Super cycles in natural gas prices and their impact on Latin American energy and environmental policies

Resources Policy 65 (2020) 101513

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Super cycles in natural gas prices and their impact on Latin American energy and environmental policies �squez Cordano a, b, 1, *, Abdel M. Zellou c, 2 Arturo L. Va a

� GERENS Graduate School, Lima, Peru Department of Economics, Pontifical Catholic University of Peru, Peru c Clear Future, USA b

A R T I C L E I N F O

A B S T R A C T

JEL classification: E32 (Business Fluctuations Cycles) L71 (Mining, Extraction, and Refining: Hydrocarbon Fuels) Q41 (Energy: Demand and Supply) E37 (Forecasting and Simulation: Models and Applications) L51 (Regulation and Industrial Policy: Economics of Regulation) Q58 (Environmental Economics: Government Policy)

There was an upward trend in energy commodity prices since 2000, but with the surge in supply coming from unconventional oil and gas resources in North America, the trend in natural gas prices has become downward in recent years. However, the exploitation of these resources is generating public concerns due to the possible adverse environmental impacts of using hydraulic fracturing and other techniques on underground water. The purpose of this paper is to address the following questions: are there super cycles in natural gas prices? What are the environmental consequences in Latin America of the exploitation of unconventional gas given the cyclical behavior of gas prices? How are the governments in the region implementing energy and environmental policies to regulate unconventional shale gas production? With the last peak occurring in 2006, we identified three super cycles in natural gas prices, and it is predicted to observe a new super cycle in the 2020s. Our analysis indicates that the unstable political situation, the institutional weakness, the governmental intervention through asset nationalization, high capital expenditures to develop LNG export projects and to explore shale resources, as well as the pre-salt discoveries in Brazil make uncertain that the shale gas boom achieve a significant impact in Latin America during the coming gas-price super cycle.

Keywords: Super cycles Long cycles Exhaustible resources Natural gas prices Energy and environmental policies Shale gas Trend-cycle decomposition Christiano-fitzgerald band-pass filter Latin America Environmental regulation

1. Introduction Given the importance of energy resources in the global economy, it is hardly surprising that many researchers and analysts have extensively

studied the prices of energy products. Long-term trends, behavior over the business cycle, sensitivity to geopolitical developments, and the causes of short-run volatility have all been of keen interest to policy­ makers, oil & gas producers, consumers, and investors. The surge in

* Corresponding author. E-mail addresses: [email protected] (A.L. V� asquez Cordano), [email protected] (A.M. Zellou). 1 Address: Avenida Primavera 1050, 3rd floor, Santiago de Surco, Lima, Peru. Arturo L. V� asquez Cordano is Associate Professor of Economics & Business and � Director of Research at GERENS Graduate School in Lima, Peru. He is also Assistant Professor of Economics at the Department of Economics of the Pontifical Catholic University of Peru (PUCP). I thank Tatiana Nario, Paola Rojas Valero, Thais Ch� avez, and Edison Ch� avez for their valuable research assistance. A previous version of this article titled “Where are natural gas prices heading and what are the environmental consequences in Latin America?“ was presented at the 2016 Annual Congress � of the Peruvian Economic Association held at PUCP. I thank GERENS Graduate School for its partial financial support to develop this paper under Research Grant No � 001-2016-EPG-GERENS. 2 Abdel M. Zellou is partner at Clear Future, USA. We are grateful to the editor of Resources Policy, G.A. Campbell, and three anonymous reviewers for insightful comments and suggestions. The views and opinions expressed in this paper are those of the authors and should not be interpreted as those of their institutions. All errors and omissions are our own.

https://doi.org/10.1016/j.resourpol.2019.101513 Received 14 April 2018; Received in revised form 24 August 2019; Accepted 8 October 2019 Available online 20 November 2019 0301-4207/© 2019 Elsevier Ltd. All rights reserved.

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fracturing activities,4 the construction of new gas infrastructure without careful management, weak regulatory institutions, unstable legal rules, corruption and little law enforcement in the region (O’Donnell, 1993; �squez Cordano, 2012; Levitsky and Murillo, 2012; Laffont, 2005; Va �squez cordano et al., 2013b). Va In this context, the objective of this paper is to address the following questions: are there super cycles in natural gas prices? If so, are we currently on the upside or downside of a cycle? Is it possible to identify a new super cycle in the foreseeable future? What are the economic and environmental consequences in Latin America of the exploitation of shale gas resources given the cyclical behavior of gas prices? How are governments in Latin America implementing energy and environmental policies to regulate unconventional gas extraction? In order to deal with these questions, Section 2 analyzes the presence of super cycles in natural gas prices. This analysis will provide the necessary framework to understand how the likely pattern of gas prices in the future will affect the economic perspectives to develop uncon­ ventional gas resources in the most relevant oil countries in Latin America: Argentina, Brazil, and Mexico. We use the band-pass filter approach proposed by Cuddington and Jerrett (2008) to study long-term trends in U.S. natural gas prices and search for evidence of super cycles in these prices. Peer-reviewed literature supports this approach. For example, several authors such as Jerrett and Cuddington (2008), Zellou and Cuddington (2012a,b), Erten and Ocampo (2013), Cuddington and Nülle (2014), Erdem and Ünalmıs¸ (2016), Ocampo, 2017, Jacks (2018), as well as Ocampo et al. (2018) have sustained and remarked that super-cycle analysis provides an excellent statistical framework to study the recurrent historical behavior of commodity prices over time in order to obtain insights regarding their future behavior and their impact on economic activity and political behavior. Besides, our paper also follows the approach of Gruss (2014), who considers the downturn of the super cycles in commodities prices to analyze output growth in Latin America and the Caribbean. Incorporating into the paper the super-cycle analysis of natural gas prices to evaluate policy scenarios follows a long tradition in the energy and resource economics literature promoted by authors like Fouquet and Pearson (1998, 2012). The authors state that “the analysis of historical evidence, however, not only yields an understanding of the past and the background to the present but also offers potentially valuable insights into energy futures” (1998: 1). Similarly, Zellou and Cuddington explain that "[e]vidence demonstrating the presence of super cycles in energy com­ modities is valuable for national and state governments, financial in­ stitutions, and oil and gas companies. At the level of government, countries that rely on the import or export of energy commodities need to take into account the presence of super cycles in energy commodities in order to define their revenue and spending policies. At the firm level, the

prices in the early years of the 21st century has generated much dis­ cussion about both long-term trends and possible “super cycles” in commodity prices. See, e.g., Rogers (2004), Heap (2005), Cuddington and Jerrett (2008), as well as Jerrett and Cuddington (2008). Alan Heap defined a super cycle as a “prolonged (decades) long trend rise in real commodity prices” (2005: 2). The upswings of these super cycles last 10–35 years as a country or region goes through a structural transformation associated with industrialization and urbanization. This structural transformation usually follows the rise of demand for energy commodities and metals as the manufacturing sector expands (see Kuznets, 1973). Cuddington and Zellou (2013) provide a formal model of super cycles driven by the structural transformation of a typical economy during the development process. They show that the presence or absence of super cycles will depend critically on the speed of capacity adjustment to surging mineral demand during industrialization. Cud­ dington and Jerrett (2008), as well as Jerrett and Cuddington (2008), found evidence of super cycles in metals prices, while the studies of Zellou and Cuddington (2012a, 2012b) focused on super cycles in oil and coal prices. The long-term behavior of natural gas prices for assessing energy projects is of current importance in Latin America where discoveries of new conventional deposits of gas have occurred during the last decades in countries such as Peru (Camisea), Bolivia (Tarija), Brazil (pre-salt deposits in the Santos basin), Trinidad & Tobago (offshore reservoirs) and Colombia. Large unconventional deposits of shale gas3 have also been assessed in Argentina (Vaca Muerta shale play), Brazil and Mexico, suggesting that Latin America may become a significant pro­ ducer (and also an exporter) of natural gas in the coming years. Given that natural gas projects (such as non-conventional shale gas fields) take years or decades for being developed and operated, it is crucial to know how natural gas prices will evolve over the long run. This analysis is essential to assess if energy companies will have the right necessary economic conditions to start new investments in the exploration, extraction, and development of new gas fields in specific regions such as Latin America. As Cuddington and Jerrett (2008) have pointed out, natural resource capital investments have long gestation periods; therefore, the prospects of an emerging energy super cycle have essential implications for profitable capacity expansion of existing en­ ergy projects or new oil & gas investments by both private and government-owned energy companies. However, the development of unconventional gas projects requires stable prices over the long run to improve their economics and guar­ antee their feasibility given the substantial capital expenditures required to start production in unconventional fields and set up the necessary infrastructure to deliver natural gas to domestic and international markets. Thus, a careful assessment of whether super cycles characterize the behavior of natural gas prices (especially U.S. prices since they are used in the Latin-American region as a reference to set up gas delivery contracts and take-or-pay agreements) is relevant to evaluate if Latin America will become a significant player in the international natural gas industry. Similarly, if a boom in shale gas extraction in Latin America happened due to a favorable long-term gas price cycle, it could also generate adverse environmental impacts as a result of the potential safety risks. These risks are associated with the increase in hydraulic

4 Hydraulic fracturing (also known as fracking) is the propagation of fractures in a rock layer by a pressurized fluid. It is a technique extensively used nowadays to extract hydrocarbons trapped in highly impermeable rock for­ mations such as shale plays. It consists of injecting, at high pressure, millions of gallons of water, sand and chemicals (i.e., fracturing fluids) to the formation located several hundred meters underground in order to fracture the rocks and allow the liberation of hydrocarbons to the surface. This procedure creates fissures from wellbores drilled into reservoir rock formations, allowing hydro­ carbon fluids to flow to the wellhead for primary processing and distribution. The technique can allow exploiting unconventional resources such as shale gas, tight gas, and coal seam gas. The first use of hydraulic fracturing was in 1947, but the modern technique, known as horizontal slickwater fracturing that made the extraction of shale gas economical was first used in 1998 in the Barnett Shale Formation in Texas. See King (2012) for further details.

