Repsol YPF’s Tank Is Running on Empty
Repsol YPF, the product of a merger between national oil companies from Spain and Argentina, is facing a tough situation. The recent change in the government of Bolivia, which brought to power populist President Evo Morales, has led to a number of uncertainties about the future of Repsol YPF.
On January 26, 2006, Antonio Brufau, managing director of Repsol YPF, sent an urgent and surprising message to the CNMV, Spain’s National Stock Market Commission, as well as to stock market authorities in the U.S., oil analysts and the media. Brufau reported that his company was cutting its proven reserves of natural gas and crude oil by the equivalent of 1.245 billion barrels of oil. In other words, overnight, the company was losing 25% of its global reserves (of 4.926 billion barrels).
The reduction involved reserves in three countries – Bolivia (52%), Argentina (41%) and Venezuela. In these three countries the company said it had lost most of its reserves, although the cuts also affected Algeria. According to Altina Sebastian, a finance professor at the Complutense University of Madrid, “If the reserves are a storehouse where they go to feed their ordinary medium or long-term activities, then Repsol urgently needs to find new sources of resources. Its replacement rate is low, about 20%; it only renews two out of every ten barrels that it sells each year. This ratio is quite a bit below the leaders of the sector.” In addition, she explains, “the ‘golden shares’ that were provided to the Spanish government so it could block any corporate move on Repsol will be abolished in the near future, so there is a significantly larger risk of a hostile takeover.”
Brufau also announced that he has frozen the company’s investments in Bolivia at 400 million euros; that is, half the amount projected in the company’s strategic plan for 2005-2009. The reason given for this change in plans was that some projects have become economically unviable because of Bolivia’s new Law of Hydrocarbons, which raises taxes on production to 32% and raises taxes on royalties to 18%. This is one of the first decisions that the new president of that country [Morales] made after gaining power, and it has dealt a severe blow to the Spanish-Argentine oil company.
“Last month, Bolivia’s energy minister, Andrés Soliz, held meetings with representatives of the foreign companies and with ambassadors of countries that have investments in Bolivia,” notes Sergio R. Torassa, finance professor at the European University. When those meetings ended, adds Torassa, “Soliz declared that the oil companies operating in Bolivia have shown signs that they will work with the new rules of the game that will be in effect in the sector.”
Nevertheless, Torassa says that these meetings are a “first point of contact, since the rules of the game are still in the process of being refined. In fact, for the oil companies, nationalization of gas resources is not the main cause for concern. Two things are more worrisome: First, taxes on exploration and sales will rise. Second, as a result of the populist and anti-imperialist rhetoric that Morales and his party are so proud of, it will not be possible to sell Bolivian gas to the United States, which is the customer that has the greatest potential.”
An Opportunity for Latin American Oil Companies
Although the new Law of Hydrocarbons affects every energy company, each enterprise is a world in itself. As a result, the dark clouds hanging over Repsol YPF contrast with the new, bright horizons that could open for Latin American oil companies. That’s the view of Hugo Macías Cardona, a professor at the University of Medellín (Colombia) and coordinator at CIECA, a center for research into economics, accounting and administration. “The problems involved in developing Bolivian energy would seem to mark an abrupt turnabout in the country’s energy policy, and mean increased ownership by companies from South America (Brazil and probably Venezuela), to the detriment of investors from Europe and North America,” says Macías. “The energy policy of Bolivia seems to be turning toward South America.”
In fact, Macías believes that “the consequences for the energy industry are not very important. In reality, another company can begin to exploit the [country’s] resources, since they are now negotiating with Brazil’s Petrobras. For Spain, the threat is significant because it could lose control of its energy industry, which would move into the hands of foreigners.” Several international energy companies are active in Bolivia, including British Gas, Vintage (U.S.), Pan American (U.S.) and Pluspetrol (Argentina). However, 80% of the country’s reserves are concentrated in just three hands: France’s Total, Petrobras, and Repsol.
The drastic measure taken by Repsol could mean “a weakening in its financial position and additional distrust among its current and potential investors,” says Macías. “Inevitably, this would lead to a reduction in its operations and, at least, end its expansion. And it will have a direct effect on the levels of its profitability.” For Torassa, the new and sad reality of Repsol YPF will mean an inability to fulfill its strategic goals. “With this cut in its reserves, it is impossible for the company to fulfill its goal of producing 1,132.5 Mboepd as forecast for 2009. It’s more likely that production will remain at current levels, which is 1,165 Mboepd.
