Argentina possesses some of the richest source rocks in the world, consisting of formations with highly favorable characteristics for shale oil and gas production. These source rocks are located in seven sedimentary basins containing multiple formations covering a total area of 308,210 sq km (119,000 sq miles). Of these, the Vaca Muerta Shale in the Neuquén Basin is the largest and represents the best potential to increase Argentina’s oil and gas production in the medium term. Also within this basin are two additional source rocks—the Los Molles and Agrio formations—that have considerable potential for natural gas production.

By early 2012, several foreign companies as well as Repsol-Yacimientos Petrolíferos Fiscales (YPF) were beginning to drill exploratory wells in the Vaca Muerta Shale.

Then, in April 2012, the government of Argentina sent shock waves through the industry when it announced it would take over Repsol’s share of the former state-owned oil company YPF. The government’s action was driven by the ever-increasing energy imports, which Argentina can little afford. Natural gas from Bolivia and spot market LNG make up the bulk of energy imports. The current account deficit is increasing every year and will be about $14 billion this year, mainly because of natural gas imports.

Showing promise

Before the expropriation, Hart Energy Research & Consulting viewed the Vaca Muerta Shale as the most promising of all shale developments outside the U.S. and Canada. Investment by foreign companies in exploratory and pilot wells was proceeding at a rapid pace. These companies, which include large U.S. independents, international majors and small independents from Canada and Argentina that also have concessions in the Neuquén Basin, were exploring the shale resources. What has happened to development since the expropriation?

Reactions by foreign companies to the nationalization were mixed using data on wells drilled by operator by year from the Argentina office of the Secretary of Energy. Chevron, though it had been active in Argentina for years, didn’t drill any wells in 2012. ExxonMobil, which had recently reentered the upstream, postponed drilling on its concession until 2013. Total reduced its well count in 2012 to half that of 2011. Other companies such as Petrobras and Apache maintained a steady drilling pace.

By 2013 most companies were drilling again at about the same pace or higher than in 2011. This was driven by several factors, beginning with Chevron’s agreement with YPF in July 2013 to jointly invest $1.24 billion to drill 161 wells in the Vaca Muerta Shale. Chevron and YPF recently announced that they would spend another $1.6 billion on unconventional development in the Neuquén Basin, including drilling another 170 wells. Chevron operates the joint venture (JV) and will drill 140 gross wells in 2014.

Shale concessions

Also in 2013, recognizing that the country needs investment by companies with expertise and financial strength, the federal government made certain significant changes to the fiscal regime through Federal Decree 929. Key provisions of the decree include a change to the oil import tax that raises the internal oil price to $83/bbl, the lifting of some of the restrictions on repatriating profits earned in Argentina and price supports for natural gas production. The situation also improved in December 2013 after the government agreed to pay Repsol $5 billion for its assets that were expropriated in Argentina.

The government added specific provisions for shale concessions that allow concession extensions over the Vaca Muerta to be extended by 35 years rather than the standard 25-year extensions. On natural gas prices, the government replaced the Gas Plus plan, which was an agreement between a producer and an industrial user that rarely yielded more than $4/MMBtu, with a guaranteed price of $7.50/MMBtu. The hitch with the gas price support is that companies must maintain a high production rate determined by the government over a fixed time frame to get the higher price. This may be difficult for companies that are primarily drilling shale gas wells because of the need to continuously drill wells to maintain a production rate. A second potential pitfall is that the difference between the fixed gas price and the $7.50 price is to be paid directly to the operating companies by the government.

YPF has continued to drill wells in the Vaca Muerta, closely following the plan laid out by Repsol-YPF. With 169 wells as of mid-2014, YPF has drilled the majority of Vaca Muerta wells to date, mostly on its Loma La Lata Block. Production from these wells at the end of April 2014 was reported to be 19,000 boe/d. Most of the wells are vertical or directional and are producing from the Quintuca Formation, which YPF considers part of the Vaca Muerta.

