax credit increasing realized netbacks. Companies which meet the criteria are allowed to recover 55% 70% of the retentions as VAT or tax deductions. The benefits of the programme can be substantial; in 2010, Petroleum plus contributed ~$200mm to YPF s earnings. Refining Plus: Similarly, the refining plus programme rewards refiners for investing in new capacity and/or for upgrading existing capacity. Such refiners are able to export refined products at internationally competitive prices, provided the local demand has been satisfied. Currently a number of refiners are increasing capacity to handle heavier crudes in order to improve throughput capacity. Page 20

21 Source: HIS Herold Recent M&A Activity Period Buyer Seller Deal Type Reserve/ Resource Type Transaction Value ($mm) Proved Reserves (mmboe) Implied $/boe 2011 Gran Tierra Energy Inc Petrolifera Petroleum Limited Corporate Conventional Bridas Corporation; Bridas Energy BP plc Holdings Ltd; CNOOC Limited 2010 Asset Conventional 7, Bridas Corporation; Bridas Energy CNOOC Limited 2010 Holdings Ltd Asset Conventional 3, Sinopec Occidental Petroleum Corporation Asset Conventional 2, EPI (Holdings) Ltd City Smart International Investment Ltd; TCL Peak Winner Investment Ltd Asset Conventional 431 n.a n.a 2009 Pluspetrol Petro Andina Resources Inc Corporate Heavy Oil There have been a number of high profile transactions in Argentina over the past few years, with valuations ranging from $8/ proved boe to $22/ proved boe. Our reserve valuation is in the middle of this range $13/boe. This is based on a long term oil price of $60/boe for an equally weighted portfolio of proved oil and gas reserves. In 2010, the largest transaction in Argentina was the CNOOC and Bridas ~$7B acquisition of BP s 60% interest in Pan American Energy. The price per barrel was ~$8/boe, based on proved reserves of 858mmboe. In the same year, China Petrochemical Corporation, Sinopec, paid ~$12/boe for Occidental s assets in the Golfo San Jorge, Cuyo and Neuquén basins. The $2.5B transaction allowed Sinopec to acquire 202mmboe of proved reserves in Argentina. Regional players have also shown an interest in Argentina. In 2009, privately controlled Pluspetrol acquired PetroAndina Resources for $441mm or $22/boe. The deal gave Pluspetrol the ownership of PetroAndina s producing assets in Trinidad and Tobago and importantly, ownership of El Corcobo Norte (ECN) heavy oil field in Argentina s Neuquén basin. In 2011, Gran Tierra acquired Petrolifera Petroleum for $193mm, an implied value of $21/boe, based on the target s proved reserve base of 9mmboe. Another indicator of the renewed interest in Argentina is the increase in the farm-in transactions and license acquisitions by larger E&Ps and integrateds. Notable examples include Apache, Total and Exxon. Over the years, Apache has built up a 5.2mm gross acre exposure to Argentina s hydrocarbon provinces, including a 1.7mm gross acre exposure to the Neuquén basin. In January 2011, Exxon was awarded to two blocks in the Neuquén basin to explore for tight and shale gas. Shortly after, Total announced it acquired an interest in four Neuquén basin permits with the objective of exploring for shale gas resources. In addition to the asset sales and corporate acquisitions, investors have also shown an interest in equity transactions. In March 2011, Repsol sold 3.8% of its interest in YPF directly to Lazard and other investors for $42.40/share and followed this up with a sale of 7.6% of its interest in YPF (at $41/share) as a secondary offering on to the NYSE market. Repsol plans to sell down a further 3% of its interest in YPF to retail investors in Argentina over the course of Going forward, we expect interest in Argentina to remain strong. We also expect to see smaller and independent E&P s, already present in Argentina, to continue selling stakes to larger E&P and integrateds as the country shale plays are derisked. Page 21

