Cristian Martin
Pampa Energia (NYSE:PAM) is one of the leading Argentinian energy companies, with operations spanning generation, petrochemicals, natural gas extraction, and the gas and electricity transportation networks.
I wrote about PAMP in March 2023 (buy), and January 2022 (hold). These articles contain a more detailed revision of PAM’s operations. In the March 2023 article, I presented several forecasts for the different segments of PAM. Fortunately, the 9M23 results all fit inside of my forecasted results.
In this article, I review the recent results and future developments of the company under the new Argentinian government.
Electricity generation
The electricity generation segment has two components: government-set rate generation (PAM calls this legacy) and PPA contract generation. The former is difficult to model because it’s dependent on government action, while the latter is easy to model because it depends on long-term dollar-denominated contracts.
Back in March, I expected PAM to generate operating profits of between $240 and $350 million from the generation segment. As of 9M23, the company has generated $230 million, so it will probably end the year closer to the lower end of my forecast. The main reason for the underperformance has been a delay in peso adjustments in the legacy segment. At the same time, the company added 380 MW of capacity (300 MW in thermal, 80 MW in wind) with an average payment of $60/MWh at full utilization, this helped the segment.
The question going forward is whether the legacy business will be more profitable. Different government signs have respected the PPA contracts, so that segment should not be at risk.
I believe that Javier Milei, the new president, will have trouble changing the current remuneration scheme of the electricity market, and that, therefore, we could expect a continuation of the current system in the future. There are two reasons for this. First, the Argentinian government has signed commitments to purchase most of the gas needed to power the thermal plants (the Gas.Ar plans), therefore it will continue to be a central player in providing the gas to the plants. The second one is that the government will increase the cost of electricity to households via the reduction of subsidies. Therefore it will have no interest in fueling these increases even more via paying more for generation.
If the new government decided to privatize the electricity market (allowing the different players to buy from each other), the most efficient players would be at an advantage because the price would be set by the marginal producer. PAM would be at a great advantage in this case because it controls hydro plants (the cheapest source of energy on a variable cost basis) and several modern thermal plants. I do not believe that PAM would be able to self-supply itself with gas because the government has already committed to buying it (via GasAr) and will probably therefore either supply it for free or resell it via market auction.
One very positive aspect of the new government taking office is that probably PAM will be able to renew the licenses for the hydro concessions in Argentina’s west, which mature between 2024 and 2027. I do not believe the new government would want to rationalize these plants.
For that reason, and until there is more information on the new government’s policies, to keep my forecasts of between $240 and $350 million in operating profits for the segment.
Gas and oil extraction
PAM is a large player in the unconventional natural gas market, supplying 10% of Argentina’s total natural gas production.
Again, back in March, I expected the segment to generate about $170 million in operating profits for FY23, and it has generated $166 million up to 3Q23.
The gas segment is relatively easy to model for a portion of the production, but not for its growth prospects. Until 2028, PAM has commitments from the Argentinian government to purchase an average of 12 million m3/day of natural gas at $3.6/MMBTU (as stated in the GasAr plans for round 4 and round 1 and 3 extensions, in Spanish). The new government has stated that it plans to respect these contracts. The lifting cost for PAM (including D&A) was $2.93/MMBTU in the 9M23 period, so this contracts should remain profitable going forward, forbid a huge increment in the cost of drilling.
However, the company already produced 12 million m3/day for most of 2023 (Argentinian government natural gas production dashboard, in Spanish). How can it expand further?
The problem with natural gas is that you can quickly run into a situation with too much of it, and you have nowhere to put it because gas cannot be stored as easily as oil. So let’s review the places where PAM could put its gas expansion.
The spot market is mostly saturated, with spot prices close to or below $3/MMBTU for most of 2023 (Argentina spot prices), which would make production non-economic if D&A is added to costs. Argentina does not have an LNG facility, and, therefore, cannot export large quantities of natural gas to distant countries. Even if an LNG facility was announced, it would take a decade to build.
The main customer of Argentinian gas is Chile, which is connected via several gas pipelines to Argentina. Chile’s alternative to Argentinian natural gas is LNG, mostly from the US or Trinidad and Tobago. That means that prices in Chile are much better, at close to $9 to $10 per MMBTU (Argentina natural gas exports panel, in Spanish; BNAmericas report of recent transactions).
