YPF Sociedad Anónima
Q2 2016 Earnings Call Transcript

Published: 7 Aug 2016

[Operator:]

Welcome to the Second Quarter 2016 YPF Sociedad Anonima Earnings Conference Call. My name is Sylvia, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Diego Celaa. Diego, you may begin.

[Diego Celaa:]

Great. Thank you, Sylvia. Good morning, ladies and gentlemen. My name is Diego Celaa, Head of Investor Relations at YPF. I would like to thank you for joining the YPF second quarter 2016 earnings Webcast. The presentation will be conducted by our CFO, Mr. Daniel Gonzalez. And also is with us our new CEO, Mr. Ricardo Darre who will be introducing himself by the end of the presentation. During the presentation, we will go through the main aspects and events that explain our second quarter results. And finally, we will open up the call for questions. We will be making forward-looking statements. So, I ask you to carefully review the cautionary statements on slide two. Our agenda today will include the review of the second quarter results, including an update of our shale and tight development projects, a brief description of our financial situation and a brief summary to conclude. Please, Daniel, go ahead.

[Daniel Gonzalez:]

Thank you, Diego. Thanks, everybody for joining us this morning in which we are reporting our second quarter 2016 results. This was a quarter where as you all know, we faced a difficult operating environment with a slow local economy, low international prices, strikes that affected production and a significant devaluation of the currency vis-a-vis the same quarter last year. Still, these results were significantly above those of the previous quarter and totally in line with our budget and with guidance. In this scenario, revenues were up by 32% in the quarter when compared with the same period of 2015 and adjusted EBITDA reached ARS17.2 billion which was a 38% increase. However, operating income was down by almost 5%, as such growth in EBITDA was more than offset by the increasing depreciation expense as our fixed assets are valued in dollars and the peso depreciated 59% against the dollar during last year. Total CapEx was down in the second quarter by 1.8% in pesos, reaching a total of ARS14.5 billion as a result of our scheduled reduction in drilling activity. In this second quarter, total hydrocarbon production showed a slight growth of 0.3% vis-a-vis a year ago, due to an increase of 26% in NGL production, with 2.8% decrease in crude oil and 0.4% decrease in natural gas production. These production results were negatively affected by the strikes we suffered during the period. Similarly to what we went through in the first quarter, the local currency devaluation had a negative impact in our income statement figures when expressed in U.S. dollars. Revenues in dollar terms were down by 17% as diesel and gasoline prices dropped by 13% and 11% in dollar terms, while exports in dollars were down 28% on lower international prices and lower volumes. EBITDA was down 13% in dollars, affected by the previously explained reduction in revenues and the positive impact of a dilution of our cost base in dollar terms as the majority of our costs are peso denominated. Consequently, the EBITDA margin expanded to 33% in the quarter. Actually, EBITDA was almost 50% higher in dollar terms than the first quarter of this year, as this second quarter benefited from additional price increases for our fuels sold at the pump. Let's switch back to Argentine pesos to go over more detailed analysis of the quarter. Operating income, as I said was down 5%. In the upstream segment, the revenue increase resulting from higher prices for both crude and natural gas was not enough to offset the effect of higher depreciation and higher exploration expenses that I will explain in more detail in following slides. Our downstream sector is catching up from the impact of the severe devaluation we experienced at the end of last year as we continued to increase prices during the quarter, but insufficient yet to generate a similar operating income than last year. The offsetting factor was the one-time positive result of ARS1.5 billion generated by the deconsolidation of the Maxus entities, shown under the corporate and other bar in the slide. On June 17 of this year, the Maxus entities announced their filing for reorganization proceedings under Chapter 11 of the U.S. Bankruptcy Code. And as a result of these proceedings, YPF ceased to have control or significant influence over the Maxus entities and therefore, will not consolidate the results of the Maxus entities any longer. This deconsolidation has resulted in this ARS1.5 billion gain, as the Maxus entities had negative equity. Continuing on with our operating income analysis, in this chart, we can get in more detail on the reasons behind the negative variation. Revenues grew by ARS12.8 billion or 32%, resulting from a few factors

[Ricardo Darre:]