3 Shale gas refers to natural gas that is trapped within shale formations. Shales are tight fine-grained sedimentary rocks that can be rich sources of petroleum and natural gas. Thus, shale gas and natural gas are the same product; they are molecules of methane (CH4).

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exploration-development-production-distribution-research-and-develop­ ment cycle of energy projects often spans several decades, as do super cycles” (2012a: 172).5Finally, super-cycle analysis can also be useful to understand how the fluctuations of raw-material prices generate macro­ economic imbalances on emerging commodity export economies (Drechsel and Tenreyro, 2018), such as natural gas exporting countries. In this context, the information regarding the existence of super cycles in gas prices is essential from a strategic perspective, because it allows assessing the possible economic and political scenarios that might foster or deter the development of shale gas investments in a region like Latin America with vast unconventional gas resources. Considering the evidence from the super-cycle analysis, Section 3 focuses on studying how a possible expansionary phase of a new super cycle in natural gas prices might affect the economics of shale development and shape en­ ergy and environmental policies in Latin America. In this sense, we proceed to assess the environmental consequences of the exploitation of unconventional gas, given the cyclical behavior of gas prices, in Latin America. This assessment will allow us determining how governments can implement energy and environmental policies to regulate uncon­ ventional gas extraction in this region. Section 4 concludes.

Since 1988, the HH has been the delivery and reference point of the New York Mercantile Exchange (NYMEX)7 natural gas futures and options contracts. Second, since Latin America is a region with a low level of market integration, for several decades governments and private companies in the region have taken as given the U.S. HH gas prices as references for their natural gas pricing policies. U.S. HH gas prices are relevant for Latin America since they are used in the region as a reference to set up gas delivery contracts, power purchase agreements, and take-or-pay contracts. Through the netback pricing method, gas developers in the region can determine wellhead reference prices for their local gas pro­ duction. For example, Mexico uses the U.S. HH gas price to define wellhead prices for PEMEX and Reynosa cities, areas which determine the reference gas prices for the country. In Argentina, the government uses a basket of U.S. fuel oil prices and the HH price to determine minimum reference prices for the natural gas �squez Cordano et al., 2013a). Likewise, traded in the country (Va Argentina secures cargoes from the spot market at a fixed price based on the short-term market, generally considering the HH gas prices as a basis plus a premium in U.S. dollars. Moreover, domestic Brazilian gas prices are strongly correlated with the HH price, while several power plants have long-term power purchase agreements indexed against the HH price (Honor� e, 2016). In Peru, HH gas prices serves as a reference price for the LNG export contracts (sales and purchase agreements) that the company PERU LNG (owned by Hunt Oil, Shell, among other oil com­ panies) has with the Mexican Federal Commission of Electricity (V� asquez, Tamayo et al, 2014; Honor� e, 2016). Similarly, long-term Chilean LNG import contracts consider the HH price plus a premium since 2012 (Honor�e, 2016: 30). The U.S. natural gas price series comes from the U.S. Energy Infor­ mation Agency.8 The series covers the period 1922 to 2015 and repre­ sents the price expressed in U.S. dollars per thousand cubic feet. Fig. 2 displays the real prices of natural gas using the Consumer Price Index (CPI) as a price deflator.9 An Oregon State University website publishes the longest span U.S. Consumer Price (CPI) Index series starting in 1774 on an annual basis used in this paper (Oregon State University, 2013). Fig. 2 provides long-term annual data on real natural gas prices from 1922 to 2015 in the U.S.A.

2. Trends and super cycles in natural gas prices 2.1. Background Fossil fuels (coal, oil, and natural gas) have been the primary sources of energy since the Industrial Revolution. Fig. 1 displays the evolving role of each fossil fuel in U.S. energy consumption since 1850. At the world level, fossil fuels represented about 80% of total primary energy supply in 2010, and this share is expected to remain roughly unchanged through 2035, according to forecasts by the International Energy Agency (IEA). The share of natural gas increased rapidly since World War II and remains constant at around 20% since the late 1970s. Alternative energy production is growing, but its share of global energy consumption is expected to remain roughly unchanged over the next 20 years. The bottom line appears to be that fossil fuels, including natural gas, will remain the primary energy resources for years to come and the evolution away from fossil fuels will be slow. Therefore, analyzing gasprice super cycles is critical to assess future scenarios for the evolution of gas prices and their impact on the markets worldwide.

2.2.2. Band-pass (BP) filter methodology The BP filter is a univariate technique that allows the extraction of cyclical components from a given series.11 Baxter and King (1999), as well as Christiano and Fitzgerald (2003), have recommended the use of

2.2. Data and band-pass filter methodology applied to gas prices 2.2.1. Information about gas prices In this paper, we focus on analyzing the existence of super cycles in U.S. gas prices. Two arguments support our choice. First, the United States has become a reference market for gas pricing since the restruc­ turing of the natural gas markets in the 1970s with the liberalization of wellhead prices (by means of the Natural Gas Policy Act of 1978), which was followed by the open access to the trunk pipeline natural gas infrastructure through the FERC Order 436 of 1985. Under the dereg­ ulation of the U.S. natural gas market, the trading place “Henry Hub” (HH) located in Louisiana became the center of the U.S. gas market.6

7 The NYMEX is a liquid market which serves as a reference for almost all the trade of natural gas in North America and as a reference point for exports contracts to Mexico and several Latin American countries (Neumann, 2009). 8 Sources: The full series is downloadable from the EIA website: http://www. eia.gov/dnav/ng/hist/n9190us3A.htm. The CPI series is downloadable from the Oregon State University website: http://liberalarts.oregonstate.edu/spp/po lisci/research/inflation-conversion-factors-convert-dollars-1774-estimated2024-dollars-recent-year. 9 Other price deflators, such as the Producer Price Index for all Commodities (PPI), give similar results. 10 The U.S. Energy Information Administration defines the natural gas well­ head price as the natural gas price calculated by dividing the total reported value at the wellhead by the total quantity produced as reported by the appropriate agencies of individual producing states and the U.S. Bureau of Ocean Energy Management, Regulation and Enforcement. The price includes all costs before shipment from the lease, including gathering and compression costs, in addition to State production, severance, and similar charges. 11 Cuddington and Jerrett (2008) and Jerrett (2010) provide an excellent extensive description of the use of asymmetric Christiano-Fitzgerald band-pass filter for super-cycle analysis and apply it to the study of metals prices.

5 Furthermore, Erten and Ocampo state that “[t]he presence of super cycles in commodity prices matters for a number of decisions in production as well as in policymaking. First, trends in commodity prices have been considered for a long time a central policy issue for commodity dependent developing countries. Second, since the decision to increase capacity is directly related to expected future prices, and investment projects might take several years and even de­ cades (when they involve the development of new regions) to complete in capital-intensive mining sectors, firms must pay special attention to such medium-term price trends as they make investment decisions” (2013: 4). 6 The Henry Hub integrates connections with more than 16 trunk pipelines, LNG infrastructure and three large salt caverns for storage.

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Fig. 1. Primary energy consumption level (top panel) ad share (bottom panel) for the United States between 1850 and 2010 *. * Fossil fuels (oil, coal and natural gas) represent about 80% of the total energy consumed since 1900. That consumption is for all sectors of the economy from transportation to the industrial sector. Source: Tol et al, (2006). Information updated up to 2010.

band-pass filters in economics.12 The band-pass or frequency filter ex­ tracts cyclical components of a given time series that lie within a spec­ ified “window” or range of frequencies. The user specifies the lower and upper bounds of the periods of the cycles of interest. The use of the BP filter methodology to assess long-term trends and

super cycles in commodity prices has become a standard practice in the literature of energy and resource economics (Cuddington and Jerrett, 2008; Jerrett and Cuddington, 2008; Erten and Ocampo, 2013; Cud­ dington and Nülle, 2014; Erdem and Ünalmıs¸, 2016; Jacks, 2018). The advantage of the Christiano and Fitzgerald’s approach is that it allows decomposing the cyclical component within a pre-determined window or various frequencies present in commodity prices. Lower and upper bounds of the periods of the cycles are usually taken as 20–70 years to identify the super-cycle component in commodity prices. As Jacks points out regarding Christiano and Fitzgerald’s research, “[the BP filter] has as its basic insight that time-series data—like the real commodity price series under consideration here—can be characterized

12

Similar band-pass filter techniques are used in different fields, e.g. hard sciences such as electronics and physics. The second author of this paper has encountered it, for example, in spectral imaging and spectral decomposition in geophysics in the oil and gas industry to extract 3D images of reservoirs in the presence of oil, gas or water. 4

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the available data span.”13 This property is particularly important for our analysis since the available natural gas price only goes from 1922 to 2015, which is not a very large timeframe for a cyclical decomposition. Therefore, given our interest in identifying whether a new super cycle in natural gas prices is emerging or fading in the final years of our data sample and how this event may affect investment conditions for shale gas developments in Latin America, we choose the ACF-BP filter. The latter is relevant in our analysis because it allows preserving as much data as possible, especially at the end of our sample. Following the previous works in the literature about commodityprice super cycles, we extract four different components from the gas price series: the super-cycle component, an ‘intermediate’ cycle, the business cycle and the trend component. The period ‘window’ for these components is defined so that they are mutually exclusive and exhaus­ tive (note that the seasonal component is not measurable with annual frequency data). The super-cycle component, for example, has a window of 20–70 years. The trend component is defined to include all cyclical components beyond 70 years: T(70, ∞) � Actual – BC(2,8) – IC(8,20) – SC(20,70) where T, BC, IC, and SC represent the trend, business-cycle, intermediary-cycle, and super-cycle components, respectively.

