Capital Flight Endangers Argentina's Energy Future
Following the announcement at the end of 2013 that the U.S. Federal Reserve will gradually taper its quantitative easing program in the new year, several key emerging markets are showing signs of financial instability. Perhaps the shift in U.S. monetary policy alone would not have caused so much volatility had it not coincided with the sudden bout of political instability in Thailand, Ukraine, Brazil, and Turkey; nonetheless, nervous investors are now guarding against signs of instability, preparing to take capital back to safer markets in Europe and the United States.
This current situation bodes ill for Argentina in particular because of its already weakened fiscal and financial positions -- with the value of the peso in a fragile state and domestic hoarding of dollars continuing to undermine confidence in its sovereign tender, the ongoing instability carries the danger of pushing the credit-starved country over the brink.
All eyes on shale
If Buenos Aires does have one trump card, it would be the massive oil and gas deposits in the Neuquen Province at the foot of the Andes. The Vaca Muerta field there alone holds the world's fourth largest oil reserve, estimated at around 22.5 billion barrels. Developing these resources would not only boost exports and raise the value of the collapsing peso but also relieve Argentina of the backbreaking energy import bill, which has been rising 25% annually and reached $13 billion in 2013.
Expanding oil and gas development promises to be Argentina's greatest chance for economic salvation. However, the peso's precarious position and Argentina's credit problems weigh heavily on the operations of the country's state-owned oil company, YPF . The project at Vaca Muerta still needs billions of dollars in additional investment, and even though Chevron has agreed to fund $1.5 billion in a joint venture with YPF, the project still needs additional capital to develop new technology and expand production. But so far, despite the best efforts of YPF and the Argentine central bank, the much-needed investments do not appear to be forthcoming.
YPF doing its utmost, but Kirchner must go first
Under its CEO Miguel Galuccio, YPF has done much to encourage investments by successfully lobbying the government to increase prices at the pump and spearheading ongoing negotiations to compensate Repsol SA for the shares in the Vaca Muerta oil field that Buenos Aires had expropriated in 2012. Galuccio hopes that these efforts will ease the sale of bonds abroad and bring the much needed capital for developing Vaca Muerta.
Furthermore, Argentina's central bank has signaled its determination to honor foreign debt by opting to protect its international reserves over upholding the long-term government policy of protecting the peso's exchange rate.
However, considering the country's fundamental weaknesses and the current market environment, these efforts are too feeble to draw capital to Argentina. Currency traders expect to see further devaluations of the peso in the fourth quarter when export earning from soybeans weaken. And with annual inflation already at nearly 30% and economic growth projected at no more than 1.5%, international investors are right to be wary. In addition, barriers to returns such as price caps, trade barriers, and a ban on sending profits abroad stand in place and remain too politically challenging for the current government to abolish.
Look to fundamental weaknesses
Chevron is strangely still upbeat about its joint venture with YPF in the Neuquen Province. Its CEO John Watson noted that there are already about 16,000 barrels/day of oil being produced from Vaca Muerta and that this figure will only grow, promising investors that they "should see benefits in production before too long." However, Chevron has yet to address the risk inherent in investing in a country as unpredictable and unstable as Argentina.
The crux of the matter is that 2014 is not a good year to invest in emerging economies, and those that are more fragile than others are certainly not exempt. Argentina's debt and currency problems have induced the country to engage in disastrous policies in the past. The Austral Plans of 1985 and 1987 and the open convertibility of the peso are only few of many such examples.
The signal that investors are looking for is one that ameliorates political risk, and incumbent president Cristina Kirchner with her unwavering position on debt restructuring does not inspire confidence. Therefore, YPF's medium-term prospects are weak and unlikely to change until after the presidential election in 2015.
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The article Capital Flight Endangers Argentina's Energy Future originally appeared on Fool.com.Yong Kwon has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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