Okay. Good morning, everyone. Thank you, Daniel, for this introduction. After many years of working around the globe, it's a pleasure to return to Argentina and join this great team of professionals. I've only joined the company four weeks ago, but I had the opportunity already to visit the field and I was impressed with what I saw and with the very high level of competence of our teams. Of course, YPF was born in 1922. So, yes, some fields are mature and produced with a high BSW, but the inventory of good assets is impressive. On the upstream, we're sitting or YPF is sitting over a massive acreage, 3 million acres of good quality rock in Vaca Muerta. Over the last three years, very good infrastructure of development was built on this Vaca Muerta, including sand supply, water supply systems, roads, pipeline networks, processing plants, like the ones are going to be start up in Loma Campana in the next few weeks. There's also an excellent well performance control center for Loma Campana that is at the very first level of technology worldwide. We're starting to see the first improvements of the batch drilling in forward clusters in Loma Campana. Daniel mentioned a target of $10 million per well by the end of the year. I'm a bit more optimistic than that. Another particularity of Vaca Muerta is that, contrary to what some groups present in the U.S., in Argentina and in Vaca Muerta, fracking is not the mother of all evils. In fact, it's accepted as a good industrial technical practice and is not challenged with far-fetched arguments. Same for the water usage, all the fracking in the Neuquen is done with waters of the Rio Neuquen which in fact only, I think the number is 5% of its water is used by the communities before it is, it drops into the sea. So, the volumes that we, of water we used in Vaca Muerta are not challenged at all by the community or the environmental groups. Same thing for the downstream. I had the chance to visit, the opportunity to visit the refinery in Lujan de Cuyo in Mendoza. YPF has clearly a solid industrial base with refineries having very, very high availability. The Company probably profits from the know-how that was brought by Repsol in some years ago and continued making investments in our facilities that have put the refineries of YPF at the very top level of international, I would say, availability and reliability. When I visit the refinery in Lujan de Cuyo, I asked all the difficult questions. I visit all the key spots, like the [fairing] systems or the water disposal facility. And I was impressed because it's really a worldwide top-class facility. Lastly, I visit last Friday the research center of Y-TEC in Berisso. And again, I was very, very positively impressed. I saw a world-class group of engineers, Ph.D.s, and technicians carrying applied research on subjects critical to our business, frack propagation, propane qualities. In particular, I was impressed by the work being done on nanotechnologies oriented toward oil and water separation and, again, other subjects key to our operations. And I repeat a world-class research center in Berisso here in neighbor to our refinery in La Plata. Overall, a very-very good first impression, I won't expand much more. I'm very green on this Company. So, I can only say I look forward to meet each one of you individually in the future. And I would like to pass the call back to Daniel to conduct the Q&A session. Thank you.

[Daniel Gonzalez:]

Sylvia?

[Operator:]

Thank you. We will begin the question-and-answer session. [Operator Instructions] And the first question comes from Bruno Montanari from Morgan Stanley.

[Bruno Montanari:]

Good morning, everyone. Thanks for taking my questions. So, my first question is related to these natural gas receivables from the government. So, regarding these $630 million you mentioned that were collected in the form of government bonds, just wondering if you could give us some details on that, especially on the exchange rate. So, did you receive the original amount denominated in dollars at the current FX rate, or was it somehow settled differently in local currency? That's the first question. And then the second question I have is about fuel prices. We've seen quite favorable moving fuel prices in the first half of the year. So, should we expect more hikes if currency continues to devalue and inflation decreases, or would you say we're about done for the year? Thank you very much.

[Daniel Gonzalez:]

Thank you, Bruno. Morning, a very good question in terms of the receivables, unfortunately, the government decided to pay us the equivalent in pesos of the receivables of last year. So, we did not receive those receivables at the ARS15 per $1 exchange rate. Therefore, that created a difference, not accounting, but a different in value in terms of what we expect and we believe that we should be paid. And what the government decided to pay -- this is to us and to the rest of the industry. It's not just to YPF. So, we are currently analyzing our different alternatives in order to protect our interests because we strongly believe that we made the investments based on the notion that the gas plan subsidy was dollar based and not peso based. With regards to your second question and fuel prices increases for the remainder of the year, I think what we will monitor is also the evolution of demand because, as I said during the call, the second quarter was really soft. July was soft, especially in diesel, less so in gasoline. So, we need to determine when and if there is the potential to continue to increase prices. Of course, if the currency devalues further, we would have no option and continue to increase prices. But, in the meantime, we will just monitor demand and make sure that prices are the right prices in order to move our products to the consumer.