Fig. 2. N: Nominal and real prices of natural gas, 1922–2015*. * Real prices are obtained using the Consumer Price Index (CPI) (base year 2015) as the price deflator. The U.S. natural gas wellhead price series10 spans the period 1922–2015 and is expressed in U.S. dollars per thousand cubic feet. The natural gas price for 2015 is a monthly average over the first ten months of the year: no more data was available for 2015 at the time of writing this paper. Prices are displayed on a log scale. Source: U.S. Information Energy Administration.

2.2.3. Super-cycle analysis of gas prices and the assessment of policy scenarios As mentioned before, the current literature about energy and resource economics has emphasized the use of super-cycle analysis to assess future scenarios for the evolution of commodity prices. This literature has identified recurrent super cycles affecting several com­ modities, including oil and coal, through long periods of history. These consistent patterns of commodity price cycles entail long-lived de­ viations from their underlying trends in the past, the present, and possibly in the future (Ocampo, 2017). The relevance of super-cycle analysis to predict future policy de­ velopments have been recently pointed out by authors like Jacks who states that the boom/bust episodes found in commodity prices over super cycles “are found to be historically pervasive and, thus, potentially relevant for commodity exporting nations” (2018: 3). In that sense, super-cycle analysis of commodity prices is not a purely statistical ex­ ercise. Recent theoretical research provided by Cuddington and Zellou (2013) has shown that the existence of super cycles in nonrenewable commodity prices is based on the microeconomic foundations of com­ modity supply and demand in world markets. Under plausible micro­ economic assumptions regarding the short-run and long-run nature of commodity supply and the derived demand for minerals as intermediate goods in production sectors, the authors show that their model generates “an asymmetric price cycle with a peak price that is about 250% above the trend and an expansion phase that lasts for about 20 years. Thus, [their] simple model is capable of producing a single super cycle with a frequency and amplitude in the range estimated in the empirical liter­ ature on super cycles” (2013: 75). Then, as the authors emphasize, the asymmetric ChristianoFitzgerald band-pass filter allows detecting super cycles correctly. Sta­ tistical analysis of super cycles in commodity prices helps empirically

as the sum of periodic functions. Their work then establishes the ideal (infinite sample) band-pass filter, allowing for slowly evolving trends and imposing no restrictions on the distribution of the underlying data. Furthermore, they suggest a finite-sample asymmetric band-pass" (2018: 7). In contrast, conventional filtering techniques like the HodrickPrescott (HP) filter have several drawbacks. For instance, the filters have drawbacks: sensitivity of results to the choice of the smoothing parameter, end-point bias, the possibility of generating correlation across the filtered variables and slow reaction in establishing turning points in long-run trends (the HP filter can estimate that commodity prices continue to rise, even in a context of a significant reversal). Recently, Hamilton, 2016 strongly recommends not to use the HP filter since “it produces series with spurious dynamic relations that have no basis in the underlying data-generating process” (2016: 2). Thinking of frequency filters in terms of time rather than frequency domain, Baxter and King (1999) explain that band-pass filters are so­ phisticated two-sided moving averages. They differ from the standard moving averages in two ways. First, the (ideal) weights of various leads and lags are chosen to filter out cyclical components that do not fall within the chosen window. By choosing symmetric weights on each lead and corresponding lag, we can prevent a phase shift in the extracted component. Second, there are asymmetric as well as symmetric filters. The asymmetric Christiano-Fitzgerald band-pass filter (ACF-BP) has been recommended in the literature for analyzing commodity prices, because it allows us to analyze these prices by computing cyclical components for all observations at the beginning and the end of the data span (Cuddington and Jerrett, 2008; Jerrett and Cuddington, 2008; Erten and Ocampo, 2013). In other words, it “allows for the extraction of filtered series over the entire sample, thus, ensuring that no data from either the beginning or the end of the sample are discarded” (Jacks, 2018: 7). Likewise, Zellou and Cuddington (2012a: 172) states that “[a] lthough asymmetric filters invariably introduce some phase shift into the filtered series, they have the advantage of allowing computation of the filtered series over the entire data span rather than being limited to a trimmed data span caused by the number of leads and lags used in calculated the filtered series. This is advantageous if one is particularly interested in studying cyclical behavior near the end (or beginning) of

13 Recently, J� egourel (2018) has developed a research comparison among different journal articles that study the super cycle hypothesis, stating that the band-pass filter constitutes the workhorse for super-cycle analysis of com­ modity prices nowadays. In addition, the author characterizes the dynamics of commodity prices considering three phenomena which they are subject to (very) long-term trends, medium/long cycles, and short-term varia­ bility/volatility. Super-cycle analysis corresponds to the study of the long-term cycle phenomenon observed in commodity prices. The author identifies that in the literature, the band-pass filter proposed by Christiano and Fitzgerald (2003) is the most common and adequate method to identify super cycles in com­ modity prices.

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Fig. 3. Super cycles in the U.S. Real natural gas pri­ ces. * For comparison and analysis, the super cycles in real oil prices are provided as well. The units on the ver­ tical axis represent percentage deviations from the trend. The shading corresponds to the super cycles in real natural gas prices with the corresponding dates (from trough to trough). Three different SCs in natu­ ral gas prices are identified from trough to trough: SC1: 1948–1970; SC2: 1970–1995; SC3: 1994–2017. Source: Own elaboration.

corroborate the theoretical results regarding the microeconomics of world commodity markets and helps assess future scenarios for the evolution of commodity prices.14 As we can see, the current literature supports the idea that the sta­ tistical analysis of super cycles is, in fact, relevant to predict future policy scenarios for the evolution of commodity prices, such as natural gas. Super cycles are created following the microeconomics of supply shocks (technology innovations, resource depletion, etc.) and demand shocks generated by prolonged demand expansions of raw materials, as major economies move through urbanization and industrialization phases of their development processes (Heap, 2005; Cuddington and Jerrett, 2008; Erten and Ocampo, 2013). On the other hand, from a political economy standpoint, super-cycle analysis has also been used to understand how cyclical mineral price fluctuations can affect the likelihood of social conflicts related to extractive activities. For instance, Berman et al. (2017) analyzed how the recent mineral-price super cycle has affected the number of conflicts observed in Africa over 1997–2010, finding that the last super cycle accounts for 14%–24% of the average violence in the African economies. Therefore, looking at the statistical evidence of super cyclical behavior in commodity prices can help identify possible future patterns for these prices in the future, which in turn make possible to carry out predictions of the impacts of super cycles in an economy (Benguria et al., 2018; Reinhart et al., 2016; Berman et al., 2017). As Cuddington and Zellou point out, “[a]s other regions reach the development ‘take-off’ phase, additional super cycles should emerge” (2013: 75). Hence, it is vital to incorporate in our paper the super cycle analysis of natural gas prices in order to assess future scenarios for the pattern of gas prices affecting the Latin American region, which are pretty influenced by the US HH gas price, as mentioned before.

2.3. Trend and super cycles in natural gas prices 2.3.1. Super cycle in U.S. Natural gas prices Fig. 3 displays the super cycles (SC) in real natural gas prices for the U.S.A. For comparison and analysis, we provide the super cycles in real oil prices as well. The units on the vertical axis represent percentage deviations from the trend. For example, þ0.20 indicates 20% above the long-term trend. The shading corresponds to the super cycles in real natural gas prices with the corresponding dates (from trough to trough). We can identify three different super cycles in natural gas prices from trough to trough: SC1: 1948–1970; SC2: 1970–1994; SC3: 1994–2017. The first two super cycles in natural gas prices lasted 22 and 25 years, respectively. If the current super cycle lasts as long as the previous two, one may expect the next trough to occur right before or around 2020. Moreover, one may also notice a strong correlation between the super cycles in oil and natural gas prices (Table 1).15 Finally, the amplitudes of the super cycles in natural gas prices are smaller than the ones in oil prices. They are still quite significant with values at 59% above the trend for the peak in 1982 and 40% for the next peak in 2006 (Fig. 3). Since Pindyck and Rotemberg (1990), the literature has documented that prices of unrelated raw commodities have a persistent tendency to move together. The demand-driven nature of these cycles generates that the individual commodity prices tend to move together with a strong positive correlation (Cuddington and Zellou, 2013; Erten and Ocampo, 2013). The co-movement of oil and gas-price super cycles is a conse­ quence of the fact that commodity prices started to be driven by global economic growth together with the “financialization” of commodities. In fact, given that both prices are determined in the world hydrocarbons market, there is a natural connection between both prices. In addition, some gas contracts in the market consider price formulas indexed to oil 15 Basically, the strong co-movement between both super cycles observed in oil and gas prices is explained by the demand shock for raw materials generated by the expansion of economies such as Japan and Europe in the 1950s and 1960s after World War II, and the industrialization of large developing econ­ omies such as China and India in the last decades. The industrialization process of these economies over the years generated a simultaneous demand increase for several commodities such as minerals, oil and natural gas (Cuddington and Jerrett, 2008). As mentioned before, Cuddington and Zellou (2013) explain this empirical finding using a simple commodity market model that generates correlated super cycles for different commodities when a demand shock for raw materials happens.

