KEY CHALLENGES

Nationalization trend

Latin America's various waves of nationalisations throughout the 20th and continuing into the 21st centuries are barriers to the country achieving its shale gas revolution because they discourage investment. In 2012, Argentina compulsorily acquired Repsol's majority stake in YPF S.A. ("YPF"), Argentina's NOC. Argentina has also nationalized its pension funds and Aerolíneas Argentinas, an airline. In addition, the ongoing controversy between Argentina and Britain over the Falkland Islands has hindered oil exploration in the region.

Although Venezuela's NOC Petróleos de Venezuela S.A. was nationalized in 1976, the Bolivarian Revolution led by Hugo Chávez and continued by Nicolas Máduro saw the nationalization of Venezuela's energy, mining, construction, telecommunications and other sectors. Chavez' presidency set the stage for Evo Morales' nationalization of Bolivia's hydrocarbon sector when he took office in 2006 and a trend towards nationalizations by Ecuador's Rafael Correa.

Dwindling investor friendly policies

Investment in Latin America's shale has also been challenged by governmental policies in some countries. For example, Argentina's handling of its inflation figures, exchange rate restrictions, default on its international debt and general regulatory uncertainty are not conducive to foreign  investments. Brazil's policy focus on offshore pre-salt activities has deterred its shale gas development; its significant domestic content policies are also expected to unnerve some investors. In addition, some Latin American countries' labor policies and price caps on the domestic market have also deterred potential investors in the shale industry.

Indigenous and environmental protests

Another reason some investors might shy away from investing in Latin American shale is because of the risk of indigenous and environmental protests. For example, in 2011 an Ecuadorean court fined Chevron over US$8 billion for alleged environmental and social damage to Ecuador's Amazon region caused by Texaco, which Chevron acquired in 2001. The lawsuit was brought by around 30,000 Amazonian tribespeople and communities who claimed that above-average cancer rates and other severe problems were due to toxic waste-water/sludge being dumped into rivers supplying their drinking water. Although Chevron awaits a hearing from the international arbitration tribunal in The Hague on the claim, it has lost millions of dollars in production and fees.

Brazil's proposed Belo Monte dam, which is being developed to provide hydroelectric power to the country, has also encountered significant opposition to its construction from indigenous and environmental groups. Indigenous groups protest against the harm they argue Belo Monte will bring to their way of life and environmentalists contend that the dam will unleash irreversible environmental consequences, such as greenhouse gas emissions and deforestation.

LOOKING FORWARD

In order to develop its shale resources, Latin America will need to attract a significant amount of capital investment to finance the technology, infrastructure and human capital necessary to effect a US-style shale revolution. Investors will likely be attracted to the region's economic growth, which is expected to propel natural gas use from 7.6 tcf/d in 2012 to 16 tcf/d in 2040, and its vast estimated technically recoverable shale gas reserves (around 1,431 tcf). The region's coastal geography, which provides convenient avenues of export to European and Asian markets, is also attractive to investors. Moreover, some argue that Latin American governments' and companies' prior experience working with extractive industries should lower barriers to entry for shale development. However, the aforementioned nationalization trend and indigenous and environmental protests in the region throw up obstacles to achieving the investment necessary to fully develop Latin America's shale gas resources. This means that it will likely take more time for Latin America to achieve its shale gas revolution than it did for its North American neighbor.

ARGENTINA

On the basis of the [reserves], recent regulatory developments and our clients' interests, we have identified Argentina as the country with the best prospect for shale gas development in Latin America.  (…)

Industry background

Argentina's oil and gas history dates back to the early 20th century when YPF, Argentina's NOC, was formed. Oil production in the country peaked in the late 1990s, with natural gas production starting to decline in the 2000s. Nevertheless, Argentina's demand for energy has remained strong.

Various explanations for the decline in Argentina's oil and gas production exist. The Argentine government has attributed the decline to underinvestment and excessive dividends at YPF, which was privatized in the early 1990s. Argentina relied in part on that rationale when it compulsorily acquired Repsol's majority stake in YPF in 2012. This government takeover may have deterred investment in Argentina's unconventional resources.