[Bruno Montanari:]

Perfect. Thank you so much.

[Operator:]

Our next question comes from Frank McGann from Bank of America Merrill Lynch.

[Frank McGann:]

Okay. Good morning, and thank you, both. Just in terms of costs, I was just wondering how you're seeing the cost structure right now, what additional costs, concessions you can potentially get on the supplier side or other costs that could help to alleviate some of the pressures that were seen in the quarter and that probably will occur over next 6 to 12 months from the adoption of the new labor agreement. And related to that in terms -- same trends perhaps that what you see on the cost side related to the shale oil and tight gas developments, can you get substantial reductions from here on top of the -- for example, the well cost reduction that you've gotten to 11 million currently and 10 million expected by the end of the year? And then for a second question, maybe just following up on a comment you made during the presentation, where you mentioned that the diesel market had gotten quite a bit more competitive, I just wondered if you'd give us a little bit more detail on what you're seeing there.

[Daniel Gonzalez:]

Thank you, Frank. Well, in terms of costs, as you have seen, we have significantly diluted in dollar terms our cost base this year, of course, in a big way helped by the devaluation of the currency. And we are expecting to maintain this cost reduction of close to 20% in dollar terms for the full year. Okay? It is true, though, that the second part of the year, the wage increases will kick in. I believe that we were able to get away with a reasonable increase in terms of wages, this 30%, which kicks in, in three different installments, 18% in July, 5% towards the end of the year. and 7% next year, results in an average increase of labor costs this year closer to 25% vis-à-vis last year in pesos. So, that is clearly below the valuation. And I think it's a very good first step in order to take our cost bases to a more sustainable level going forward. In terms of suppliers, there are some contracts in which we've made significant improvements, fracking for instance, directional drilling, and other contracts in which the old contracts expired, there is more idle capacity, there's more competition. And we're able to get away better terms. So, those, I'd say, three factors, the dilution of the cost basis in dollars because of a devaluation, the better contractual terms for new services or the same services with new providers sometimes, and some efficiency initiatives that have been put in place and are slowly providing results should help us in achieving this very challenging target of having total cost basis down 20% and vis-a-vis last year. Now, with regards to costs for the shale and the tight, which more talking about more efficient CapEx, if you will, I think that the trend is pretty much the same with the additional advantage that here, we're making significant progress in our learning curve. We're doing things differently. We're doing things better, which is to be expected, right? After 500 wells, it is reasonable that we start seeing the results of this learning experience. So, Ricardo said it during his remarks. We are optimistic that we will get to those costs per well that we just outlined. And I think, with those costs and the productivity that I mentioned during the presentation, with hopefully accumulating close to 600,000 BOEs in the life of the well, if prices at some time recover in the next couple of years, I think that we can prove very economic reasonable returns for the shale. For the tight, we already have very good returns because the prices of gas are really attractive. And we are seeing the same improvements in terms of productivity and in terms of costs that I just mentioned for the shale. With regards to the competitiveness or the competivity, I'd say competition in the diesel market in Argentina, where clearly the, as I said, the economy is slow, with a slow economy, some competitors may be willing to provide higher discounts on prices. We have been protecting our pricing power. This has been a priority to us. If that results in a slight reduction in share, we will make sure to recover that share over time. But, we are comfortable with our strategy going forward. And then there are more imports of diesel oil than before. With the previous government, this was in a way closed. This is not the case any longer. So, there are more imports coming from competitors, coming from traders and that just makes our lives tougher. We are very confident in our commercial backbone and we will protect our share and we will protect our pricing going forward.

[Operator:]

Our next question comes from Anish Kapadia from TPH.