14 In another strand of the literature, Benguria et al. (2018) analyzed the transmission channels through which commodity price super cycles affect open economies using a dynamic microeconometric model with heterogeneous firms. The focus of the authors is to predict how super cyclical behavior in commodity prices affect resource-depended economies such as Brazil in Latin America. They found that “[h]igher commodity prices increase domestic demand (wealth channel), disproportionately benefiting nonexporters, and induce wage in­ creases (cost channel) especially among unskilled workers, hurting unskilled intensive industries” (2018: 1).

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For the real price of natural gas, the trend is a U-shaped curve, up to 2002, as predicted by Slade (1982), Heal (1981) and Pindyck (1978), but with a downward orientation for the past nine years. In real terms, the trend in natural gas prices has increased by 171% between 1945 and 2002, representing an average annual increase of 3%, which represents a sharper increase than for real oil prices. Note that the super-cycle component is currently at the intersection of the trend component, suggesting that the downward trend phase of the SC is far from over to reach the trough. The recent downward trend in real natural gas prices started in 2006, showing evidence that technology is winning the race against depletion (Tilton, 2002), mainly thanks to the production from shale resources exploited using fracking techniques. The real oil price trend also has a U shape: downward until World War II and then upward at a rate of roughly 2% per year after that (Fig. 5). Note that the trends of both series change direction more than once, in contrast to the predictions of Slade (1992) theoretical frame­ work and empirical results. For comparison and analysis, we provide the calculation of the trend of real oil prices as well. The trend component observed in natural gas prices is indeed downward since 2002, but the slope is very gentle. It is too early to assess how rapid the decline is going to be. The natural gas super-cycle component is downward as well and is already under the trend (see Fig. 4). If a length of the current super cycle is assumed to be similar to the previous two, a trough could be expected to occur around or before 2020, before prices bottom out and start picking up again. This result is more or less in line with current price forecasts, even though the current futures are on the high end of it. Source: Own elaboration. The trend component for the natural gas price we are currently observing since 2002 is indeed downward, but the slope is very gentle, and it is too early to assess how rapid the decline is going to be. The natural gas price super-cycle component is downward as well, and it is already slightly under the trend (see Fig. 4). If a length of the current super cycle is assumed to be similar to the previous two, a trough could be expected to occur around 2020, before prices bottom out and start picking up again. This result is more or less in line with current price forecasts, even though the current futures are on the high end of it.

Table 1 Correlation between the super cycles in natural gas prices and oil prices. Covariance Analysis:

Ordinary

Sample (adjusted): 1922 2012 Included observations: 91 after adjustments Balanced sample (listwise missing value deletion) Correlation

LPRNG_SC

LPROIL_SC

LPRNG_SC LPROIL_SC

1.000000 0.753884

1.000000

Source: Own elaboration. LPRNG_SC: Natural gas price super cycle. LPROIL_SC: Oil price super cycle.

Fig. 4. Real U.S. Natural Gas Prices, along with their Trend and Super-Cycle Components *. * The shading corresponds to the different super cycles in real natural gas prices identified in Fig. 3 above. An upward trend in real gas prices started after World War II and ended in 2002. In real terms, the trend in natural gas prices has increased by 171% between 1945 and 2002 (in log terms), representing an average annual increase of 3%. Note that the SC component is currently at the intersection of the trend component, suggesting that the downward trend phase of the SC is far from over to reach the trough. The vertical axis is on a log scale. Source: Own elaboration.

2.3.2. Are there super cycles in European and Asian natural gas prices? We evaluate whether super cycles in U.S. natural gas prices are associated with other super cycles in natural gas prices from other relevant markets such as Europe and Asia. For this purpose, we collected price data for these regions, obtaining monthly data for European LNG average prices, Asian LNG average prices, and European pipeline average prices between 1988 and 2014 from the publication “Energy Prices and Taxes” issued by the International Energy Agency (IEA, 2015; IEA, 2009) and compiled following the work of V� asquez Cordano et al. (2013a). The available database only allowed to obtain 25 annual ob­ servations, a fact that severely limits any super-cycle study.17 We compute the super-cycle components of the European and Asian natural gas prices using the ACF band-pass filter. For comparison, we add the super cycles of oil and U.S. natural gas prices calculated in the previous

�squez cordano et al., 2013b; prices (Razavi, 2009; Aune et al., 2009; Va Li et al., 2014; Honor�e, 2016). Zellou and Cuddington (2012a,b) have also shown that there is a strong correlation between oil and metal price super cycles.16 Fig. 4 displays the super cycle and trend components for the U.S. real natural gas price series. A comparison of the long-term trend compo­ nents of the two energy commodities is interesting in light of ongoing discussions about the increasing scarcity of nonrenewable resources and peak oil (Cuddington and Nülle, 2014).

17 There is not much available price data for Europe and Asia from official sources, because until the 1990s an important amount of gas sells among countries in those regions were established based on bilateral gas contracts, in which gas prices were formed using indexing formulas related to oil fuels (Razavi, 2009; V� asquez Cordano, García and Ruiz, 2013). It is only in the 1990s and 2000s that the first trading hubs in Europe were created, such as the Na­ tional Balancing Point in the United Kingdom (1996), the Title Transfer Facility in the Netherlands (2003), the transit Zeebrugge hub in Belgium (2000), and the transit Central European Gas hub in Austria (2005) (Heather, 2012). In the case of East Asia, we have the case of the Singapore LNG trading hub estab­ lished in 2014, from which SLInG LNG price index is derived. This explains why there are not many gas price quotations for these regions. Sadly, this fact in­ hibits us from performing an extensive super-cycle analysis for European and Asian gas prices in this paper.

16

Recently, several empirical works have provided evidence that the comovement is a robust stylized fact using FAVAR models (Lombardi et al., 2012), networks analysis (Gomez et al., 2011), dynamic factor models (Alquist and Coibion, 2013; Delle Chiaie et al., 2017), and dynamic stochastic equilib­ rium models (Fern� andez and Rodríguez, 2018). Regarding the co-movement in commodity prices, Fernandez et al. explain that “[a] salient characteristic of these movements -often comparable to a wild roller coaster ride-is that they share a common factor. The latter cannot be solely attributed to these econo­ mies exporting similar commodity goods. Indeed, the common factor arises also because there is a marked tendency for the price of different commodity goods to move in tandem” (2018: 37). “From the supply side, the crude oil and natural gas price linkage is mainly driven by the direct competition for drilling re­ sources at the wellhead” (Mchich, 2018). 7

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Resources Policy 65 (2020) 101513

Fig. 5. Trend in real natural gas prices.

section. We show the results of our analysis in Fig. 6. Unfortunately, the data allows only to partially capture one super cycle in European and Asian gas prices. The figure permits us to identify that the super cycles of European and Asian gas prices comove with the U.S. gas-price super cycle with a lag of about 3–5 years, and follow the Brent oil-price super cycle. This result points out that gas prices in regional markets are, to some extent, correlated. Regarding the corre­ lation among the super cycles in oil and gas prices, Li et al. (2014) explain that European and Asian gas pricing mechanisms have been traditionally related to oil products, such as fuel oil or the Brent oil price. Thus, natural gas prices usually adjust to reflect the changes in the prices of oil products, rather than the gas-to-gas pricing scheme used in North America since the 1980s (where gas prices are tied to supply and de­ mand conditions). However, in recent years, some gas contracts in Europe and Asia are reputed to contain references to the U.S. Henry Hub gas price to consider for a portion of the weight in the pricing formulas.

