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CHRONICLE SPECIAL
Knowledge@Wharton

On May 11, Repsol-YPF, the Spanish petroleum company, announced its latest find: the discovery of hydrocarbons in Brazil’s Santos Basin. The discovery, baptized Panoramix, is located 180 kilometers off the coast of the state of Sao Paulo. In addition to its significant potential for gas and liquids, the find reinforces the company’s commitment in Brazil, where it has made three great discoveries in the first five months of 2009. The first, Piracuca, was made in January. Three months later, Repsol-YPF confirmed its economic viability. The second, also located in the Santos Basin and named Iguazú, was confirmed in April. The third, Panoramix, has just started up.

CHANGING FOCUS

These discoveries fall within the new strategic map that Repsol is drawing up in Latin America, which will permit the company to reduce its exposure to the decisions made by some governments in the region, including Ecuador, Bolivia, Venezuela and Argentina. In addition, the firm is turning its attention toward North America, where it is eyeing the possibility of supplying energy to the United States.

Repsol, headed by Antonio Brufau, has undergone tough times in recent years. Populism peaked in several countries in the region, putting at risk a large part of Repsol’s investments. The “Argentinization” of YPF, on the part of Argentina’s president Cristina Kirchner followed expropriations by Bolivia, Venezuela and Ecuador. With the arrival of Kirchner to the presidency, the government began a process aimed at recovering the capital of YPF, almost a decade after it was acquired by the Spanish company Repsol. This forced the company to diplomatically try to save as much of its investments as it could, since it lost 25 percent of its reserves in two years. However, at the same time, it was redesigning its strategy in the region, as part of its Strategic Plan 2008-2012, aware that it had to reduce its exposure to these countries, and that it had to respond to them not only with good words but also with powerful moves. And in Brazil, it has found one of the most important of such moves.

The clearest example of the importance Brazil has acquired for Repsol is that the company considers its discoveries in the deep waters of the Cuenca de Santos to be one of the ten key projects in its Strategic Plan 2008-2012. The great potential for exploration transforms these waters “into one of the principal areas of growth for the company in the world,” Repsol has announced. In addition, it helps strengthen Repsol as the largest foreign company in terms of control of mining exploration, and the second-largest in the entire country, exceeded only by Petrobras, the national oil company. With numbers like these, Argentina and Venezuela lose any leverage over Repsol.

STRATEGIC MOVE

“The company has succeeded in reducing its exposure to those countries,” notes Joaquín Garralda, professor of strategy at the IE Business School. Repsol has relieved some of the tension it suffered because of the hostile moves taken by governments such as those of Argentina’s Cristina Kirchner and Venezuela’s Hugo Chavez, “which severely punished the company’s share price,” says Garralda. “It has also made the company powerful, which could help its managers reestablish their positions.” At the moment, Argentina seems to be changing its tone -- not only because Repsol is playing its cards, but also because Repsol has realized that it is trapped between a rock and a hard place by the collapse of the stock market, which has delayed plans to bring 20 percent of the Argentine oil company’s shares onto the stock market.

“Analysts always criticize Repsol for its lack of reserves, which is a problem that it tried to compensate for by acquiring Argentina’s YPF, but the position taken later by Kirchner complicated things,” notes Xavier Mena, professor of economics at Esade Business School. “Nevertheless, this is a problem that every large multinational oil company faces. Exxon, BP and Shell are also falling in the global rankings of reserves because countries around the world are nationalizing their reserves, and as a result, the publicly owned giants are becoming more influential. So the privately owned multinationals are launching plans to find reserves in deep waters that are considered international, and must compete with technology and financial muscle.”

Some governments continue to be open to foreign companies -- such as Peru, headed by President Alan Garcia. According to Mena, “Peru was a country already open to multinationals under the previous president, Alejandro Toledo, and it continues to be so now with Garcia.” So for the Spanish oil company, Peru is now a major country in the Andean region. In fact, Repsol has announced that it will invest $500 million a year during coming years, until it reaches a total of $6 billion of investments in natural gas and hydrocarbon projects. Currently, the company has invested $2.2 billion in the country, in which it arrived in 1995. Peru has become the third-largest country in the world in terms of Repsol’s foreign investments, behind only Spain and Argentina. That makes sense, given the strong relationship between the government of Garcia and the possibilities that Peru offers for expanding in the petroleum sector.