As of the end of 2013, compensation negotiations between YPF and Repsol began. It is hoped that the compensation deal to be negotiated will bolster investor confidence in Argentina's oil and gas sector and encourage the billions of dollars necessary to exploit Argentina's unconventional resources. Argentina has estimated reserves of technically recoverable shale gas resources of 802 tcf. These are the second largest reserves of shale gas resources in the world after China, according to the EIA Report.

Legal framework

The Province of Neuquén, where most of the shale gas activity is taking place, has not yet amended its oil and gas law to include specific unconventional oil and gas regulations. However, it has issued limited regulations on unconventional gas, namely:

• Hydrocarbons Law No. 2,453 of the Province of Neuquén ("Law");

• Provincial Executive Order No. 3,124 implementing Hydrocarbons Law No. 2,453 of the Province of Neuquén; and

• Provincial Executive Order No. 1,447.

In addition, in September 2013, a National Senator sent a draft bill to the National Congress to regulate the extraction of shale oil and gas through the hydraulic fracturing method ("Bill"). The Bill was sent for debate to the Commission of Environment and Sustainable Development and the Commission of Mining, Energy and Fuels of the National Senate. As of January 2014, the Bill has not been debated.

Ownership of hydrocarbon resources

In 1994, the National Constitution was amended, transferring eminent domain over natural resources to the provinces. However, the amendment did not make any specific reference to who (i.e. the provinces or the federal government) had jurisdiction over those resources. As Article 1 of National Law No. 17,319 ("Hydrocarbons Law") provided that the ownership of hydrocarbon deposits belonged to the nation state, this situation caused conflicts between the provinces and the federal government over regulation in relation to natural resources. Most, but not all of such conflicts were overcome in 2007 when National Law No. 26,197 ("Short Law") was enacted, which effectively transferred ownership and authority to grant control of hydrocarbons to the provinces, save for offshore areas beyond the 12 mile limit of provincial jurisdiction.

(…)

In Argentina, at the Federal level, the key players in the oil and gas sector are:

National Secretariat of Energy ("Secretariat"). The Secretariat's role consists of:

o enforcing the hydrocarbon regime at the federal level;

o preparing the national energy policy;

o controlling offshore concessions and permits beyond 12 marine miles; and

o regulating the inter-provincial and cross-border transportation concessions, the

hydrocarbon foreign trade and the liquefied petroleum gas market.

Commission on Strategic Planning and Coordination ("Commission"). The Commission was established by Executive Order No. 1277/2012 and given the following tasks: o establishing a sanction regime;

o setting a plan of minimum budget and investment goals;

o maintaining the Registry of Hydrocarbon Investments;

o controlling and approving investments plans of IOCs and NOCs in the hydrocarbon

sector; and

o publishing reference prices for the sale of hydrocarbons and fuels.

Federal Hydrocarbon Council ("Council"). The Council was created pursuant to National Law No. 26,741. The Council's functions are to:

o promote coordinated action by stakeholders regarding National Law No. 26,741 (i.e. the law calling for national self-sufficiency in hydrocarbons and expropriating 51% of YPF, hereafter "YPF Law");
o guarantee compliance with YPF Law's purposes; and

o establish a national hydrocarbon policy

Ente Nacional Regulador del Gas ("ENARGAS"). Established under National Law No. 24,076 ("Gas Law"), ENARGAS is a regulatory authority whose functions are to regulate the transportation, distribution, commercialisation and storage of gas.

Federal Organisation of United Oil Products ("OFHEPI"). OFHEPI is an organization composed of the federal government and the oil producer provinces. OFHEPI jointly represents the common interests of the oil producer provinces in respect of the exploration and exploitation of the hydrocarbons reserves located within their territories.