These facts may be behind the association between the gas and oil price super cycles. The observed lag in regional gas prices, on the other hand, might be explained by the fact that the regional gas markets in the world are still �squez Cordano et al., not well integrated (Siliverstovs et al., 2005; Va 2013a; Li et al., 2014). Nevertheless, this trend may change in the future due to the increase in LNG international trade across different regions over the world (Olaya, 2006; Razavi, 2009; Aune et al., 2009; Neumann, 2009; Brown and Yücel, 2009; British Petroleum, 2018), as well as the transition from “oil indexation” to “gas-hub indexation” in natural gas contracts worldwide (Xunpeng and Variam, 2018). As stated before, governments and companies in Latin America since the 1980s have traditionally used gas pricing policies based on U.S. Henry Hub gas price. However, in the future with the increasing inte­ gration of regional gas markets thanks to LNG trade, it is likely that the European and Asian gas prices will be used more frequently as price markers for gas contracts in Latin America. Henceforth, we will develop our policy analysis of the implications of the super cyclical behavior of natural gas prices for energy and envi­ ronmental policies in Latin America based on our analysis of the U.S. Henry Hub gas price presented in this section. 2.3.3. Summary of results To sum up, our statistical analysis allows us to observe that the current gas-price super cycle may be in the last part of a contractionary phase by now. Given the recurrent historical behavior of this com­ modity, we expect that a new super cycle might occur in the 2020s, probably explained by a recovery and normalization of the world eco­ nomic activity, especially in regions like China, India, the European Union, and North America as IMF, 2018 and British Petroleum (2018) have recently assessed. According to the IMF, the world will grow at a steady growth rate of about 4% per year in the next decade. However, it is necessary to see how the trade war between China and the U.S.A. will end. The tariffs imposed on USD 200 billion of U.S. imports from China by the Trump administration might limit the growth possibilities of the world economy in the coming years, which in turn might soften the expansion of the next gas price super cycle. The analysis of the cyclical behavior in gas prices helps us assess a future scenario for the evolution of gas prices. This outcome is essential to evaluate if there might be favorable economic conditions to exploit

Fig. 6. Super-cycle components of the U.S.A, Asian and European natural gas prices. Source: Own elaboration. 8

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Resources Policy 65 (2020) 101513

shale gas resources in Latin America, where there is a long tradition to take into account the U.S. HH gas price as a reference to make invest­ ment decisions on gas projects. In Section 3 we combine the quantitative results obtained in this section with qualitative policy analysis to provide an informed evalua­ tion of what might happen in Latin America regarding the shale gas development if gas prices would enter in an expansionary phase of a new super cycle starting in the early 2020s. On this regard, we follow Fou­ quet and Pearson (1998), Cuddington and Jerrett (2008), Zellou and Cuddington (2012a,b), Erten and Ocampo (2013), Ocampo (2015), Jacks (2018), as well as Ocampo et al. (2018). An expansionary phase of a new super cycle in gas prices might induce a hike in shale gas in­ vestments in Latin America. However, the expansion of shale production under this scenario might increase environmental risks in the sur­ rounding areas of the gas projects. A boom-bust cycle in Latin America might also create macroeconomic instability, trade imbalances, and slower growth18 if the cycle effects are not well controlled (Davis and �squez Cordano, 2013a). Va In the next section, after having demonstrated the presence of super cycles in natural gas prices, we will focus on the policy consequences in Latin America regarding the exploitation of unconventional shale gas resources given the cyclical behavior of gas prices. How can govern­ ments implement energy and environmental policies to regulate un­ conventional shale gas extraction in Latin America? We will also examine whether the fact that super cycles characterize the behavior of natural gas prices (especially U.S. prices since they are used in the region as a reference to set up gas delivery contracts) is relevant to evaluate if Latin America will become a significant player in the international natural gas industry.

Fig. 7. Shale Resource Estimates. Unproved wet shale gas technically recov­ erable resources*. *Total World Recoverable Resources: 7577 trillion cubic feet (tcf).

The evidence shown in the previous section regarding the long-term trend and super-cycle components of U.S. natural gas prices indicates that we are probably finishing an age of downward prices that took several years. According to our super-cycle analysis, an expansionary phase of a new super cycle can occur around the beginning of the decade of the 2020s, in which gas prices may grow at moderate rates. Our re­ sults support the claim made by the International Energy Agency (IEA) that the world will experience a “golden age” of natural gas consumption (IEA, 2011). The shale gas boom in the USA19 and the accelerated in­ crease of LNG international trade (global demand for LNG has increased by an average of 7% per year since 2000) appears to indicate that extraction and transportation technologies are overcoming the non-renewable nature of natural gas (Tilton, 2002; Business News Americas, 2015). IEA (2011) projects that, in the coming twenty years, the world en­ ergy matrix will shift toward a higher reliance on natural gas as a pri­ mary energy source. Natural gas will satisfy 25% of total primary energy demand by 2035, and that over 40% of the new gas needed (1.8 trillion

cubic meters) to satisfy the growing world energy demand will come from unconventional sources, mainly shale formations.20 Therefore, both an increasing energy demand and a moderate growth for gas prices due to technology improvement may be critical factors explaining the development of shale gas reservoirs that might explain 60% of global supply growth in the coming years (IEA, 2011; IEA, 2012b). In this context, Latin America has an expectant position. According to a recent study made by the U.S. Energy Information Administration (EIA), Latin America has the largest technically recoverable resources (TRR) of shale gas in the world. Fig. 7 points out that Latin America would have TRR for 1979 trillion cubic feet (tcf) (26% of world’s total shale gas resources), less than double the resources of the U.S.A. and Canada together (EIA, 2015). Moreover, three Latin American countries, Argentina, Mexico, and Brazil are among the top ten countries with shale gas TRR in the world. These countries concentrate around 80% of the region’s shale gas re­ sources. Argentina has 41% of TRR in the region, while Mexico and Brazil have 28% and 12% of the shale resources available in Latin America, respectively. Table 2 presents the status of shale TRR of Latin American countries. As we can see, some countries with smaller shale deposits may also have incentives to exploit these resources given the size of their economies, and their energy needs to foster economic development. Besides, Latin America can also benefit from already available technologies to hit untapped shale gas resources that have been devel­ oped during the last decade when high gas prices in the United States stimulated the perfection of horizontal drilling and hydraulic fracturing (IEA, 2011; Rahm, 2011). In this sense, countries in the region only need to promote clear investment rules and a pleasant business climate to foster foreign direct investment and technology transfer to developing their shale resources during the likely expansionary phase of a new gas-price supercycle in the next decade. Given the magnitude of the shale gas potential in Argentina, Mexico, and Brazil, in the next section, our analysis will focus on these countries in order to assess whether a shale gas boom can start as a consequence of growing energy demand and moderate gas prices over the coming super cycle.

18 A slower growth does not mean that there will be harmful consequences for different social groups in a country such the poor during a boom-bust process over a super cycle. See Davis and V� asquez Cordano (2013b) for evidence about this result. 19 Regarding this point, according to Business News Americas (2012), “un­ conventional oil and gas resources trapped in shale reservoirs had been largely ignored by the industry until recently, with only research and development (R&D) departments focusing on the untapped wealth these formations might someday reveal. However, at the turn of the 21st century, sustained high energy prices and increasing import dependence in large consuming markets created incentives for the development of new technologies to exploit domestic shale potential. This was notably the case in the United States, the birthplace of the shale revolution, where the swift commercialization of these resources took many observers aback."

20 Other benefits of shale gas extraction can show up at a regional and local level inside producing countries. These benefits are associated with, for example, the increase in local employment and economic activity related to complementary services for gas production (e.g., consulting and engineering services, drilling activities, transportation of materials and waste, etc.) How­ ever, Kinnaman (2011), who has conducted a review of several studies on the subject in the U.S.A., argues that these benefits can be overstated due to methodological problems related to the measurement of the effects of shale gas production on the local and regional economies. Thus, these benefits should be assessed with care.

3. The future of shale gas and environmental energy policies: implications for Latin America

9

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years will be permitted to sell 20% of their production on international markets free of export duties or sell it to the local market at international prices. Likewise, oil companies have the right to freely get the foreign exchange earned from the export of these hydrocarbons. They also have the right to a reduction of 25% of oil royalties for ten years. On the other hand, the period of exploration and exploitation is fixed between eight and thirty-five years, respectively, and it represents an additional of two and ten years over standard concessions. Also, it re­ inforces the “Gas Plus” program, introduced in 2008, to encourage the production of unconventional natural gas. This scheme allows selling output from unconventional deposits at much higher prices than the regular ones.23 With the election of President Mauricio Macri, Argentina expected several reforms oriented towards policies to attract foreign investment. One of the proposals of Macri was to establish clear rules to attract and stabilize foreign investment in productive sectors. Concerning the en­ ergy sector, Macri promised to overhaul the regulation of public services and energy subsidies to restore confidence in the institutions, since the renationalization of YPF has damaged the country’s reputation in the �n, 2015). Also, he promised to create international community (La Nacio a Ministry of Energy to manage energy policy exclusively. Currently, Argentina’s Vaca Muerta shale play is considered one of the most important unconventional resources in the world.24 Thanks to the investment policies of the oil and gas sector promoted by Macri’s administration, foreign investment has now picked up, and the shale play may at least achieve its potential. Currently, total output from Vaca Muerta in barrels of oil equivalent (BOE) has achieved just over 75,000 BOE/D, a 60% hike since the start of its exploitation in 2016 (Rassenfoss, 2018a).25 Argentinian government-led reforms have been important drivers to the output growth in Vaca Muerta, in part since the government urgently needs the economic revenues from Vaca Muerta to stabilize its fiscal deficit (Cooley and Donnelly, 2012). Macri has conducted an intensive international campaign to attract foreign oil companies and Argentinian ones to raise their investment in the exploration and development of shale plays. Also, the government and its oil company YPF are committed to lower labor costs for the gas industry (Rassenfoss, 2018b). Labor unions and contractors have made concessions on contracts in exchange for commitments on spending and labor hiring.26 Overall, Macri’s government has generated positive expectations worldwide, and reforms are expected to boost the confidence of foreign investors in Argentina in the future. The right combination of good energy policies and a favorable expansionary phase of a new super cycle in the 2020s may transform Argentina as the new shale gas powerhouse

Table 2 Technically recoverable shale gas resources in Latin America (tcf). Country

Shale gas (tcf)

Argentina Mexico Brazil Venezuela Paraguay Colombia Chile Bolivia Uruguay

802 545 245 167 75 55 49 36 5

Source: EIA (2015).