22 Source: EIA Other Basins & Potential Shale Plays Besides all the activity in the Neuquén basin as previously discussed, a good part of Argentina s oil and gas reserves are located in several other basins. Each has slightly different nuances in terms of geology and other micro factors, but our macro view on the pricing regime, potential for enhanced recovery, conventional exploration using modern technology and shale potential still applies to these basins. To get an idea of how production and reserves are situated throughout the country, see the charts based on 2009 data from Argentina s Institute of Petroleum and Gas below. Golfo San Jorge Stratigraphy Golfo San Jorge Overview Located in Central Patagonia, the basin covers an area of ~42mm acres, comprising onshore and offshore sections. The onshore section of the basin covers an area of ~30mm acres, and accounts for 30% of Argentina oil and gas production. The basin is characterised by conventional faulted and high permeability sandstones (at depths of 1,800-9,000ft), which deliver high multiphase fluid flow rates per well. Typical trap mechanisms in the basin include stratigraphic pinchouts, tilted horst blocks, faulted anticlines and structural traps. The basin s first commercial well was drilled in Comodoro Rivadavia in Currently, the Golfo San Jorge basin has ~12,630 wells and produces 267mbopd. Due to its long production history, the majority of Golfo San Jorge s wells are declining and producing increasingly larger volumes of water. Today, the basin produces ~3mmbopd of water. Furthermore, ~41% if the basin s oil production is achieved through artificial lift mechanisms, with Page 22

23 Source: EIA Sucker Rod Pumps, (over 9,000 installed) being widely adopted 7. Other lift mechanisms include Progressive Cavity Pumps (over 1,600 installed) and Electric Submersible Pumps (over 1,300 installed). Crown Point Ventures, a company operating the basin, estimates it would cost ~$6.25mm to drill, equip and tie in five wells in basin. This puts Golfo San Jorge s average well cost at $1.25mm. Other significant operators in the basin include APCO Oil and Gas, Pan American Energy, YPF and Tecpetrol. Golfo San Jorge Shale Potential Golfo San Jorge s shale zone includes the Late Jurassic Early Cretaceous Aguada Bandera formation and the Early Cretaceous Pozo D-129 formation. At depths of up to 15,000ft, these formations have limited penetrations. The Aguada Bandera and Pozo D-129 formations are estimated to contain 50tcf and 45tcf of risked recoverable resources, respectively. San Jorge Shale Potential Formation Aguada Bandera Pozo D-129 Age Late Jurassic/ Early Cretaceous Early Cretaceous Area (km 2 ) 22,000 13,000 Depth (ft.) 6,500 16,000 6,600 15,800 Interval Thickness (ft.) Interval 0-15, ,500 Organically Rich 1,600 1,200 net TOC 2.2% 1.5% Risked Gas In Place (tcf) Risked Recoverable Resources (tcf) Clemente M. Hirschfeldt, Rodrigo Ruiz, Selection Criteria for Artificial Lift System Based on Mechanical Limits: Case Study of Golfo San Jorge Basin, Society of Petroleum Engineers, 2009 Page 23

24 Source: EIA Austral Magallanes Stratigraphy Page 24

25 Source: EIA Austral Magallanes Overview The 44mm acre basin extends from the southern part of Argentina to Chile s Tierra del Fuego area. Conventional gas is produced from the basin s 6,000ft deep Early Cretaceous Spring Hill formation. The basin is the youngest of Argentina s productive province; commercial production from the basin began in The Austral basin is gas prone, with Total being the largest gas producer in the basin. The basin is also primarily responsible for all of Chile s oil and natural gas production. Austral Magallanes Shale Potential We believe the basin s untested shale zones are the Lower Inoceramus and the Magnas Verdes Lower Cretaceous formations. The EIA estimates that the Lower Inoceramus and Magnas Verdes formations each contain 88tcf of risked recoverable resources. Importantly, the Austral Basin is primed for export, as there are pipelines connecting the basin s fields to gas deficient Chile. Potential consumers in Chile include Methanex a methanol producer. Due to the unavailability of natural gas, the company s plant in Chile s Tierra del Fuego area is operating at 26% of installed capacity. Methanex requires ~370mmcfd of natural gas to operate at optimum capacity; the company currently receives ~53mmcfd from its suppliers. A liberalisation of Argentina s gas market or a relaxation of gas export controls will provide an opportunity for operators in the basin to generate low cost revenue by exporting gas, through already installed pipelines, to neighbouring offtakers, such as Methanex. Austral Shale Potential Formation Lower Inoceramus Magnas Verdes Age Early Cretaceous Early Cretaceous Area (km2) 50,700 50,700 Depth (ft.) 6,000 10,000 6,000 10,000 Interval Thickness (ft.) Interval 400 2, Organically Rich net TOC 1.6% 2.0% Risked Gas In Place (tcf) Risked Recoverable Resources (tcf) Page 25