[Anish Kapadia:]

Hi, I had a question, first of all, just on YPF's longer-term strategic vision for the Vaca Muerta. You've now had I think well over five years to study the Vaca Muerta, drilled a lot of wells, got a lot of data. So, I just wanted to kind of get an update on what your thoughts today about the optimal pace of development where you're seeing the constraints, where production can get to in the next five years and how returns compare when you look at oil versus gas? And then just returning to the point on the costs, you've got well costs down to $11 million now. If you look at some of the comparable plays in the U.S. targeting these kind of similar very high-quality rock to what you've seen, you're getting breakevens down to less than $40 per barrel and I think well costs are more than, obviously, less than half of what you're getting at the moment. So, just seeing -- how long do you think it will be until you can get to U.S.-style well costs, or are there kind of certain factors in Argentina that mean the well costs will stay significantly higher than what we see in the U.S.? Thank you.

[Ricardo Darre:]

Okay. I can -- this is Ricardo. I can probably half answer that question. The future of Vaca Muerta is not as simple as might be seen as the distance. It's not one single reservoir. It's not one single structure. There are different qualities of rock. There are different productivity or expected ultimate recovery per field. It goes from very dry gas to full condensate. Making a point and saying we will be in Vaca Muerta developing this field or this fluid or this portion of the rock today as -- is not literally possible. We have to break the Vaca Muerta into different areas, different fields, and treat each one separately. Today, we're concentrated in the three fields Loma Campana, El Orejanoa, Aguada -- help me -- Amarga Chica. And we are looking at moving forward into other small fields within the Vaca Muerta. But, today, giving a full picture of saying we'll be in Vaca Muerta producing so much in five years, it's a question that is literally impossible to answer. Now, on the cost side, it's correct that we should be -- to think that we should be getting closer to the cost of the U.S. But, the U.S., you have to make a distinction also. You can go to -- compare Vaca Muerta with the Barnett, and we'll be killed. The Barnett is $2 million per well and $3 million to frack, while the Utica is probably more in the 8 million to 9 million per well all included. If you want to get the most recovery out of your well, you might not want to control the number of stages or -- that you frack or the length of the drain. Of course, we'll concentrate on the fixed cost of drilling and get it to the rock. And then on the unit cost of the elementary cost of the frack, the sand, the water, the pumping operation, I think the comparison with the U.S. is not straightforward. We're not talking about the same depths. We're not talking about the same rock. We're not talking about the same needs for stimulation on the rock. So, again, I'm sorry that I'm not giving you a straight answer with numbers. But, the concept is the Vaca Muerta cannot be projected as a whole on -- with a horizon of five years. And the cost of the wells will improve. The reference of cost in the U.S. is probably not the most valid reference. We will have to look at dollars per barrel equivalent. Thank you.

[Operator:]

Our following question comes from Felipe Santos from JPMorgan.

[Felipe Santos:]

Yes, good morning, everyone, just a quick, two quick questions. First one, you mentioned about the gas and power initiatives. How much of this energy generation will be used to your own needs, and how much use are you going to be selling to the market? This would be the first question.

[Daniel Gonzalez:]

Okay, Felipe. In the case of the windfarm, it'll be initially fully used for our own operation. In the case of the 105 megawatts in Loma Campana, again, significantly all of that for our own operation and that of our partners because there, we operate on a 50/50 basis with partners, although the project is being carried by us and GE, not with our partners. And in the case of Tucuman, it's 100% for the grid. That's in the same area where we are already generating power, YPF and General Electric already has an operation in place. That's why it's so synergetic to build that 270 megawatt plant in that area.

[Felipe Santos:]

Okay. Thank you so much.

[Operator:]

And following question comes from Ricardo Cavanagh from Itau BBA.

[Ricardo Cavanagh:]

My question also goes on the strategy of the Company. Basically, how do you foresee the growth path of YPF in the coming years, understanding EBITDA generation well might suffice to sustain production, without the capability of growing much, and the scope to augment leverage is limited? And in relation to this question, do you foresee in the new scenario for Argentina the possibility that the country starts attracting relevant interest of international companies, basically referring more to tight gas that seems to be the most profitable area as I understand? Thank you.

