Journally Speaking: Immunized from nationalization

Shale oil’s short-cycle production could immunize foreign investors against the risk of expropriation; governments taking private property for public use. This may provide an opportunity for the increasingly risk-averse global oil industry.

A new paper, “Shale Renders the ‘Obsolescing Bargain’ Obsolete: Political risk and foreign investment in Argentina’s Vaca Muerta,” authored by the Baker Institute’s Gabe Collins, Mark Jones, Jim Krane, Ken Medlock, and Francisco Monaldi, discussed this opportunity in detail.

The discussion focused on Argentina, which is a well-known risky area for foreign investment, especially in the oil industry. “Argentina is a risky place for foreign investors, with frequent political swings from right to left, weak enforcement of contracts and property rights, endemic corruption, combative unions and a volatile macroeconomic environment,” the authors wrote. In 2012, the Argentine government completely expropriated the Spanish oil giant Repsol’s in-country holdings, which shocked foreign investors interested in the country’s world-class natural resources.

And yet, between 2013 and 2019, oil supermajors returned and invested $13 billion to develop oil and gas concessions in Argentina. But compared with the investment in traditional oil like Repsol and others, the investment after 2013 was almost entirely concentrated in the Vaca Muerta shale oil field.

With 153,000 boe/d in average daily production in 2018 and 250,000 by the middle of 2019, the Vaca Muerta had become the most productive shale play outside North America, according to the report.

Shale production has specific attributes that protect it from expropriation, the authors argue. They explained that, unlike conventional extraction, shale, which requires horizontal drilling and hydraulic fracturing, has a very short production cycle, and has fewer geological risks than other frontier exploration areas.

“Shale oil and gas production has changed the incentive structure and the political calculus around resource-nationalist behavior,” they wrote. “The willingness of foreign investors to return to Argentina in the immediate aftermath of a major expropriation provides some evidence of these changes, as does the data showing that the new investments are heavily weighted toward shale.”

“The immense interest by foreign investors will almost certainly eventually trigger a series of midstream and downstream investments—including export facilities and domestic infrastructure to support industrial use—that will be crucial to full monetization of the resource,” they added, noting that the surge of shale investments has continued even after the 2019 elections that ousted the “pro-business” administration of Mauricio Macri.

Understanding why shale developments may be less vulnerable to political interference or expropriation is crucial to understanding the future of oil and gas globally, the authors said.

“To keep output stable, shale producers must maintain a constant rate of well-drilling—resembling more a manufacturing process than a traditional oil play. If the drilling is interrupted, shale production collapses,” they wrote. “Moreover, shale investors begin to recover their capital relatively quickly, sometimes after just one well has been completed. If the well is profitable, investors can bet again on another one, and so on.”

If the government violates the terms of contracts, companies can simply stop investing, and oil production would quickly collapse. The government would find that its seized assets have almost no production or cash flow.

Foreign investment into resource-nationalist Argentina signals a “watershed event” for the global petroleum industry and for the study of political risk in foreign investment, the authors argued.

“While we focus here on Argentina, the case may have implications for the global oil market. If risk is institutionally and structurally lower in shale investments, the realization could encourage wider proliferation of shale production outside the US, all else equal,” they said.

The authors believe that this will create a wider geographic distribution of oil production, surpassing the major producers that dominate the oil market. This could have a long-term impact on the landscape of the oil market.