There are two potential advantages to drilling vertical wells, at least early in the development phase. First, they cost less to drill. Second, the Vaca Muerta is very thick, up to 305 m (1,000 ft) or more, and the geological properties of the shale can vary dramatically over the vertical section making it difficult to determine where to land the lateral portion of a horizontal well. Vertical wells can be logged over the entire formation providing useful data over the vertical interval. YPF also reported results from one horizontal well that produced an initial rate of 450 bbl/d of oil.

The JV between Chevron and YPF is focused on the Loma Campana Block, which is adjacent to the Loma La Lata Block and within the oil window. Production from this concession started in February 2014, and by March it was producing nearly 10,000 bbl/d of oil. Out of the planned 141 wells in the first JV agreement, 82 were completed in 2013, and the companies plan to drill 170 wells this year. Additionally, Chevron will spend $140 million to explore in the Chihuido de la Sierra Negra concession 100 km (62 miles) north of the Loma Campana concession.

Other companies are drilling again in the Vaca Muerta Shale. ExxonMobil drilled five wells in 2013. Its latest horizontal well in the Bajo del Choique Block in May 2014 tested at an average rate of 770 bbl/d of oil. The well was drilled to a total measured depth of 4,572 m (15,000 ft) with a 1,000-m (3,280-ft) lateral.

Shell has four producing oil wells in the Vaca Muerta on its Sierras Blancas Block. Production began in March 2013 at 465 bbl/d of oil. Shell will increase its unconventional drilling capital to about $500 million in 2014 from $170 million in 2013. Total is planning to drill 12 horizontal wells and will conduct pad drilling on the Agua Pinchana Block in the wet-gas window.

A world-class play

The Vaca Muerta certainly has the potential to become a world-class shale play. Much will depend on the economics of the play, which are driven primarily by oil and gas prices and well costs. The new gas pricing will create a good incentive if it holds up. Though exploratory wells have cost upward of $15 million, drilling and completion costs should come down in the development mode. YPF’s current well drilling and completion costs average $11 million, but the company reported that it expects to reduce them to $7.5 million on the Loma Campana Block by deploying pad drilling and walking rigs.

Still, the industry must use caution when comparing well costs in Argentina with costs in the U.S. The typical Vaca Muerta horizontal well has a lateral length of about 1,000 m, which is considerably less than the 1,524-m to 3,048-m (5,000-ft to 10,000-ft) laterals that are common in most U.S. shale plays.

Despite the recent activity, oil and gas investment in Argentina is risky. The macroeconomic picture has continued to deteriorate. Inflation remains at 25% per year or higher, the currency was recently devalued, and labor unions continue to strike for higher wages to keep up with inflation. Though the decline in overall oil production has been arrested, having reached 7% per year in 2011, natural gas decline rates have increased and are approaching 6% per year. Since most of the current account deficit stems from natural gas imports, the current Vaca Muerta oil window development plans will not likely improve the situation. There is considerable shale gas potential in the Neuquén Basin, in the Vaca Muerta and other formations. If it wants to reduce gas imports, the government may need to increase the gas price support to bring it closer to the cost of LNG imports and eliminate the production requirement as a condition for obtaining the higher price.

Meanwhile, companies will continue to focus on shale oil. According to Juan Jose Aranguren of Shell, if total spending in Argentina over a six-year period were to reach $300 billion to develop Vaca Muerta, the country would be oil self-sufficient starting in 2020 and would keep producing for as many as 40 years.

In early 2012 before the nationalization of YPF, Hart Energy developed a scenario indicating that Vaca Muerta shale oil production could average 82,000 bbl/d in 2020 with the drilling of 1,825 wells at a cost of about $18 billion to $25 billion. After the nationalization this seemed to be unrealistic, but now it again appears achievable. YPF and Chevron are on track to drill significant numbers of wells, and other companies may follow as long as the proper incentives remain in place.