Cry for Me, Argentina

by Ivan Martchev | April 20, 2012 12:06 pm

In 2009, MSCI (NYSE:MSCI[1]), the benchmark index provider for investors in emerging markets, reclassified Argentina from emerging market to frontier market[2]. This demotion of sorts culminates the long history of pragmatism-lite policies of numerous Argentine governments.

The latest governmental action to seize control[3] of YPF (NYSE:YPF[4]) from Spain’s Repsol (PINK:REPYY[5]) is only a continuation of the demonstrated hostility toward foreign investors that will further isolate the country in the investment community, hurting FDI and economic growth for years to come.

“Oil reserves have dropped 30% in the past years and the demand keeps growing. If I were an oil company and I had wells here and in other countries, I’d go to the other countries,” former Argentine energy secretary Emilio Apud said in 2010.

Problems with Argentine oil production have been known for a decade as high taxes and royalties have discouraged investment in new exploration and production despite the established potential of Argentine energy deposits. The economy has seen rapid GDP growth at an average of 7.3% a year since 2003, creating a surge in demand, while oil production has gradually eroded after peaking in 1998.

Clearly, the 35% tax on profits and a 12% royalty on the value of oil production have been the main culprits, as well as the occasional price controls on fuel prices. Energy multinationals with Argentine operations have been following Emilio Apud’s advice for years, developing their reserves in more friendly jurisdictions.

However, Argentine hostility toward foreign investors goes further than YPF, as FDI data shows. In the first half of 2011, foreign direct investment in Argentina dropped 30% from a year earlier — the biggest decline among the region’s major economies — while the whole of Latin America and the Caribbean received a 54% boost in FDI, according to the relevant U.N. regional commission. In the period, Argentina received $2.4 billion in foreign investment, compared with Brazil’s $44.1 billion, Mexico’s $10.6 billion and Colombia’s $7 billion.

I suspect that after the nationalization of the controlling stake of YPF, next year the above FDI dichotomy will likely repeat. Inept economic policies have been repeating over and over for 100 years[6], and one would think that after such diligent persistence, a lesson had been learned.

The above is likely to suppress valuations for the country’s whole equity market, even if no further nationalizations come, much in the same way valuation for the Russian market[7] remained depressed after the infamous Yukos affair (Russia’s largest energy company Gazprom (PINK:OGZPY[8]) trades with a forward P/E of 2.55 and a price-to-book valuation of 0.55). In the case of Russia, valuations also are depressed because of the extreme leverage to the price of oil and exposure to Europe[9], while Argentina has a more balanced economy.

Argentine governmental actions begin to resemble those of Hugo Chavez of Venezuela — another Latin American country with huge potential that is badly lagging in economic progress because of failed socialist policies. Argentina will compensate Repsol somewhat, but this likely will not be based on the going market rates for oil companies with similar reserve profiles.

While respect for property rights is key to the success of any emerging market, Repsol should take some blame for failing to find an angle with the famously strong-armed Kirchner administration. It looks bad to pay generous “90% of net income” dividends to owners while oil production is falling; YPF shows a five-year average dividend yield of 8%, which is extreme for any major energy company that is actively investing in growing production and reserves — precisely Kirchner’s argument that Repsol was milking YPF and not serving the needs of the country.

It is unfortunate for YPF that other Argentine oil companies have managed to grow reserves and invest in the same (hostile) environment. British Petroleum (NYSE:BP[10]) controls Pan American Energy LLC in Argentina. Between 2001 and 2010, Pan American increased its oil and gas production in Argentina by 70% from 142,000 to 241,000 barrels of oil equivalent per day. This allowed it to double its market share, taking it from 9% to 18% of total hydrocarbon production (natural gas and oil) in the country. Pan American also invested in exploration as it maintained an organic reserve replacement rate of 143% without purchasing assets.

The YPF seizure is unlikely to derail the Argentine economy geared toward the boom in agricultural and hard commodities, but the totality of misguided policies of the Kirchner administration certainly has the potential to do so as many Argentine governments have done over the years. YPF’s seizure did derail one thing, though: investor interest in Argentine stocks.

Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the above mentioned securities.

Endnotes:
  1. MSCI: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSCI
  2. frontier market: http://investorplace.com/2012/04/msci-tries-to-make-frontier-markets-safer/
  3. governmental action to seize control: http://investorplace.com/2012/04/ypf-what-happens-when-politics-become-a-factor/
  4. YPF: http://studio-5.financialcontent.com/investplace/quote?Symbol=YPF
  5. REPYY: http://studio-5.financialcontent.com/investplace/quote?Symbol=REPYY
  6. 100 years: http://economix.blogs.nytimes.com/2009/10/06/what-happened-to-argentina/
  7. Russian market: http://investorplace.com/2012/04/brics-report-from-russia-with-oil/
  8. OGZPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=OGZPY
  9. exposure to Europe: http://investorplace.com/2012/03/europe-can-rally-more-but-it-isnt-fixed-financial-stocks/
  10. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP

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