Talking PointApril 27, 2012

Last tango in Beijing?

As Argentina seizes control of YPF, China avoids an M&A catastrophe

“No one in their right minds” will want to invest in Argentina now, warned Felipe Calderón, Mexico’s president, after Buenos Aires nationalised YPF earlier this month.

One reason for his fury: Mexico’s state oil giant Pemex holds a stake in Spanish energy firm Repsol, YPF’s erstwhile owner.

But Calderón might need a gentle reminder that Mexico was one of the first to nationalise its own oil sector, grabbing assets from the US and the British to form Pemex in 1938. The US ambassador at the time predicted a buyer boycott and that the Mexicans “would be drowned in their own oil”. But a retaliatory blockade failed with the onset of the Second World War and the nationalisation is now remembered fondly enough in Mexico, with a civic holiday.

How about in Argentina today?

This time it’s less about the British and Americans than the Spanish and the Chinese. Prior to seeing YPF nationalised, Chinese oil major Sinopec was reportedly on the verge of buying the company from Repsol. Now the situation is unclear.

How is Sinopec involved?

The more cynical types sniff an Argentine plot to grab YPF and sell Repsol’s former stake to Beijing. After all, unlike Repsol, the investment-crazy Chinese would surely put their cash into opening new oil fields, as Buenos Aires had been demanding of the Spanish firm?

A flaw in this analysis is the speculation that the Kirchner administration may not even have been aware that Repsol was close to selling to Sinopec. Caixin magazine revealed “late-stage” discussions only a few days ago, with the rumour that Sinopec had signed a non-binding deal to buy YPF for $15 billion. But the Repsol may have held off on presenting the terms to the Argentine government.

Speculation about the timing of the nationalisation nevertheless still abounds. Another take on how events played out: did President Cristina Fernández de Kirchner hurry it through to avoid having to seize an asset from the Chinese themselves?

It has a plausible ring to it: Kirchner could ill afford to alienate the Chinese, now a leading lender to Argentina and a major buyer of many of its commodities.

Last year, Sinopec made its first foray into Argentina, buying Occidental Petroleum’s assets for $2.5 billion. Local policymakers were complimentary. “The vision that the Chinese have is to go forward without worrying too much…the big North American, British and Spanish energy firms are more selective about where they invest in the world,” former energy secretary Emilio Apud explained to Reuters.

But whether Sinopec would have been more cautious had it grasped that full nationalisation was on the policy agenda is an unknown. Chinese companies have grown more sensitive to political risk as they invest in far-flung locations. Last year’s experience in Libya was chastening, for instance, with the rebel government threatening to penalise Chinese companies for Beijing’s apparently pro-Gaddafi stance in the early days of the revolt.

Back to Argentina, and any investment in YPF looks increasingly problematic. Repsol has already warned that it will take legal action against anyone attempting to invest in the nationalised firm. It is also Sinopec’s leading partner in Latin America, following the sale of 40% of its Brazilian arm to the Chinese for $7.1 billion in 2010. Relations would surely take a turn for the worse if Sinopec looked to be profiting from Repsol’s Argentine debacle.

But won’t Argentina be keen on some kind of deal?

Perhaps: although it looks politically awkward for Kirchner to sell a chunk of YPF back to a foreign firm so soon after taking control of the company on national interest grounds.

“Our model is one of recovering sovereignty,” Argentina’s president told reporters this month, although her administration has been careful to add that it doesn’t necessarily intend to run YPF as a purely state-owned entity. Planning Minister Julio De Vido was sent out on a tour of foreign oil firms last week, partly as a reassurance mission but also to tempt potential partners, said Argentine media.

As of last weekend, there had been no dialogue with Sinopec. “But that doesn’t mean that we won’t have contacts in future,” De Vido explained.

The other obstacles to Sinopec’s future involvement?

China’s domestic media have been talking up the common ground in Sino-Argentine relations. After all, both nations are developing countries, says China Securities Journal, and both like to find ‘government’ solutions to problems.

But that ignores the usual Chinese motivation for investing in overseas oil: to secure crude for export (sometimes to be sent back to China itself).

That seems to fly in the face of statements coming out of Buenos Aires about using YPF to secure self-sufficiency in oil. That might also be a factor in why Brazil has been more of a focus for China’s oil investments than Argentina to date. Alongside the Repsol tie-up, Sinopec has paid $3.54 billion to Portugal’s Gaip Energia for a 30% stake in another deep-sea project off the Brazilian coast.

Nor is there any guarantee that a bid for YPF would go through anyway, says the Financial Times. It exhibits CNOOC’s failure to secure BP’s stake in Argentina’s second-largest oil producer, Pan American Energy, as evidence.