[Daniel Gonzalez:]

Let me address the second part of the question. And Ricardo will try to answer the first part of the question, which is a more difficult one. I think, for tight gas, we are already in discussion with a couple of partners for certain areas. We will not disclose in more detail and not at this stage what we would be willing to do. But, yes, we agree with you that the economics are encouraging on those tight gas projects. Having said that, with everything going on in Argentina with the gas tariffs, I think investors like yourselves would like to understand a little bit better what kind of visibility there is with gas prices for the future. If you ask me, I feel very comfortable that, while Argentina will continue to need to import gas for at least the next 10 years, local prices of gas should trend towards import parity. And at those levels, our projects are really attractive. Now, with everything going on, with gas tariffs being challenged in court, [I also warn] it might probably not be the ideal time to go looking for a partner for natural gas project. But, there are a couple of projects that we have already been showing. And we've seen a lot of interest from a couple of partners. And there are projects in the tight where we already have partners. Okay? I just mentioned that this acquisition of Rio Neuquen, we are very excited with that acquisition. We believe there is a lot of value there. But, we've only acquired a one-third stake there, right? So we will operate, but we will have two partners in that case. Rincon del Mangrullo is another case. We have a partner. So we believe in developing the tight and the shale with partners. We will continue to do that. But we will always be careful in doing the transactions at the right time, as I believe we have so far, in order to protect our value going forward. So, I don't envision any change of strategy in terms of partnerships, tight or shale, Ricardo.

[Ricardo Darre:]

Yes, I agree with the concepts expressed by Daniel. Clearly, we have to grow now, protecting our financial base. We don't have the capital to develop the full Vaca Muerta ourselves. We will open to partners, to new investors. We're already in the trend of discussing with other companies or investors for beyond the three fields we're operating now with Dow, Petronas, and Chevron. We will have to concentrate also on our core activities. Do we need to be a drilling company and hold onto YPF Servicios Petroleros? Do we need to have 100% equity in all our midstream network in our refineries and the whole of our assets? We will have to develop, being very careful with our use of capital and use or divest the assets that are not really core to our business and our growth. The second big axis of work is cost control, cost cutting. We have to change the way we work. YPF has probably a history of being a consolidated company. I don't want to be not with the corporation, but be a Gazprom we do everything, from step one to step 100 of the energy chain. We're probably not the best to do everything. We have to concentrate on where we're good. We're good on our industrial base, on refining and petrochemicals. We're sitting over a massive acreage of good rock. We have to concentrate our exploration efforts on prospects that will lead to a quick development. I'm thinking about deepening on fields in Golfo San Jorge. We have to stay away from prospects that will take too long from discovery to first oil. I'm thinking about offshore. We have to stay away from prospects or plays that have a very high CapEx and OpEx. I'm thinking about heavy oils in Mendoza. We have to concentrate our investments where it pays and where it pays quick. Now, I'm probably talking too deep strategy for somebody that has been only four weeks in the Company. So, I'll moderate my words. But, I hope that answers your question at least on the baselines.

[Ricardo Cavanagh:]

Yes, sure they do. And thank you, both.

[Operator:]

Next question comes from Francisco Schumacher from HSBC.

[Francisco Schumacher:]

Thanks, Ricardo, Daniel, and Diego, for the call. I would like to know if you have already assumed the operation of Rio Neuquen. What did you find there, any things you can improve? I heard in the past that you consider Petrobras Argentina's gas assets were good quality. What are your plans in that area? What is the potential you're seeing there? Thanks.

[Daniel Gonzalez:]

Thank you, Francisco. Unfortunately, we have not yet taken control of the operation. We -- that transaction between Pampa and Petrobras only closed a week ago. And we paid our first share of the two areas that we are actually acquiring in south part of Rio Neuquen and 80% of Aguada de la Arena. I believe that we will be taking control at some point in the last quarter of this year or maybe end of the third quarter. We -- it's a little bit too early to say what we are going to be doing there. Remember that we will own a third. So, we will have to discuss the budget with our partners. But, as I said, we like the area. We like tight gas. We learned a lot about tight gas. So, we are very excited with the prospects. And hopefully, towards year end, we'll start providing some guidance in terms of the strategy to operate that field going forward.

[Operator:]

We have no further questions at this time.

[Daniel Gonzalez:]

Okay. Well, thank you, Sylvia. Thank you, everybody, for joining us on the call today. If there are any follow-up items, please feel free to run them through Diego and [Pablo] whenever is convenient. Have a good day.

[Ricardo Darre:]

Thank you.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.