Energía Argentina Sociedad Anónima ("ENARSA"). Created pursuant to Law No. 25,943, ENARSA is a partially state-owned company (53% national state, 12% provincial governments and 35% traded on the stock market). ENARSA has ownership of all offshore concessions and permits, which are located within 12 to 200 nautical miles and that were not subject to a concession at the time of their creation. ENARSA calls for bids in these offshore areas and is also in charge of the LNG program.

YPF S.A. YPF is an NOC (51% national states and 49% provincial governments). YPF currently is the sole holder of exploration and production rights and is also associated with provincial owned companies ("POCs") and IOCs. YPF is in a privileged situation as it is the right holder of most of the areas with unconventional potential in the Province of Neuquén.

(...)

In Argentina the provincial governments perform the following functions:

• granting exploration and exploitation concessions and permits;

• imposing and collecting royalties and taxes;

• granting transportation concessions within their territory; and

• regulating hydrocarbons exploration and production within their territory.

The sections below will concentrate on Federal regulations and the regulations of the Province of Neuquén.

KEY CONTRACTUAL ISSUES

Exploration term

A distinction is drawn between the following categories of areas (Articles 10 and 22 Law):
• Proven - These are areas which reflect sedimentary or stratigraphic traps where the existence of potentially commercially exploitable hydrocarbons has been established. No exploration permits are granted in these areas.

• Of secondary interest - This category deals with areas that contain oil and gas reserves but:

o are inactive;

o have reverted to the provincial government; or

o come from abandoned tenders.

No exploration permits are granted in these areas.

• Possible - These are areas not included in the "Proven" and "Of secondary interest"

categories. Exploration permits are granted as follows:

o First period, up to four years;

o Second period, up to three years; and

o Third period, up to two years.

This means that a permit can be granted for a total of nine years in possible areas.
• High-risk exploratory - This category contains areas that present significant geological complexity. Exploration permits are granted as follows:

o First period, up to six years;

o Second period, up to four years; and

o Third period, up to three years.

Permits can therefore be granted for a total of 13 years in high risk exploratory areas.

For all categories:

• an extension period of up to one year is available at the election of the permit holder, who must justify it on technical grounds;

• the minimum exploration permit area is 100 km2 (Article 23 Law); and

• the maximum exploration permit area is 100,000 km2 (Article 24 Law).

Relinquishments

Article 25 Law provides that upon completion of:

• the first period, the permit holder shall relinquish 50% of its permit area;

• the second period, the permit holder shall relinquish 50% of the remaining permit area;

• the third period, the permit holder shall return the entire remaining area, unless it exercises the right to use the extension period. In this case, the permit holder shall relinquish 50% of the remaining area.

Exploitation term

Exploitation concessions are granted for 25 years (Article 34 Law), plus any unelapsed period of the exploration permit (Article 22 Law). Article 34 Law further provides that exploitation concession can be extended for up to 10 years.

Delineation exploitation concession

Pursuant to Article 32 Law, "To the extent possible, each of the parcels covered by a concession should match up with all or part of the commercially exploitable oil and gas productive traps".

Article 32 further states that the boundaries of each block may not exceed the area retained under the exploration permit.

If an exploitation concession does not result from an exploration permit, the exploitation

concession area may not exceed 250 km2 (Article 33 Law).

NOC participation and carry

Save for the de facto compulsory participation of ENARSA in offshore exploration permits and concessions licences, there is no requirement as to a compulsory minimum state participation at the Federal level. However, pursuant to Article 12 Law, the Province of Neuquén shall, if it so determines, receive a participatory share (payable in cash or, exceptionally, in kind) of the products of the exploitation activity.

In addition, Article 114 Law provides that some areas may be reserved for

exploration/exploitation by state-owned companies (i.e. at the provincial level, these are

generally the POCs). Private companies can associate with state-owned enterprise to work on the areas reserved for state-owned companies. The state-owned company percentage participation interest will be determined in the association contract (Article 118 Law). In 2010, consortiums led by YPF were awarded most of the areas offered for hydrocarbon exploration in Neuquén in association with Neuquén's POC (Gas y Petróleo de Neuquén). Therefore, IOCs will need to enter in a JV with YPF and Gas y Petróleo to conduct exploitation for unconventional exploration in Neuquén.

