Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?

Primary Credit Analyst: Fabiola Ortiz, Mexico City (52) 55-5081-4449; fabiola.ortiz@standardandpoors.com Secondary Contact: Luciano D Gremone, Buenos Aires (54) 114-891-2143; luciano.gremone@standardandpoors.com

Table Of Contents
Argentina's Resources Are Vast Mexico Has Strong Prospects Brazil Remains On The Sidelines Other Countries Also Have Solid Potential Resources Are Abundant, But Tough To Tap Related Criteria And Research

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Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?
(Editor's Note: The boom in production of U.S. shale oil and gas could potentially move the country to energy self-sufficiency by 2017 and is already affecting supply dynamics globally. The boom is having a material positive effect on some industries and a negative impact on others. Standard & Poor's Ratings Services believes that the anticipated development of vast shale reserves outside the U.S. in countries, including China, Argentina, Australia, Mexico, Venezuela, Brazil, and Canada, as well as in Europe, will transform the global oil and gas supply landscape, bringing massive new production online globally. Industries that Standard & Poor's believes could benefit over the longer term from a shale energy boom in Latin America include oil and gas transportation, petrochemicals, power generators, energy-intensive manufacturing (cement, paper, and glass), steel and metal making, infrastructure construction/project finance, and nitrogen fertilizer producers.) Although the shale energy boom in the U.S. has been the big story for the past few years, Latin America is sitting on some of the biggest shale resources in the world. The U.S. Energy Information Administration (EIA) analysis of resources in 41 countries estimates a total of 345 billion barrels of technically recoverable shale oil and 7,299 trillion cubic feet (Tcf) of shale gas. Latin America holds 1,975 Tcf of shale gas resources, and 72,800 million barrels of shale oil of the total. Argentina, Mexico, and Brazil are among the 10 countries with the largest shale gas technically recoverable resources in the world. Latin America's shale gas resources are seven times higher than its conventional hydrocarbon reserves. Yet despite this vast potential, the pace of exploration and development has been slow, as huge drilling costs and environmental concerns remain major obstacles. Over time, however, we believe developing these resources could benefit Latin American oil and gas companies' credit quality by diversifying their hydrocarbon resources and boosting cash flow generation and profitability. Overview Latin America holds the highest technically recoverable resources shale oil and gas in the world. Argentina, Mexico, and Brazil stand to benefit the most by tapping these unconventional energy sources. However, due to high costs, environmental concerns, and other conventional projects that are being prioritized, development has been slow so far.

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Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?

Chart 1

Argentina's Resources Are Vast

Argentina appears to have the largest shale gas resources in the region. According to EIA's estimates, it ranks second globally with 802 Tcf of gas, just after China's 1,115 Tcf. Argentina's major shale gas resource is located in the Vaca Muerta formation in the Neuquina basin. Argentina has an estimated 802 Tcf of risked, shale gas in-place out of 3,244 Tcf of risked, technically recoverable shale gas resources. State-owned YPF S.A. and international energy giants, such as Chevron, ExxonMobil Corp., and Total S.A., are currently, or would be relatively soon engaged in, exploratory drilling and in the early stages of extracting shale gas. YPF holds the largest lease for shale gas in the country, and it has been successful in drilling and producing shale gas. The company's capital expenditure program of $820 million will focus on upstream investments, particularly to develop unconventional deposits in the Vaca Muerta shale formations. Moreover, we believe that YPF would need private participation to finance and develop this program at a higher pace. For example, the recently signed agreement between YPF and Chevron for the exploitation of Vaca Muerta would speed up the levels of investments. However, heavily regulated hydrocarbon prices, high inflation, foreign exchange controls, and unpredictable economic policy continue to be the main challenges in developing Argentina's unconventional hydrocarbon resources.

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Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?

Mexico Has Strong Prospects

According to the EIA report, Mexico has the world's sixth-largest shale gas resources and Latin America's second-largest, with about 545 Tcf, and the seventh-largest shale oil resource with approximately 13 billion barrels of oil. These resources are mainly located in northeastern Mexicowhich is essentially a continuation of the Eagle Ford shale play in the U.S. As of the date of this report, the national oil company, Petroleos Mexicanos (PEMEX), had identified 175 exploratory opportunities in five plays. However, the exploration phase has been slow. In 2011, PEMEX began to drill for shale gas at the Emergente-1 well with an initial rate of about 2.9 million cubic feet. The company has drilled eight additional wells, and during the first quarter of 2013, it recorded an initial production of 400 barrels per day of shale oil with an API gravity of 38 from the Anhelido-1 well in Tamaulipas. The company will continue to evaluate the potential production of shale hydrocarbons in Mexico, but it estimates that it will invest only 2% of its total budgeted capital expenditures--about MXN6.5 billion annually (about $500 million)for this purpose in the next couple of years. However, we believe that the energy reform, which the Congress is expected to receive in September, could significantly boost investments in this field. Like other companies in the region, we believe that PEMEX has in the medium term other projects with higher priority on the conventional resources side. For example, PEMEX is currently focusing on deepwater exploration and production for conventional oil in the Gulf of Mexico. PEMEX expects that commercial shale gas production may begin after 2015.