The bid for Pan American, made by Bridas Corp, a venture co-owned by CNOOC, broke down in November last year. Recriminations swiftly followed, with BP suggesting that CNOOC had failed to secure the requisite regulatory approvals.

CNOOC has since blamed BP for the deal’s collapse. But the decision to pull back also came less than two weeks after Kirchner had ordered energy and mining companies to repatriate export revenue, in a bid to slow capital flight from South America’s second-biggest economy.

Is Beijing more likely to become Argentina’s lender of last resort?

Against this more negative outlook, there is also plenty of excitement that Argentina could be home to massive hydrocarbon resources. That’s especially true of its Vaca Muerta shale field, potentially the world’s third-largest.

The investment required to extract large volumes of shale oil will also be huge, of course. But fortuitously, the shale sector has been a target of Sinopec’s, not least because China is thought to possess rich reserves itself.

“Shale gas and shale oil are very critical resources for China’s future,” Fu Chengyu, Sinopec’s chief executive, told reporters in March. “Unconventional gas will be a key investment area for Sinopec and a critical area for us for production [in the long term].”

Still, given the commercial sensitivities surrounding foreign shareholdings, Beijing might choose to rely more on a loans-for-oil policy as an alternative to direct investment in Argentina.

This tallies with a recent report from Inter-American Dialogue, a Washington-based think tank, which highlights how China’s policy banks have provided $75 billion of loans to Latin America since 2005. Venezuela, Brazil, Argentina and Ecuador have secured 91% of the funds on offer, with China Development Bank and China Exim Bank serving up the majority of loans.

So far Argentina hasn’t signed up for oil-backed financing. An earlier $10 billion loan was offered as a credit line for railway investment, to cover payments to Chinese companies (see WiC70).

Inevitably, Chinese financial assistance looks critical for countries struggling to access the global markets. That’s a particular issue for Argentina, Ecuador and Venezuela: all three of whom face interest rate spreads well above those of similar-sized Latin American economies.

By comparison, Chinese terms on Argentina’s $10 billion borrowing seem to have been less onerous: China Development Bank charged 600 basis points over Libor, well below the 935 basis point spread on Argentine sovereign debt.

The common refrain has been that China will then extract its pound of commercial flesh elsewhere, especially by locking in a crude oil supply at long-term discounts.

But the Inter-American Dialogue report could find little evidence of this happening in practice. When a bank like CDB commits capital, yes, the recipient of the loan pledges to export hundreds of thousands of barrels of oil a day. But China isn’t getting its crude on the cheap, as the contracts usually stipulate that market prices are paid for the oil.

Why else might Sinopec be cautious?

Before grabbing back YPF, Argentina blamed Repsol for allowing the company’s oil production to fall by more than a fifth in the decade to 2010. But the Spanish firm has countered that the real reason for the decline is political, with price caps and export taxes making further investment uneconomic.

Of course, the irony here is that Sinopec faces something similar in China, where the price of petrol is also capped. That’s even been a factor in its push to move upstream, as well as into international markets.

The impact of the caps became evident again in March when Sinopec executives reported an Rmb35.8 billion ($5.7 billion) annual loss in its domestic refining operations (although overall net profit was still up 1.4% to Rmb71.7 billion).

Caps on prices hurt most when the international oil price spikes, agree HSBC’s Paul Spedding and Kevin Lian, in a research piece published last month that identifies a decade of declining margins for the Chinese oil majors.

WiC has written too about griping from Sinopec and its peers on the domestic pricing regime, including high-profile disputes with the NDRC – China’s top economic planning agency – on how best to calculate refining losses due to price-capping (WiC132), as well as the persistent efforts of Sinopec bosses to influence the public debate on why fuel prices should be allowed to rise (WiC96).

Sinopec continues to argue that domestic fuel prices are unsustainably low, especially as the pricing mechanism was introduced at the end of 2008 when crude had dropped to below $40 per barrel. Oil prices remain above $120 today.

In response the NDRC has said that the current scheme is moving towards a set up in which gasoline and diesel prices track the price of international crude much more closely. New rules have been introduced allowing tariffs to be adjusted when the 22-day moving average of crude increases by more than 4% on its previous price move. Prices were raised on March 20 by 8% after the average climbed more than 10%, HSBC notes.

But China’s oil majors are still dissatisfied and grumble that the increases aren’t being enforced as fully as the rules require.

Despite this, HSBC thinks more petrol price hikes are unlikely until Beijing feels it has fully conquered the nation’s inflation problem. Policymakers are more likely to act too when international oil prices are lower.

Fresh from this frustrating experience with price controls at home, it’s all the more puzzling why Sinopec was interested in buying YPF at all. The Argentine government after all sets a $42-per-barrel cap on the price of crude sold to its own refineries. That makes it tough for YPF to make money.

Kirchner may in fact have done Sinopec’s shareholders a favour by derailing its acquisition.

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