The problem is that Argentina already represents 70% of Chile’s gas imports (Chile imports and exports of fuels, in Spanish), and that gas represents less than 20% of the country’s generation matrix (Chile’s generation matrix, in Spanish). I do not think that there is a lot of room to grow here under the current conditions, and PAM is currently exporting about 1 million m3/day to Chile.
Until there are new announcements (a plant of LNG in Argentina or Chile, new large consumers of energy projects in Argentina, etc.) I do not think PAM will be able to grow its gas production further profitably. Therefore, I keep my previous estimations of $170 million per year in operating profits from this segment.
Enter oil
PAM announced that they were planning to get into the oil market aggressively. I believe that the capacity constraints in natural gas are behind that idea. Oil doesn’t suffer from the same capacity constraints as natural gas because it can be exported.
The company swapped some assets in the Vaca Muerta Basin for a property with substantial oil prospects. The new property, called Rincon de Aranda, is just above two of Vista’s (VIST) production properties, Bajada del Palo Oeste and Aguada Federal (Vaca Muerta oil region map, in Spanish).
PAM announced that they plan to invest $160 million in the project initially to drill 8 wells (2 pads). They expect to produce 15 to 20 thousand barrels daily by 2027 or 2028. For example, VIST, which is almost a pure-play oil producer in Vaca Muerta, has invested $2.6 billion to date (gross PP&E quarterly) and produces 45 thousand barrels daily.
In the case of the oil segment, I prefer to watch and wait. The property could prove not as productive, or PAM could not have the same capabilities as VIST to develop low-cost oil. It could also prove easier for PAM to develop these capabilities after learning from VIST and YPF (YPF).
Petrochemicals and the transporters
PAM also owns and operates Argentina’s only plant of styrene and polystyrene. This segment has ranged in operating profits between $20 and $50 million, depending on the level of appreciation/depreciation of the Argentinian peso compared to its inflation rate. In this respect, 2023 proved to be a bad year, and PAM is generating $25 million in operating profits from this segment for the 9M23 period, so at the lower end of my expected range. I do not expect this to change in the future.
PAM also owns a 35% stake in TGS (TGS), and a 30% stake in Transener, the national grid system operator. I have recently covered TGS and believe it is fairly valued at $2.1 billion, representing $735 million for PAM. Transener is a fully regulated business, whose profits will depend 100% on government policy. Using a ROA approach, I value Transener at approximately $100 million, or $30 million for PAM, but the company trades in Argentina (ticker BCBA:TRAN) for a market cap of $160 million, or $48 million for PAM.
Financing
PAM has $610 million in dollar-denominated assets versus $1.3 billion in mostly dollar-denominated debt. That debt matures mostly in 2027 and has an average maturity of 3 years.
Because the Argentinian capital market is heavily restricted, Argentinian companies can issue dollar-denominated debt in pesos at extremely generous rates. Specifically, PAM was able to issue $128 million maturing in 2025 at a rate of 5%, or close to SOFR. I do not expect this situation to continue because I expect the new government to open the foreign capital account, and therefore, Argentinian capitals will have other alternatives abroad. This means that PAM will probably need to refinance above its current average of 8.3%.
The company has been plowing back most of its cash flows into PP&E, a trend that will probably continue even further with the addition of the oil business.
Conclusions
In the future, I expect PAM to generate EBIT of between $430 million on the low end and $570 million on the upper end. Converted to NOPAT this represents $279 to $370 million. This implies no growth in any of its segments, and breakeven at its oil operations.
PAM’s current market cap is $2.5 billion (it has 55 million ADR equivalents trading at $45.5), although some sites show $6.5 billion, I believe because they incorrectly convert PAM’s Argentinian stock price to USD using the official exchange rate. To that, we add $700 million in net debt and remove $790 million from TGS and Transener.
We arrive at an EV of $2.4 billion, approximately, or an EV/NOPAT multiple of between 8x and 6.5x. I believe this is a fair value with the information we have today, but I would not purchase PAM at these prices. Instead, I would wait for more information on a few key aspects: how interest rates in US dollars for Argentinian large-cap companies behave after the government opens the foreign account; the efficiency and learning curve of the oil operations; and potentially, announcements regarding the generation market, and LNG projects that could absorb gas production in Argentina or Chile.