3.1. Argentina: A shale gas powerhouse in Latin America? In 2004 Argentina experienced a severe energy crisis. Its domestic consumption increased rapidly due to widespread gas price subsidies, while its domestic production declined due to the contraction of foreign investment in the upstream gas industry after the debt crisis of 2002 and the persistent governmental intervention in the Argentinean energy market. The Argentinian government had to cut exports to Chile, initiate energy rationing, and start importing gas from Bolivia (Isbell, 2006). This energy crisis motivated the government to look at unconventional resources. According to EIA (2015) and Business News Americas (2012), of the 802 tcf of TRR in Argentina, the Neuquen basin (where there are formations of good potential such as Vaca Muerta, Los Molles and Agrio) contains 73% of the total. This tremendous potential has attracted in­ ternational oil companies (IOCs) including U.S. firms such as Petrogas, Apache, ExxonMobil, Pan American Energy (controlled by British Pe­ troleum), Chevron, Royal Dutch Shell and Total. Currently, Argentina has a system where the control and ownership of hydrocarbon resources reside in its provinces.21 The Hydrocarbons Law Reform, published on 31 October 2014, has the aim to create in­ centives to encourage long-term foreign investment in the oil and gas sector. Furthermore, the government initiated a standardization process regarding tax issues and methods of awarding contracts for the explo­ ration and exploitation of conventional and non-conventional hydro­ carbons. This policy was applied to avoid Argentinian inter-province competition. Even though the Reform incorporates the technical concept of nonconventional hydrocarbons, it does not establish a distinction between tendering processes for conventional and non-conventional hydrocar­ bons. Under the Reform, an oil company receives a concession in a specific area where it can perform commercial exploitation of all hy­ drocarbons within its extension but, in the case of non-conventional hydrocarbons, it must inform its willingness to exploit those resources and present a pilot plan to the corresponding province. According to Arroyo and Perdriel, 2015, another way of awarding an area of non-conventional resources is through partnerships with provincial companies (state-owned enterprises at the provincial level). The Argentinian state enterprise “Yacimientos Petrolíferos Fiscales” (YPF), nationalized in 2012,22 plans to invest US$ 6.5 billion during 2013–2020 to foster national gas production, of which US$ 1.8 billion are intended for the exploration and exploitation of unconventional resources and well stimulation. To finance this amount, in 2013 YPF signed investment agreements to explore for shale gas with Chevron ($1.24 billion) and Dow Chemical ($120 million) for the areas of Loma Campana and Orejano, respectively (YPF, 2012). Regarding the tax system, under an investment promotion scheme, international companies that invest more than $250 million over three

21 22

23 Other factors affecting the future of shale gas development in Argentina include the increase in gas transportation taxes, the end of tax breaks in Tierra del Fuego, policies to promote energy self-sufficiency, steps to discourage ex­ ports (including LNG), restrictions on the repatriation of dividends and foreign exchange controls. See Roig (2012) for more details regarding the problems associated with exploiting shale gas resources in Argentina, including the challenges of applying hydraulic fracturing techniques in the Argentinean formations. 24 The shale rocks in the Vaca Muerta formation are considered to have a very high quality, similar to the rocks found in the U.S. shale formations such as Eagle Ford, Bakken and Marcellus plays (Rassenfoss, 2018a; Donelly, 2018). 25 The majority of this throughput is coming from the Loma Campana joint venture between the Argentinean YPF and Chevron. According to Wood Mackenzie, shale gas production is expected to achieve 113,000 BOE/D by the end of 2018, and as high as 1 million BOE/D within the next 15 years (Donelly, 2018: 12). 26 The Argentinian government is expecting that these policies may cut development costs by 20% on average in order to get more competitiveness for its gas industry. In this context, YPF has disclosed a $30-billion, 5-year in­ vestment plan for Vaca Muerta, and ExxonMobil has committed around $200 million in a pilot project in the formation.

Art. 124 of the Constitution of 1994. El País (2012). 10

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of the world. However, there are some drawbacks that Argentina may face to take advantage of a possible expansionary phase of a new gasprice super cycle in the 2020s. First, the country has to deal with the economic instability related to its massive defaulted foreign debt of around US$ 82 billion (the largest default in economic history at the time of its occurrence in 2002), its unstable exchange rate and currency crisis, its massive fiscal deficit, as well as an erratic inflationary process. Second, Argentina must confront the political instability it is experi­ encing since the ages of the Kirchner’s administration in the 2000s associated with corruption scandals and the deterioration of institutions. As Ocampo states, Argentinian institutions have deteriorated in the last decades due to cycles of populism that have been preceded by commodity-price super cycles. In words of Ocampo, “one could say that Argentina is the only country that went from barbarism to decadence after catching a glimpse of civilization” (2015:2). An expansionary gasprice super cycle and the consequent massive exploitation of the Vaca Muerta shale play may create another populism cycle in Argentina, as seen in the past, which may erode the weak institutional endowment left in Argentina. Moreover, it is uncertain whether favorable energy pol­ icies stimulating shale gas investment in Argentina will continue after Macri’s right-winged administration comes to an end in December 2019, when president-elect Mr. Alberto Fern� andez takes power. Another populism cycle with a left-winged administration during the next gasprice super cycle might create adverse climate conditions to invest in shale gas resources in Argentina.

Table 3 Results of the tenders of Round One. Tenders

Blocks offered

Blocks allocated

% Total Supply

First tender Second tender Third tender

14 9 25

2 6 25

14% 60% 100%

Source: SENER and Energy Secretariat CNH, 2015. Elaboration: Own elaboration.

modernization of the industry through more significant private invest­ ment in capital and technology (Arroyo and Perdriel, 2015). In this re­ gard, the Mexican government established two ways for private participation in the exploration and exploitation of hydrocarbons: direct assignment and tenders. Before the energy reform, PEMEX was responsible for exploration in Mexican territories. Through the Round Zero, PEMEX requested the State to reserve exclusive areas for its operation before the entry of the private sector. As a result, the Energy Secretariat (SENER) assigned PEMEX 83% of probable reserves28 and 21% of prospective resources.29 Regarding tenders, the reform generated four types of contracts with the State. First, it introduced licenses, where the State transfers total exploration and exploitation rights of hydrocarbons to private com­ panies. Second, it incorporated risk-sharing contracts, where the State shares the profit with private companies. Third, the reform put in place production sharing contracts, where the remuneration of private com­ panies consists of a percentage of the value of production. Finally, the reform established service contracts, in which the State hires a company for the exploration and exploitation of hydrocarbons and pays it when the company sells the oil products extracted from the concession area. In 2015, the Mexican government initiated the first round of tenders (Round One) of new contracts for exploration and exploitation of hy­ drocarbons in which Mexico auctioned 169 blocks, of which 98 blocks were non-conventional. Round One had five phases, and each phase included blocks more difficult to extract. By December 2015, Mexico conducted three tenders. Table 3 shows a summary of the blocks offered and assigned in each tender. In the first tender, the blocks allocated were only 14% of the blocks offered in the tender. The general causes were lower oil prices, the unattractiveness of the tendered blocks, and big government claims given market conditions (Forbes, 2015). Given these results, the Mexican government published a document of “lessons learned” and amended contractual terms to make them more attractive for private investors.30 As a result, the second and third tender had more favorable results. The fourth tender of the First Round included ten deepwater blocks under license contracts. Each block was expected to bring in around $4.4 billion in investment over the life of the contracts. The data room remained open for nine months. The last tender included unconven­ tional exploration in Chicontepec and Tampico-Misantla. On December 5, 2016, the government announced the results of this tender. It was the first opportunity for investors to bid on Mexico’s deepwater unconven­ tional resources, with four contracts on offer in the Perdido area of the Gulf of Mexico, and a further six in the Cuenca Salina areas. It was also the first phase since Round Zero in which PEMEX participated, offering its first farm out a joint venture in the Trion field, which contains 500

3.2. 2.Mexico: old ghosts may affect shale gas development According to British Petroleum, 2018, Mexico is the world’s 13th gas producer and its 11th largest oil producer. Nonetheless, its status as an essential exporter of hydrocarbons is weakening because of declining production and increasing domestic energy demand. Mexico’s oil ex­ ports have fallen on an average of 4.3% annually since 2011, having reached 1.290 million barrels per day in 2014, while natural gas pro­ duction has not kept with the strong demand (production fell 0.2% year on year since 2011, while demand grew at 4.3% on average). Thus, Mexico will have to open new hydrocarbons basins to meet domestic demand. PEMEX, the Mexican National Oil Company (NOC), is now increasingly looking at replicating the shale gas success of the U.S.A. According to Table 2, Mexico has TRR of 545 tcf divided among five basins: Burgos (72%), Sabinas (23%), Tampico (4%), Tuxpan Platform (0.5%) and Veracruz (0.5%). Although the Mexican shale gas formations share some geological similarities with the ones in the U.S.A., their development might be technically more difficult, because they are structurally more complex and many of them are located very deep in the ground (5 km), a factor that increases extraction costs. In this context, the Mexican government introduced in 2013 a radical energy reform.27 This reform consisted of reducing state control and sovereignty over hydrocarbons and the

27

According to Oxford Business Group (2018), “Mexico’s energy sector has been undergoing a profound paradigm shift since a reform program, launched in 2013, put an end to state monopolies in most subsectors and began the process of opening the production and distribution of oil, gas, petrochemicals and electricity to private investment. In parallel, the entire legal, regulatory and institutional framework is being transformed to oversee new market mecha­ nisms. The fruits of these efforts became apparent in 2016 when several notable developments took place, including two successful long-term electricity supply auctions and a deepwater oil and gas auction for exploration and production in December 2016. A significant challenge going forward will be to ensure that infrastructure is of sufficient quantity and quality for the entire country to benefit from the reform efforts.” Available at https://oxfordbusinessgroup.com /mexico-2017/energy (last access: 28/10/2018).