Brazil Remains On The Sidelines

Brazil also has large shale gas resources, about 245 Tcf according to the EIA report, mainly in the country's southeast. Brazil's most prolific petroleum basins are offshore, while its shale gas is locked up underground. However, we believe that the country's main focus in the next three to five years will be to develop its large offshore oil reserves. This will be mostly driven by the national oil and gas company, Petroleo Braileiro (Petrobras), that accounts for more than 90% of the country's total oil and gas production. Petrobras has a $236 billion capital expenditures plan for 2013-2017, out of which about $147 billion will be for exploration and production, $107 billion of which is to develop offshore oil reserves.

Other Countries Also Have Solid Potential

Colombia's oil and gas industry regulator, Agencia Nacional de Hidrocarburos, held its first auction of shale gas blocks in 2012. Additionally, Ecopetrol S.A. gave more emphasis to develop unconventional hydrocarbons in its current strategic plan by setting a specific amount to develop these resources. The company has established that one of its main priorities in the coming years will be assessing the potential of unconventional resources and future joint ventures with strategic partners to develop these resources. According to the EIA report, Colombia's Middle Magdalena Valley basin has technically recoverable shale gas and shale oil of about 18 Tcf and 4.6 billion barrels, respectively. Even though the company had only drilled three stratigraphic wells, as of the date of this report, we expect it to drill additional wells during the next five years.

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Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?

Venezuela's shale oil resources are much smaller than its estimated proved conventional oil reserves. The EIA estimates that Venezuela has about 297.6 million barrels of proved oil reserves, but only 13.4 million barrels of unproved shale oil. However, Venezuela's conventional and shale reserves are similar: 195 Tcf for proved natural gas reserves and 167 Tcf for unproved wet shale gas (see table 1). The national oil and gas company, Petrleos de Venezuela S.A. (PDVSA), hasn't begun developing unconventional hydrocarbon resources because it has been concentrating on developing the conventional reserves, which we expect it to continue doing so. The extra heavy crude oil (mostly at the Orinoco belt) makes up Venezuela's largest hydrocarbon reserves. Bolivia, Chile, and Paraguay also contain large shale gas resources. However, exploratory shale drilling in these countries has just begun.
Table 1

Shale Oil And Gas Reserves In Latin America

Estimated proved natural gas reserves (Trillion cubic feet) Argentina Bolivia Brazil Chile Colombia Mexico Paraguay Uruguay Venezuela Total 12 10 14 3 6 17 195 257 802 36 245 48 55 545 75 2 167 1,975 Unproved wet shale gas TRR*

*TRR--Technically recoverable resources. Source: U.S. Energy Information Administration, as of June 2013.

Resources Are Abundant, But Tough To Tap

Although Latin America has the highest shale oil and gas potential of any region in the world, development is still in its infancy due to several reasons. First and more remarkable, countries like Mexico, Brazil, and Venezuela still have abundant conventional reserves and resources to develop, which will be the producers' main priority in the next few years. With mature basins, declining production, and no major conventional discoveries in recent years, Argentina appears to be one of the countries with more need of rapid development of unconventional resources to stop continued declining production. Second, the oil and gas companies are evaluating whether the exploration of these resources is economically viable. As the U.S. experience has demonstrated, drilling for shale oil and gas is more costly because it requires new technologies and equipment. Additionally, shale gas wells' depletion rates are higher than for conventional ones, which also raises costs. Environmental regulations are another hurdle. Hydraulic fracturing involves injecting water, sand, and volumes of

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Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?

chemicals into the well to fracture the rocks and release the natural gas. Currently, most of the Latin American countries don't have deeply developed specific regulations regarding environmental issues. We believe that the bulk of the oil and gas production in the region will continue to come from conventional resources in the next three to five years. However, companies, such as PEMEX and Ecopetrol, have already earmarked specific amounts in their capital expenditure programs to develop shale oil and gas. In addition, Latin American oil and gas companies can learn from the U.S. experience in tapping these resources. In our opinion, there is high potential for Latin America oil and gas companies to extract profits from unconventional resources over the longer term. We believe that greater development of these resources will benefit these companies' business risk profiles by diversifying their hydrocarbon resources and would significantly increase the amount of nonconventional reserves. Moreover, once these resources are developed, it will improve companies' cash-flow generation and profitability. However, we don't expect this to have an impact on the sector's credit quality or to become key rating factors at least for the next two to three years.

Related Criteria And Research

Game Changer: Industry Winners And Losers From The U.S. Shale Revolution, May 21, 2013 Oil From U.S. Unconventional Resources Is Unlikely To Displace Canadian Crude Oil Exports Any Time Soon, June 17, 2013

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