26 Source: EIA Source: EIA Parana Chaco Stratigraphy Parana Chaco Shale Overview Covering an area of 321mm acres Parana Chaco is a large basin that extends into Paraguay, Brazil, Uruguay and Northern Argentina. To date, there has been very limited hydrocarbon production from the basin. On the Brazil side, the surface is blanketed by basalt flows which make seismic data difficult to gather and interpret, and fewer than 150 wells have been drilled in the basin. Parana Chaco s shale zone is believed to lie within the Devonian aged San Alfredo formation. The San Alfredo formation is estimated to contain 521tcf of risked recoverable resources. San Jorge Shale Potential Formation San Alfredo Age Devonian Area (km 2 ) 130,000 Depth (ft.) 5,000 11,000 Interval Thickness Interval ,000 (ft.) Organically Rich 2,000 net 1,000 TOC 2.5% Risked Gas In Place (tcf) 2,083 Risked Recoverable Resources (tcf) 521 Page 26

27 Company Exposure YPF S.A. (YPF: US $17B market cap B): Majority owned by Repsol, the former NOC, remains a dominant player in Argentina s hydrocarbon sector. In 2010, the company produced ~532mboepd and had proved developed oil and gas reserves of 982mmboe by the year s end. YPF s production and reserves come, almost exclusively, from its 117 exploration and production concessions in Argentina. YPF accounts for ~39% of oil and ~39% of gas (including NGL) production in Argentina. In 2010, YPF drilled 4 tight gas wells south of its Loma La Lata field in the Neuquén basin, encountering 4.5tcf of unconventional gas resources in the Lajas formation. In October 2010, YPF started drilling Argentina s first shale oil well, SOil.x 1, at the Loma Campana block, in the Neuquén basin; the company expects the well to prove the productivity of the Vaca-Muerta formation as an unconventional liquid hydrocarbon horizon. The well is the first of a 3 well programme, comprising 2 vertical and 1 horizontal wells; it is expected to be completed in We anticipate that Repsol will provide an update on the well, on the 12 th of May, 2011, during its 1Q11 results presentation. YPF also drilled 4 vertical wells into the Neuquén basin s oil window; the wells flowed between 200 and 400bpdand had low GORs. Three of the wells had 4 6 stages of fracturing; YPF expects EURs to be in line with those expected in the Eagleford. YPF continues to evaluate the results of two tight oil wells, La Caverna x-1 and Dolina x-1, drilled in The company is also evaluating tight gas opportunities through a pilot in the Cupen Mahuida area. The wells in Cupen Mahuida currently produce 3.5mmcfd of tight gas from the Lajas formation. YPF has a strong land position of 3mm net acres in the 30mm acre Neuquén basin. Apache Corporation (APA: US $50B market cap A): Apache is the largest U.S. independent E&P operating in Argentina. The company produces ~43mboepd, ~7% of its total production, from Argentina. APA has a total of 5mm gross acres (4.2mm net), across the Austral, Cuyo, Neuquén, and Noroeste basins. Apache is currently developing the Estación Fernández Oro (EFO) tight gas field in the Neuquén basin will see Apache drill 2 new wells and recomplete 2 existing wells on the field. The EFO field s reservoirs are located in the Lower Lajas formation, at a depth of ~13,000ft. New wells on the EFO field typically have an initial flow rate of 3.7mmcfd of gas and 184bpd of oil. Apache also expects to drill its first well in Argentina s Cuyo basin in 2Q11. In the Neuquén basin, Apache is currently drilling a 10 frac stage horizontal well. This will be drilled to a true vertical depth of 13,800ft and a lateral length of 3,280ft, targeting shale reservoirs in the Los Molles formation. The company expects to complete the well in May Apache estimates it has Tcf of tight gas in place in the Neuquén basin. Expect an update on APA s analyst day 17 th May, Gran Tierra (GTE: US $2B market cap B): The company is currently producing ~2,300bpd of oil and 4mmcfd of natural gas in Argentina (~16% of corporate production). GTE is the largest exploration landholder in the Noroeste basin which is prospective for both conventional oil and gas and recently through a farm out transaction with Apache plans to explore the Santa Victoria block for gas. The company also has a sizeable position (0.2mm net acres) in the Neuquén basin where it is currently producing conventional oil from Sierras Blancas formation. While the company has yet to talk about unconventional potential, proximity to other producers in the region lead us to believe GTE has prospective acreage for the Vaca Muerta shale. Overall, GTE has a total of 1.5mm net acres in Argentina. Page 27