Latin America Still Offers Energy Plays

by Aaron Levitt | May 10, 2012 12:46 pm

Latin America Still Offers Energy Plays

Argentina’s recent decision to expropriate and nationalize its largest energy company, YPF (NYSE:YPF[1]) has sent shock waves throughout the energy-investment community all across South America.

Deeming the oil industry one of “national public interest,” Argentinean President Cristina Fernandez de Kirchner’s government will now own and operate 51% of YPF[2], with majority owner Spain’s Repsol YPF (OTCBB:REPYF[3]) seeing its stake dwindle to just 6%. The remaining assets of YPF will be divided among federal agencies and provincial governments.

Overall, the Argentinean government accused the oil company of not investing enough back into its local fields and criticized it for not producing enough oil. Energy imports into South America’s third-largest economy rose nearly 110% last year.

The country’s actions set a dangerous precedent.

Locally, what’s at stake is Argentina’s 774 trillion cubic feet of technically recoverable shale gas and unconventional reserves, the largest in Latin America[4]. The nation is not alone in its populist momentum. Bolivia recently moved to expropriate a local unit of a Spanish power-grid operator, and Venezuela’s nationalization ambitions are well-known. Meanwhile, populist politics continue to rule investment decisions in Nicaragua and Ecuador.

Many natural-resource hunters have practically given up on Latin America as these worries persist. Nonetheless, for every Argentina or Venezuela that has begun to unwind decades of progress, there are plenty of Latin American nations that recognize the importance of foreign capital, especially in the energy sector. For investors, the continent still offers many opportunities.

A Wealth Of Reserves

Despite heightened tensions in a few nations, new oil and natural gas discoveries are drawing investors into Latin America in spades. As maturing conventional oil fields dwindle and energy demand surges, exploration efforts across the continent continue to intensify.

There are several reasons to be bullish on the region.

According to the Latin American Energy Organization (OLADE), proven reserves across LATAM currently make up around 20% of all global oil reserves. And that number doesn’t even include all of the unconventional and offshore deepwater potential of the region. Brazil’s deepwater Tupi formation alone, located 2,000 meters below the surface of the sea, may be enough to boost current Brazilian oil and gas reserves by over 50%. The area is estimated to have five to eight billion barrels of recoverable light oil and natural gas in its pre-salt reservoirs.

The potential doesn’t stop with the BRIC leader. Colombia has emerged as Latin America’s fourth-biggest oil exporter as it has roughly doubled production since 2006. The nation is close to hitting its target of one million barrels per day[5] after $5.08 billion worth of foreign direct investment flowed into the oil sector last year. The nation is partnering with various companies to beef up its pipeline and exporting infrastructure. Peru also has the potential to become a significant producer of hydrocarbons due to its vast untapped reserves. According to the Oil & Gas Journal, Peru had 582 million barrels of proven oil reserves in January 2012. The bulk of these are onshore and can be tapped using advanced drilling methods such as hydraulic fracturing[6]. Those new drilling techniques, along with the opening of South America’s first liquefied natural gas (LNG) export terminal, have enabled Peru to become a natural gas exporter despite rising domestic consumption.

Finally, Uruguay has begun to explore its offshore potential. While the nation doesn’t feature the same pre-salt geography as its neighbor Brazil, officials there are hopeful that Uruguay could harbor its own “elephant find.” The country recently began accepting bids on 15 different blocks offered for exploration[7].

Portfolio Options

While there are some worrisome situations, the region’s long-term potential for oil and gas is certainly there, and the bulk of the continent’s countries have embraced foreign investment in the energy sector. For investors, the region’s future as a major energy producer is just too good to ignore.

Several publicly traded energy companies, such as OGX Petroleo e Gas Participacoes (OTCBB:OGXPY[8]) are available for purchase. However, the only direct ways to play the region are through Brazilian energy giant Petroleo Brasileiro (NYSE:PBR[9]), known as Petrobras, and Colombia’s Ecopetrol (NYSE:EC[10]).

Pumping out more than 2.7 million barrels of oil equivalent a day, Petrobras is one of the largest energy producers on the planet. However, like the other super-majors, the company has been experiencing dwindling production from its legacy fields. That’s why it has unveiled one of the largest CAPEX plans in history.

Between 2011 and 2015, Petrobras plans to spend a record $224.7 billion on exploration[11] to tap Brazil’s deep-sea oil deposits and more than double production by the end of the decade, to about 6.42 million barrels per day. Already, that spending has trickled down to various service providers, such as FMC Technologies (NYSE:FTI[12]) and Oceaneering International (NYSE:OII[13]).

As I’ve noted before[14],[15] that sort of higher CAPEX spending is a necessary evil for energy companies and essential to long-term growth. Because of this high spending, now could be a good time to strike on shares of the Petrobras. Since the broader Brazilian market has been flat or down for almost two years, Petrobras has also been on the decline for the same time period. So shares that cost around $42 at the beginning of 2010 now trade for half that, at a forward P-E of just 7.

While Petrobras is the continent’s energy stalwart, Ecopetrol is the fast mover. Responsible for the bulk of Colombia’s energy production, the company has seen its proven net reserves grow by 63% over the last three years. Meanwhile, the company has continually improved earnings on the back of its rising production.

Despite the fact that shares have surged since Ecopetrol’s recent earnings win, the stock can still be had for less than its historical P-E of 16.5. Add the company’s 3.3% dividend yield and you have recipe for Latin American energy success.

Endnotes:
  1. YPF: http://studio-5.financialcontent.com/investplace/quote?Symbol=YPF
  2. President Cristina Fernandez de Kirchner’s government will now own and operate 51% of YPF: http://www.reuters.com/article/2012/05/03/us-argentina-ypf-idUSBRE8421GV20120503
  3. REPYF: http://studio-5.financialcontent.com/investplace/quote?Symbol=REPYF
  4. the largest in Latin America: http://investorplace.com/2012/03/play-argentinas-shale-revolution-with-apache/
  5. The nation is close to hitting its target of one million barrels per day: http://www.ft.com/intl/cms/s/0/0d759dca-92c2-11e1-9e0a-00144feab49a.html#axzz1uPHMrRhL
  6. hydraulic fracturing: http://investorplace.com/2012/04/10-ways-to-play-the-fracking-boom/
  7. The country recently began accepting bids on 15 different blocks offered for exploration: http://www.reuters.com/article/2012/03/29/uruguay-energy-idUSL2E8ETCP120120329
  8. OGXPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=OGXPY
  9. PBR: http://studio-5.financialcontent.com/investplace/quote?Symbol=PBR
  10. EC: http://studio-5.financialcontent.com/investplace/quote?Symbol=EC
  11. Petrobras plans to spend a record $224.7 billion on exploration: http://www.bloomberg.com/news/2012-03-28/petrobras-average-daily-production-fell-1-1-in-february.html
  12. FTI: http://studio-5.financialcontent.com/investplace/quote?Symbol=FTI
  13. OII: http://studio-5.financialcontent.com/investplace/quote?Symbol=OII
  14. As I’ve noted before: http://investorplace.com/2012/03/exxons-massive-spending-plan-looks-right-on-the-money/
  15. ,: http://investorplace.com/2012/03/exxons-massive-spending-plan-looks-right-on-the-money/

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