Spain Dishes Pain, Are You Worried About Argentina?

Argentina’s oil nationalization painful to an already weak Spanish economy.

This past month Argentine President Cristina Fernández de Kirchner announced a 51 percent government take over of the oil (NYSEARCA:USO) firm YPF as part of a national energy sovereignty plan.  The expropriation came completely at the expense of the Spanish (NYSEARCA:EWP) energy firm Repsol, which originally held 57.43 percent of YPF, while the Argentine government left Argentine and US shareholders untouched.  The decision has sent waves of unease throughout the Argentine and Spanish economies, as the Spanish (NYSEARCA:EWP) are seeking legal recourse through the EU (NYSEARCA:VGK) to recover their $10.5 billion dollar investment and have initiated retaliatory trade measures.  Some observers claim that Argentina’s (NYSEARCA:ARGT) rash move will scare away foreign investors, while others contend that the expropriation is in fact masking more serious problems facing Argentina’s (NYSEARCA:ARGT) economy.

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Domestically, the expropriation of YPF, Argentina’s leading oil (NYSARCA:USO) company, has received widespread political support, including a 63 to 3 vote in favor in the Argentine (NYSEARCA:ARGT) Senate.  Even Carlos Menem, who served two presidential terms in the 1990s and oversaw the partial privatization of YPF, now supports the decision.  The political impetus to nationalize Argentina’s energy sector largely comes from a loathing of the neoliberal policies passed in the 1990s, which privatized much of the Argentine economy and unsustainably borrowed money, eventually culminating in Argentina’s 2001 default and economic collapse.

Since 2004, the Kirchner administrations (including former president Néstor Kirchner, President Fernández de Kirchner’s deceased husband) have reinstated protectionist and populist policies, focusing on domestic industry and social programs.  Achieving energy sovereignty has also been a key piece of this return to populism, thus making the YPF expropriation a strong cause for nationalist pride.  Furthermore, the recent discovery of massive shale oil reserves (NYSEARCA:USO) in the Vaca Muerta basin, in Neuquen province, could grant Argentina long-term energy sovereignty and if estimates prove correct Argentina would have the third largest shale oil reserves in the world.  The Vaca Muerta reserves were discovered in 2011 by YPF, then operated by Repsol, making the YPF expropriation appear particularly strategic—letting the Spaniards bear the exploration costs and then cutting them off when extraction begins.  But Argentina currently has neither the capital nor the technology to extract the oil, and a long line of contenders, including Chevron and Exxon Mobile, are chomping at the bit to offer their expertise.  While Argentine politics make for a risky investment climate, Argentina’s geology is still highly attractive.

However, not all Argentines are content with the expropriation.  Mauricio Macri, the mayor of Buenos Aires, condemned President Fernández, claiming “this decision will get us billions of pesos into debt and distances us from the world.  We’re all going to pay for this in Argentina.”  Other Argentines are worried about Spanish (NYSEARCA:EWP) economic retaliation, which thus far has planted the seeds for a budding trans-Atlantic trade war.  The Spanish government has announced plans to restrict imports of biodiesel from Argentina (Spain’s largest supplier), which amounted to $991 million last year.  Moreover, Repsol issued a formal statement to 10 international oil companies threatening to file lawsuits against any company that invests in YPF.  This threat follows Repsol’s plans to sue Argentina in international courts, where Repsol seeks $10.5 billion in compensation for the expropriation.  Regarding the compensation, the Argentine government has said it will determine its own price for YPF, but neglected to say when it would do so.

Spain has also appealed to the EU for support, pressing for a EU complaint against Argentina with the WTO, which would “end trade advantages afforded to Argentina by the bloc under the WTO’s generalized system of preferences.”  England has demonstrated support for Spain, especially after suffering Argentina’s trade restrictions over the disputed Falkland Islands.  Even British (NYSEARCA:EWU) Prime Minister William Hague personally called on the EU to “very seriously consider the measures proposed by Spain.”  These threats are significant, as the EU is Argentina’s second largest trading partner (Brazil is the first) and isolation from the EU could rattle Argentina’s export economy.  Argentina’s uncertain standing with the EU and uncertain future for YPF has led to a hesitant business climate, even between Argentine firms, in recent weeks.

Some analysts believe that the expropriation was engineered to shift attention away from more serious problems in Argentina’s economy: inflation and capital flight.  In 2011, capital flight amounted to an estimated $22 billion as fears of monetary instability swept across the country.  While official statistics say inflation stands at 9.8 percent, independent researchers—who have been fined for disseminating their findings—have suggested that the real figure lies between 20 and 25 percent.  Because of the widespread desire to sell pesos and hoard dollars, the Argentine government has imposed restrictions on dollar exchange transactions.  The restrictions are based on monthly income, whereby each month citizens can only exchange amounts of money equal to a certain percentage of their income.  This past week the government lowered the limit from 40 to 25 percent of monthly income, spurring added demand and pushing the black market price of the dollar to 5.20 pesos, well above the official exchange rate of 4.34 pesos.

Despite the challenges facing Argentina’s economy and its poor rapport with foreign investors, the Argentine economy has steadily and impressively grown over the past decade.  Economist Paul Krugman notes that most economic journalism on Argentina focuses on populist politics and the renationalizing of industries to irresponsibly draw negative conclusions about the Argentine economy.  Since 2006, Argentina has in fact grown faster than Brazil—the highly touted BRIC country.

Thus, despite criticisms of their populist politics, the Argentines (NYSEARCA:ARGT) are managing to sustain robust growth.  And with numerous foreign investors salivating over the Vaca Muerta basin’s shale oil, Argentina will likely overcome many of the negative consequences from the YPF expropriation.  Spain (NYSEARCA:EWP), on the other hand, remains in dire crisis and will need much more than expropriation compensation to pull its economy out of recession.

John Nyaradi is the author of The ETF Investing Premium Newsletter.

Written by Ryan Landon Swanson