For years now America's energy renaissance has made headlines and attracted the interest of investors, many of whom have grown rich. The scale of America's shale resources is impressive indeed:
- Shale oil: total estimated reserves 223 billion barrels (58 billion economically recoverable today).
- Shale gas: 2,421 trillion cubic feet (Tcf) of natural gas (665 trillion recoverable).
However, those figures pale in comparison to what the Energy Information Administration (EIA) estimates are available outside the US: 3.134 trillion barrels of oil, and 20,451 Tcf of natural gas. In fact, when it comes to economically recoverable shale oil reserves, Russia is No. 1 with 75 billion barrels, followed by the US, China, and Argentina respectively. When it comes to shale gas reserves, the US is No. 4 behind China (1,115 Tcf), Argentina (802 Tcf), and Algeria (707 Tcf).
In this article I'd like to point out Argentina's potential as the world's next great oil and gas juggernaut. However, there are substantial political and economic risks involved with investing in Argentina, which is why I'd advise investors to avoid YPF
) , Argentina's largest oil and gas producer, and instead cash in on this potential boom with oil service experts Baker Hughes Incorporated
) and Schlumberger Limited
Risks associated with Argentinian oil and gas production
YPF, as the largest oil and gas producer in Argentina, seems like the obvious first choice when it comes to profiting from an Argentinian shale boom. And unlike the other major Latin American oil and gas producer, Petrobras
which I recently recommended against investing in
, YPF has several things going in its favor.
- In recent years its been able to raise prices on its oil and gas.
- Its CEO, Miguel Galuccio, is a former Schlumberger executive and appointed by Argentina's current president.
- Revenues have been growing strongly, an average of 27% annually over the last three years.
- It has recently signed agreements with Chevron, Baker Hughes, and Schlumberger as part of a five year, $37.2 billion investment program aimed at increasing oil production 29% and gas production 23% by 2017.
- It has access to the Vaca Muerta shale formation, estimated to hold 16.2 billion barrels of oil and 308 Tcf of natural gas.
- Its operating and net margins are slightly above industry average.
Indeed, unlike the horribly mismanaged Petrobras, YPF seems to be well run -- so why not invest? One simple reason: political risk
In 2012 Argentina's government expropriated 51% of Repsol's shares in YPF. It provided no compensation (though Repsol was later able to sue the government and settled for $5 billion in Argentinian bonds).
The nationalization of YPF didn't necessarily hurt investors directly and, in fact, soon afterwards the government raised prices substantially.
However, with Argentina's inflation rate at 35%, the days of energy price increases are likely coming to an end, which means YPF's earnings growth prospects are dimming in the face of populist political pressure -- the government has already capped gas prices at $2.5/Mbtu conventional and $5.5/Mbtu shale gas. With a strong precedent set for government seizures and meddling, long-term investors should look elsewhere to cash in on this potential energy bonanza.
Why Baker Hughes and Schlumberger are better choices
There are three reasons for investing in Baker Hughes and Schlumberger instead of YPF: technology, political pull, and dividend growth opportunity.
Regarding these companies' strong political connections, consider that Argentina's president appointed a former Schlumberger executive to be president of YPF (as well as forced YPF to recruit Baker Hughes' Juan Geroby to head the company's unconventional resources division). When dealing in Latin America, political clout is a very good thing to have.
No matter who is drilling for oil and gas, drilling in shale requires the best technology, such as Schlumberger's StimMAP, Baker Hughes' Intellifrac 3D seismic mapping technology, and Baker Hughes' Logging While Drilling systems, which monitor subterranean pressures in real time.
On top of this, analysts at S&P Capital IQ expect both Baker Hughes and Schlumberger to be very strong dividend growers over the next decade, with dividend growth rates of 16% CAGR and 12.5% CAGR respectively.
When it comes to investing in foreign oil and gas production, the direct route, (foreign oil and gas producers) can be fraught with excess dangers and risks that long-term investors need not expose themselves to. So called "pick and shovel" providers (oil services companies), are a much better risk-adjusted method for cashing in on the potential shale boom.
Baker Hughes and Schlumberger not only have the business and political connections to operate in the Byzantine world of foreign boardrooms and oil and gas exploration, but also offer great dividend growth opportunities.
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