In addition to the various oil and gas exploration properties Repsol has in various points around Peru, the company also participates in the deposit of natural gas at Camisea (also in Peru). It also acquired a license in 2007 to export natural gas to Mexico starting next year. Beyond that, Repsol can only hope to take over a spot in the new agenda of Barack Obama, and begin to supply gas to the United States.

Repsol hopes to do that not only from Peru, but also from Canada, where Repsol owns 75 percent of an import and re-gasification terminal called Canaport LNG, which is in the final stage of construction. It could begin operations at the end of June. This plant will become the country’s first re-gasification plant. It will not only supply the local market, but it is targeting the neighboring United States. Repsol also has an agreement to purchase the production of the Deep Panuke natural gas project of EnCana Corp., along Canada’s Atlantic coast. The project will supply up to 300 million cubic feet of natural gas a day.

Brazil and Peru can be considered the bridge for changing Repsol’s strategy in Latin America, as well as the keys to the company’s ambitious plan to double its size by 2012. Repsol will spend $16.6 billion toward that goal -- an investment figure that Repsol says cannot be changed despite the financial crisis. It seems the difficult times the company experienced over the last two years have convinced it that it needs change. And this means growing more, in order to reduce risks and diversify production.

One clear example of change: Latin America will represent nearly one third of Repsol’s entire business in 2012 if the company reaches its goals. Before launching its Strategic Plan, Latin America contributed almost one-half of Repsol’s total revenues. “Repsol does not want to abandon Latin America because that’s where the resources are, but it can diversify its risks,” notes Garralda. In his opinion, no company is free from a populist government that bursts in and wants to change the rules of the game. That puts the company’s investments at risk. However, in the case of Brazil, Garralda stresses, “Lula has surprised all of us a great deal, and I don’t believe that Repsol could suffer an attack of this sort, at least during his administration.”

Analysts at the Spanish firm Renta 4 are aware of the hard times that the sector is experiencing because of the decline in prices of crude (down 54 percent in the last 12 months), and of gas (down 42 percent). Analysts applaud the steps that the company is taking -- especially, “the appropriate strategy to reduce its excessive exposure to Argentina, which represents 66 percent of its production and 25 percent of its net operating profit, so that it can increase its production in other geographical areas that are more profitable such as Peru, Brazil and the Gulf of Mexico,” according to a recent report by the firm IG Markets. They add that “although its proven reserves and production goals continue to be the company’s weak point compared with its rivals, the recent discovery of immense reserves of crude oil in Brazil could brighten the horizon of the company and improve its prospects for production.”

GLANCE AT PAST

The major uncertainties facing Repsol today are not really new. Three years ago, Altina Sebastián, professor of finance at the Complutense University in Madrid, told Universia-Knowledge@Wharton, “If reserves are the sources that a petroleum company uses to feed its medium and long-term activity, Repsol urgently needs to find new sources of resources: Its rate of replacement is low, only about 20 percent. That means that every year it only renews two out of every 10 barrels it sells. This ratio places it considerably behind the leaders in the sector.” In the same report, Sebastián also noted that “the biggest risk for Repsol is in Argentina, from which the company derives 60 percent of its resources.”

These words provide us with evidence that Repsol has gone on to resolve the difficult obstacles that it faced over the next three years. At the time, Repsol had laid out its Strategic Plan 2004-2009, which aimed to invest $1.4 billion in order to reach its production goals of 1.324 million barrel equivalents a day. However, tricks played by Argentina, Bolivia and Venezuela dealt it a heavy blow. Overnight, the company had to recognize that its global reserves of natural gas and crude were 25 percent lower than it had expected until then. However, the company reinvented itself.

The Strategic Plan became a worthless scrap of paper. The current document, with a horizon of 2012, has investment goals that are twice as high as its predecessors. Not to be intimidated, the company had to recover its lost reserves. The only way to do that was to discover new deposits. Outside of Argentina, this had been proven to be a time bomb. Time seems to have proven Repsol correct, such as the fact that so far this year Repsol has made the largest discoveries of any company. And they have reduced their risks in hostile countries and cemented their relationships in Latin America with Peru, Brazil, and in the Gulf of Mexico. The strategic map of the company has changed, and it seems to have been for the good. This will continue to be the case after the price of petroleum recovers. As Mena notes, “When the price of petroleum is below $70 a barrel, there is apprehension about carrying out the huge investments that Repsol is achieving, which are very capital intensive, and pay off [only] in the very long term.”

Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.