Water resources rights

Companies that need to use large quantities of water to develop a project (for example, an unconventional hydrocarbons project) must obtain a permit from the relevant provincial hydrologic authority. In the Province of Neuquén, the authority in charge of granting such permits is the Hydrologic Resources General Office.

In addition, the Bill includes regulations on the use of water. In particular, it prohibits the use of groundwater that could be destined for human consumption and/or soil irrigation during the drilling and closure of wells stages in unconventional hydrocarbons projects.

Flaring

Flaring is regulated both at the Federal (Resolution No. 236/1993 and Resolution No. 143/1998 of the Secretariat of Energy) and provincial levels.

In the Province of Neuquén, the flaring and venting of gas is regulated by Law No. 2,175 and Executive Order 29/2001. In essence, these regulations provide the following:

• the release of gas must always be authorised by the Sub-Secretariat of Energy of Neuquén;

• if gas is released into the atmosphere, such gas must be flared;

• the release of gas into the atmosphere at gas wells is prohibited;

• for oil and gas wells, as from January 1st, 2000, only one cubic meter of gas per cubic meter of oil can be released into the atmosphere;

• release and flaring of gas at oil and gas wells in excess of the limit indicated above is highly restricted and exceptionally allowed on a case by case basis and for a limited period of time only, provided the operator or concessionaire of the relevant deposit files a presentation with the Sub-Secretariat of Energy of Neuquén justifying the need to release and flare gas in excess of such limit;

• for oil and gas wells, the gas released in excess of the legal limit is subject to the payment of a fee for atmospheric contamination equivalent to 500% of the average sale price of natural gas at well heads in the Province of Neuquén;

• the release of gas at oil and gas wells requires the filing of a monthly sworn statement with the Sub-Secretariat of Energy of the Province of Neuquén providing information on the quantity of gas released from the wells; and
• release and flaring of gas activities must comply with the national and provincial environmental protection regulations (e.g. National Environmental Law No. 25,675 and

Provincial Environmental Law No. 1,875).

Economic stabilization

Federal laws do not provide for stability provisions. However, in the Province of Neuquén, Article 58 Law provides that for the duration of the permits and concessions, the holder of exploration permits and exploitation concessions shall pay all of the provincial and municipal taxes and duties that are in force on the date of the award. It further provides that the Province of Neuquén may not tax titleholders with new taxes or increase existing ones, except for overall increases in provincial taxes, those collected by the national government or taxes that replace the latter.

OTHER ISSUES TO CONSIDER

Domestic market obligations

In the Province of Neuquén, subject to Article 12 Law (right of the Province of Neuquén to receive a share of the hydrocarbons produced), owners of exploitation rights are free to dispose of the hydrocarbons they extract. These hydrocarbons may be transported, processed, and marketed, along with their derivatives, notwithstanding compliance with the regulations issued by the Provincial Executive Branch (i.e. the Governor of the Province of Neuquén) on technical/economic bases that seek a reasonable degree of fluidity in the supply and profitability on the domestic market and stimulate exploration and exploitation of hydrocarbons (Article 6 Law).

There are DMO at the Federal level in Argentina:

• pursuant to Article 6 Hydrocarbons Law:

o when the domestic production of liquid hydrocarbons is not sufficient to cover internal

needs, all hydrocarbons of domestic origin shall be made available for use in the

domestic market, save when technical reasons make this unadvisable;

o the production of natural gas may be used, firstly, for the exploitation of the reservoirs

from which it is extracted and of others in the area, whether or not they belong to the

concessionaire. Secondly, any state-owned company that provides a gas distribution

service has a preference right to acquire, within acceptable periods of time, any amounts in excess of the first use at agreed prices, provided that such prices shall ensure a fair rate of return on the investment involved and taking into account the special characteristics and conditions of the reservoir; and o the marketing and distribution of gaseous hydrocarbons is subject to regulations issued by the National Executive Branch. Currently, natural gas exports can only be made after domestic demand is satisfied.