28

Hydrocarbons with at least 50% chance to be extracted from underground. Prospective resources are hydrocarbons that have not been discovered yet, but they are assessed to be potentially recoverable through future projects. 30 The Mexican government relaxed the corporate guarantee and the ability to integrate or not a consortium. Also, the Secretariat of Finance and Public Credit (SHCP) published ahead the expected investment. See El País (2015a, 2015b) for more details about the impact of the energy reform on PEMEX. 29

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million barrels of oil equivalent of proven, probable and possible reserves.31 The successful licensing auctions of deepwater oil blocks are healthy signs of the possibilities for Mexico to develop other unconventional hydrocarbons resources such as shale gas deposits over the next gas price super cycle. However, Mexico has not yet committed substantial in­ vestments to increase the geological reliability of its shale resources located in the northern part of the country. To date, Mexican conven­ tional gas reserves have severely decreased. Mexico faces a deficit of natural gas production, so it has to import around 60% of its gas demand from the U.S.A. (Solis, 2017). In order to tackle this adverse scenario, Mexico has given some steps forward to exploit shale gas resources. In March 2011, PEMEX announced the beginning of the production of its first shale gas well in Coahuila after having drilled ten wells and invested US$ 15.5 million (Solis, 2017). Moreover, in 2018 the Mexican government launched Round 3.3 to offer 14 non-conventional shale gas blocks held by PEMEX in the Burgos basin located near the Coahuila formation, which is an extension of the Engleford shale play that comes from the U.S.A. Initially, the tender was programed on September 27th; however, the Mexican National Hydrocarbons Commission (CNH) postponed the onshore shales gas bid round until the first half of 2019. The post­ ponement, requested by the Mexican Energy Ministry (SENER), was motivated by the fact that interested firms requested additional time to verify information obtained from the data rooms of the Round and to properly prepare the necessary documentation to participate (Baker, 2018). It is necessary to wait and see whether the reform is successful in attracting enough investment to develop Mexican shale gas resources. In any case, Mexico will have to confront its old demons and public op­ position against foreign investors if it wants to exploit its shale deposits effectively during the next gas-price super cycle assessed in Section 2 of this paper.32 Political analysts are concerned about what the new pres­ �pez Obrador (known as AMLO in Mexico), a leftident Andr� es Manuel Lo winged Mexican politician, will do regarding the Mexican energy re­ form. Although his technical team has stated that AMLO will not push back the energy reform, it is uncertain whether AMLO will keep his word.33 Recently, AMLO has requested to revise all contracts assigned during previous bidding rounds promoted by the energy reform of 2013. The reviewing process could take several weeks or even months because the new administration wants to review not only economic and technical issues regarding the award contracts but also environmental risks that the exploitation of unconventional resources can create. This context might increase the level of uncertainty concerning future investments in shale resources in Mexico over the next gas-price super cycle in the coming years (Baker, 2018).

3.3. Brazil: pre-salt reservoirs and political issues overshadow shale gas Brazil’s oil and gas industry experienced in recent years an acceler­ ated development thanks to the discovery of its deepwater pre-salt res­ ervoirs. Brazil produces around 3.2 million barrels per day (BPD) of oil and 1.9 billion cubic feet (BCF) of natural gas, according to British Pe­ troleum, 2018, and it has recently become a net oil exporter. Brazil’s pre-salt boom started with the discovery of the Tupi field (now known as Lula), with a total potential of 50 billion barrels of oil equivalent (BOE). Brazilian pre-salt oil wealth has eclipsed the country’s shale gas poten­ tial. Additional investment in shale gas would add more pressure on budgets and an already stretched oilfield services industry. Petrobras itself, the Brazilian national oil company (NOC), is struggling to face the pre-salt challenge. It recorded a net loss of more than US$7 billion in 2014, of which US$ 2 billion were lost due to corruption between 2004 and 2014. It is unlikely that private investors take the risk of investing heavily in shale gas because of the profitable opportunities in the Brazilian offshore. Another factor that may deter foreign private investment in shale gas is the fact that the government through Petrobras holds a tight grip on the oil and gas industry, which leaves small room for interna­ tional oil companies (IOCs) and smaller independent oil companies (Business News Americas, 2013b). Finally, despite large capital expen­ ditures, the exploitation of pre-salt reservoirs exhibits low operational expenditures helping to decrease breakeven costs down to an interval of US$30-US$40/bbl, which is competitive with even the lowest costs of U. S. shale projects. Thus, a shale rush is less likely, unless the Brazilian government introduces alternative incentives to promote shale gas development. In November 2013 the Brazilian government launched tender round N� 13 on gas concessions on land. One of the requirements was the obligation to explore and investigate the existence of unconventional hydrocarbons in the referenced areas. If the company found uncon­ ventional resources and wants to exploit it, it must notify the National Petroleum Agency (ANP) and then apply for the corresponding concession contract (Arroyo and Perdriel, 2015). A big problem that plays against shale gas development is the fact that currently, Brazil is facing a severe economic and political crisis due to the corruption scandals involving the most important oil and con­ struction companies in the country and Latin America: Petrobras, Ode­ ~o, Andrade Gutierrez and OAS. brecht, Camargo Correa, Queiroz Galva The Lava Jato (Car Wash) case in Brazil is the most important corruption crisis in the history of Latin America.34 It has paralyzed the main infrastructure projects in Brazil,35 because of the reduction of Petrobras’ investments explained by its lack of liquidity.36 As a result, Petrobras reduced exploration activities to the "minimum necessary." This reduc­ tion in investment has affected the productive chain of the Brazilian oil and gas sector, which in turn has reduced tax revenues and increased unemployment. The scandal also involves top public officials, private

31

According to Oxford Business Group (2018), “[e]ight out of 10 contracts on offer attracted winning bids, while Pemex secured a farm out agreement with BHP Billiton of Australia. Unlike previous phases, round 1.4 attracted some of the biggest global names in oil and gas, with BP, Chevron, ExxonMobil, Statoil and Total among the winning bidders. China National Offshore Oil Corporation was particularly successful, securing two of the eight contracts as a sole bidder. Moreover, the eight winning bids offered additional government profit partic­ ipation, ranging from 5% to 26.9%, with the state’s total take expected to average 66.1% of gross revenues […] as well as boosting government coffers, bringing in foreign investment and generating jobs, the exploitation of these hard-to-reach deepwater reserves will bring considerable know-how and tech­ nology to Mexico. This will be of particular benefit to Pemex, which will be able to use knowledge gained from exploiting the Trion field in the exploitation of its other deepwater reserves in the future”. 32 See Business News Americas (2013a) for further details. 33 Energíahoy. AMLO: 10 ejes rectores para el sector energ�etico. Available at: http://energiahoy.com/2018/07/02/10-ejes-rectores-de-la-propuesta-de-amlopara-el-sector-energetico/(last access: 10/28/2018).

34

The “Car Wash” scandal has also implicated a collusion case involving the major Brazil construction companies prosecuted by the Brazilian Antitrust Agency (CADE). The cartel operated between 1998 and 2014, involving com­ panies such as Odebrecht, Camargo Correa, Queiroz Galv~ ao, Andrade Gutierrez and OAS. They distributed among them 21 multi-million construction contracts with the Brazilian stated over the 16 years of the cartel operation. For more details, see EFE Agency (2017). 35 El País (2015). El “caso Petrobras” pone en riesgo las grandes obras de Brasil para 2015. Available at http://internacional.elpais.com/internacional/2015/ 01/13/actualidad/1421180516_022574.html. 36 El País (2015). Petrobras bribery scandal has cost oil firm €1.8 billion, says CEO. Available at http://elpais.com/elpais/2015/04/23/inenglish/14297983 73_430651.html. 12