To resist this change, Antonio Brufau has already announced that he will present a new strategic plan, which will involve increasing its previously forecast investments by 1.4 billion euros, through 2009. In other words, the new forecast will call for investments of 23 billion euros, instead of 21.6 billion euros.
Memories of Shell
On January 26, 2006, when Repsol lowered its reserves by 25%, it brought back memories of a scandal in which Shell played the leading role. Two years ago, the Anglo-Dutch firm also drastically revised its reserves. The crisis led to plummeting prices for Shell’s shares on the stock market, cuts in its earnings, purges in its boardroom and a rigorous investigation by the U.S. Securities and Exchange Commission.
Altina Sebastián recalls the story of Shell when she forecasts the consequences that Repsol could now suffer. “Although this case is different from the Shell scandal, it is predictable that the SEC will open its own official report on the subject. The SEC is extraordinarily vigilant when it comes to erroneous information that is supplied to shareholders…. You cannot say for sure that the resulting measures will not be serious,” she says. “The impact on the image of the company will clearly be significant.”
Repsol’s Antonio Brufau and his team also have reason to fear a hostile takeover offer from another giant in the sector as a result of their company’s weakness, the sharp drop in its market capitalization (of more than three billion euros), and the serious threat that its credit rating will be downgraded.
Torassa warns, “The fall in Repsol’s share price – which some analysts even estimate could continue to drop to 21 euros per share – has left the company in a tricky situation. Its small market capitalization, compared with the global leaders in the sector, constitutes a significant weakness.” In Spain, adds Macías, “fears are growing of a possible sale of the company via a hostile takeover offer. From the technical and financial point of view, that kind of deal is possible. The threat for Spain is that its energy sector will move into foreign hands, and Spain will lose direct control over the country’s energy industry.”
Storm Clouds on the Horizon
In addition to these uncertainties, you have to add the intense electoral environment in Latin America this year. It could cause problems if some other populist politicians take power beyond [current presidents] Hugo Chávez (in Venezuela) and Evo Morales (in Bolivia). Nevertheless, Altina Sebastián says, “The greatest risk for Repsol is in Argentina, where the company derives 60% of its resources. The replacement of Argentine economics minister Lavagna a few weeks ago means a serious about face when it comes to the country’s commitment to review the rates of companies operating in that country. In the case of Repsol, the topics under review are extremely important: The problem of developing its current reserves, the broadening of concessions, and the limits of state competition are some of the topics on the agenda.”
Repsol currently has 3.672 billion barrels of energy equivalents. Of these, 55% are in Argentina, 21% in Trinidad and Tobago, 10% in Bolivia, and 17% in the rest of the world. There are some regions where the company will have to make enormous efforts to recover the confidence of politicians and investors, especially if Macias’s forecasts come true. “Although the company asserts that it has not engaged in any accounting fraud, some people will continue to distrust its operations. In addition, because of competition within each country between various companies, some activities will continue to be developed by other companies.”
Repsol could also face a tough legal battle. According to the Spanish press, two U.S. law firms are preparing law suits against the company because of the events that were triggered on January 26. For its part, Repsol has hired two prestigious law firms to plan its defensive strategy against the avalanche of lawsuits that could result, and in order to earn the confidence of regulators (at the SEC and the CNMV).
Oddly, the specialists hired by Repsol are the same people who took the reins during the Shell case: Davis Polk & Wardwell of the U.S., and King & Spalding from the U.K. With the help of these two law firms, Repsol wants to limit its responsibility for the accounting of its reserves. Antonio Brufau has laid the blame on Repsol’s previous management team. It was headed by the company’s ex-president, Alfonso Cortina, who bought YPF and led the firm through the middle of 2004, when he was replaced by the current president. However, it should not be forgotten that Brufau was then a member of the company’s auditing board, as well as a representative on the council of the chief shareholder of Repsol YPF, the financial institution called La Caixa.
It seems that the next chapter in this exciting story may well be written in the courts.