• Whilst there are no specific restrictions on crude oil exports, export taxes (e.g. Resolution No. 394/2007), which vary according to international oil prices, effectively set a "ceiling" on the producers' share of export income.

The [data] below sets out how the Federal law addresses some of the issues to be considered by IOCs if DMO are applicable:

Issues Argentinian Regime

DMO extent
The Executive Branch has the discretion to require that all hydrocarbons of domestic origin shall be made available for use in the domestic market (Article 6 Hydrocarbons Law).

Shale gas exports
The Executive Branch shall allow the exportation of any hydrocarbons or products not required for the adequate satisfaction of domestic needs, provided that these exports are made at reasonable commercial prices (Article 6 Hydrocarbons Law).

Sale price of gas sold in thedomestic market
During any period in which the domestic production of liquid hydrocarbons is not sufficient to cover internal needs, the Executive Branch can set the prices for the marketing of crude oil in the domestic market. If it does so, such prices shall be equal to those established for the respective state-owned company that charged in

transactions with third parties, but not less than the price levels for imported oil on similar terms and conditions. However, if the prices for imported oil increase significantly because of exceptional circumstances, they shall not be considered in setting prices for marketing in the domestic market, and in such event, they may be set based on the state-owned company's actual costs of exploitation, any depreciation that is technically appropriate, and a reasonable rate of return on any investments that such state-owned company may have made, adjusted for inflation and depreciated (Article 6 Hydrocarbons Law).

Repatriation of proceeds and profits

On 25 October 2011, Executive Order No. 1722/2011 established the obligation to repatriate 100% of export proceeds for companies producing crude oil and any by-products, natural gas and liquefied gas.

Definition of domestic market

There is no definition of "domestic market" provided in the legislation.

Fiscal regime and tax incentives

In the Province of Neuquén, Article 61 Law provides that once a month, the holder of an

exploitation concession shall pay to the provincial government, as a royalty on the production of the liquid hydrocarbons extracted from the wellhead, a percentage consisting of 12%. The Provincial Executive Authority may reduce such percentage to 5%, taking into consideration the productivity, conditions and location of the wells.

In Argentina there are no tax breaks or investment incentives to incentivise investments in depleting fields.

Third party and state access to infrastructure

Pursuant to Article 42 Law, subject to the satisfactions of the concessionaire's needs, when:
• facilities have excess capacity; or

• there are no technical reasons that would prevent it, the concessionaire is obliged to transport oil and gas for third parties without discrimination against any persons, at the same price under identical circumstances.

Article 42 Law further states that should the provincial government opt for payment of the royalty in kind (as per Article 67 Law), the concessionaires will have to provide the provincial government with the transmission capacity needed for the purposes of transporting the volumes to be delivered as payment of the royalty in kind.

MARKET UPDATE

Recent developments

Currently, there is no shale gas project in production in Argentina. However, there are great expectations in relation to the "Vaca Muerta" shale gas project located in the Province of Neuquén. This project has one of the largest estimated shale gas reserves in the country. YPF (the holder of the project's rights) is executing several agreements with different companies (such as Chevron, Dow Chemical and Petronas) to perform exploration activities in the "Vaca Muerta" deposit. (…)

Companies

The following companies are currently involved in shale gas operations in Argentina:

YPF/Dow Chemical
Agreement to explore in Neuquén. YPF had drilled 60 wells by November 2012.

ExxonMobil, Apache, Chevron, EOG, Royal Dutch Shell, Total, Americas Petrogas and Madalena Venture

Expressed an interest in the Vaca Muerta field in Neuquén.

YPF/Cnooc Ltd/Bridas Corp
Agreement to explore in Neuquén.

YPF/Chevron
Agreement to explore in Neuquén.

Wintershall/Gas & Petróleo de Neuquén
Agreement to explore and develop a block in the Vaca Muerta field.

This column is based on an excerpt from the report “Shale Gas: An International Guide” from Baker & McKenzie. Republished with permission.

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