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investors, and industry tycoons37 in the country, who have been pros­ ecuted and put in prison. The corruption scandal in Brazil has wreaked havoc on the Brazilian economy with profound, long-lasting repercussions in the rest of coun­ tries in Latin America since Brazilian construction companies had op­ erations around the region. Regarding this problem, Roberts, 2018 states that “a decade of corruption scandals produced political chaos in Brazil. Kickbacks, graft, and cronyism at big state-owned companies such as the oil giant Petrobras and private concerns such as the Odebrecht conglomerate have left many Brazilians disgusted with their elites. ‘Lula, ’ the longtime head of the Socialist Workers’ Party, has been sentenced to 12 years imprisonment for money-laundering […]. His protege and successor, former President Dilma Rousseff, was impeached and removed from office in 2016 for budgetary misconduct. Her successor, market-oriented centrist Michel Temer, has also been tarnished by cor­ ruption accusations.” Many Brazilian conservatives and libertarians have recently sup­ ported the election of Mr. Jair Bolsonaro, a nationalistic military man unschooled in economics (known as the Brazilian Donald Trump). “The fear in Brazil is that he might return to the statist, populist, governmentcentric economic policies of the dictatorship years. To allay those fears, Mr. Bolsonaro is pointing to Paulo Guedes, a free-market economist and investment banker, who has become his minister of economy and is on record urging privatization of all state-owned enterprises” (Roberts, 2018). Almost half of Brazilian is against privatization because of the corruption problems that brought about the privatizations of the 1990s in Brazil. It is necessary to see how president Bolsonaro will implement energy policies in the coming years. His extreme view against environmental concerns may induce him to pass legislation to open new areas of the Brazilian rainforest to oil & gas operations. He has also manifested that he will “soften” environmental regulations for oil, gas and mining extraction.38 Bolsonaro has also manifested recently to Bloomberg Pol­ itics that he would respect private contracts related to infrastructure and natural resource exploitation and that he would be willing to consider private participation in Brazilian energy assets.39 This decision might be beneficial for shale gas development in remote areas of Brazil during the next super cycle. However, these policies might endanger sensitive areas of the Amazon, where there are large quantities of environmental assets and green spaces. This context could cause significant consternation among socio-environmental movements and civil society, which might strongly oppose Bolsanaro’s energy and environmental policies pro­ moting shale gas development in Brazil.

the region faces many economic obstacles and political challenges to develop its shale resources. The U.S. experience shows that the devel­ opment of shale gas requires substantial investments to access the technology and the skills to extract it. Latin America needs to attract foreign capitals that brings a qualified labor force and hydraulic frac­ turing technologies to make possible the exploitation of shale gas re­ sources over the next gas price super cycle. The attraction of these investments will depend on the policy of each country, the rules regarding the energy market and the State’s ability to provide a safe environment for exploration and production. Unfortunately, unstable political situation and corruption cases, the nationalist attitude regarding natural resources, the lack of transparent investment rules, high capital expenditures to develop LNG export projects and the exploration of shale resources, as well as the pre-salt discoveries make uncertain that the shale gas boom achieve a significant impact in Latin America during the coming gas price super cycle. A situation that may arise is the consolidation of regional markets in the area. For instance, regional pipelines may be built from countries with abundant shale gas to countries with insufficient reserves to supply their energy demand. An example of this is the case of Chile, which needs cheap gas to fuel its thermoelectric plants to satisfy the electricity needs of world-class copper mines that will start operations in the next decade. Chile installed Quinteros and Mejillones LNG regasification plants in 2010 and 2011, respectively, in order to counteract the pos­ sibility of gas shortages like the ones it experienced in 2004 when Argentina cut gas exports. Also, Brazil put into operation the LNG import facility in Guanabara during 2012 and the Bahia plant in 2014 (Business News Americas, 2015). If Argentina developed its shale resources taking advantage of the next expansionary phase of a new gas-price super cycle in the 2020s, it could increase gas exports to Chile and build new pipelines to supply Chile’s new mining regions. Another example is the case of Bolivia, which currently exports vast quantities of natural gas to Brazil and Argentina. If both countries exploited their shale gas, they could cut their imports from Bolivia, leaving the Bolivian gas stranded. In that scenario, the Bolivian government might want to negotiate with Peru access to the Camisea pipeline to export its gas through the LNG export plant of Pampa Melchorita near Lima, which is the only LNG export terminal in South America.40 Therefore, the future of shale gas in Latin America is not clear at all. Given the high CAPEX involved in the exploration of shale resources and the construction of LNG export plants, as well as the political instability and nationalism in the countries analyzed, it is uncertain whether financially strong IOCs with technological expertise will take the risk to invest a high amount of capital during the next super cycle. Another factor related to the possibility to develop shale gas resources in Latin America are the environmental risks related to the extraction technology and the institutional capabilities to control these risks in Latin America. We analyze this issue in the following section focusing on Argentina, Brazil, and Mexico.

3.4. Balance of the situation in Argentina, Mexico, and Brazil Our analysis in the previous sections indicates that Latin America has a tremendous geological potential to develop its shale gas industry, but 37 El País (2015). Operaci� on Lava Jato: El esc� andalo de corrupci� on de Brasil se extiende por las empresas públicas. Available at http://internacional.elpais.com/i nternacional/2015/07/28/actualidad/1438112993_870001.html (last access: 06/06/2016). The past president of Odebrecht construction company, Marcelo Odebrecht, was put in prison after the discovery of the corruption scandal. He was sentenced for nineteen years and four months in jail. He has signed a le­ niency agreement with the Brazilian Justice in order to betray top executives and politicians involved in the scandal in Brazil and other countries in Latin America. 38 See The Conversation, Jair Bolsonaro’s Brazil would be a disaster for the Amazon and global climate change. Available at https://theconversation.com/jai r-bolsonaros-brazil-would-be-a-disaster-for-the-amazon-and-global-climatechange-104617 (last access: 09/10/2018). 39 For more details, see Bloomberg Politics, These are the ‘Donald Trump’ of Brazil’s Economic Policy Proposals. Available at: https://www.bloomberg.com /news/articles/2017-10-13/-the-donald-trump-of-brazil-has-these-economicpolicy-proposals (last access: 10/29/2018).

3.5. Challenges for environmental regulation in Latin America in a worldwide shale gas boom Despite the foreseen favorable panorama for shale gas exploitation assessed from our super cycle analysis developed in Section 2, some researchers have pointed out that the increased production of natural gas from shale plays implies several environmental risks, especially in 40 Bolivian and Peruvian presidents, Evo Morales and Martín Vizcarra, respectively, have held meetings to discuss the possibility to export the Bolivian gas through the port of Ilo in the south of Peru employing the installation of an LNG plant. See Diario Gesti� on, Evo Morales propone a Perú exportar su gas por el puerto de Ilo. Available at: https://gestion.pe/mundo/internacional/evo-mora les-propone-peru-exportar-gas-puerto-ilo-232548 (last access: 09/30/2018).

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�squez Cordano et al., 2013b). The cases of the Amazon rainforest (Va water pollution, air pollution, and earthquakes have been attributed to shale gas extraction activities in places where oil companies have used fracking technologies. Table 4 summarizes the most important envi­ ronmental risks associated with shale gas extraction identified in the literature. Regarding this point, there is currently an intense debate about the environmental effects of extracting shale gas, mainly focused on the impacts of hydraulic fracturing,41 well completions, and wastewater. First, the risk with fracking is that the fractures generated to stimulate shale deposits may expand beyond the formation, allowing methane to flow to aquifers and polluting underground water. Hence proper seismic monitoring is vital to assure that the fracturing process produces microseismic activity only in the shale bed. Another concern regarding shale gas extraction is the issue related to the well injection. Construction issues, sustained casing pressure, and the presence of natural faults and fractures may work together to create pathways for fluids to migrate toward drinking water resources.42 Explosions in shale gas wells due to mismanagement of operations like the ones in Pennsylvania and West Virginia indicate that it is necessary to have well-trained personnel to conduct shale gas extraction (Zoback et al., 2010). Second, wastewater43 that comes out from wells may contaminate shallow soil, ground aquifers, lakes, and rivers if op­ erators do not use proper care regarding transportation, storage, and deposition of residual water and other pollutants from the drilling and fracking process.44 Finally, according to Howarth et al. (2011), shale gas extraction also has a green-house-gas (GHG) footprint which is significantly larger than that from conventional gas production because of methane emissions with flow-back fluids and from well drilling during the completion stage. The authors show evidence supporting the argument that the large GHG footprint of shale gas undercuts the logic of its use as a bridging fuel over the next years if the target is to reduce global warming. Because of the environmental risks associated with shale gas mentioned before, the U.S. EPA has started a comprehensive rulemaking to control wastewater and GHG emissions generated by gas extraction from underground shale formations. Likewise, the U.S. EPA is also

Table 4 Risk for shale gas production. Risks

Potential impacts

Release to water resource

- Water use. Fracking has the potential to alter the quality of drinking water resources. Withdrawals may lower water levels and alter stream flows, potentially decreasing a stream’s capacity to dilute contaminants. - Groundwater pollution. Operations under the surface could contact aquifer, which would be contaminated by drilling fluids and methane. If spills occur, groundwater impacts may persist longer than surface water impacts because of lower flow rates and decreased mixing. - Water transportation logistics. Hydraulic fracturing by well requires on average 15,000 m3 of water or its equivalent to 500 tankers load. This process can congest the roads and generate traffic. - Flowback and produced water. Potential impacts from spills or releases of produced water depend on the volume, timing, and composition of the produced water. Inadequately treated hydraulic fracturing wastewater may increase concentrations of TDS, bromide, chloride, and iodide in receiving waters. - Hydraulic fracturing and produced water disposal can lead to earthquakes of low magnitude. - Fracking using hazardous chemicals in significant quantities can be harmful to humans when exposed to the ground and surface water. - The physical properties of methane gas (low viscosity and low density) facilitate their migration towards the surface when the well integrity is deficient.

Seismicity Chemical Mixing Methane pollution

Source: U.S. EPA (2015), Arroyo and Perdriel, 2015

conducting a study of the effects of hydraulic fracturing on groundwater. The draft assessment, released recently, does not find evidence of sys­ temic impacts on drinking water resources in the U.S.A., but it identifies potential mechanisms by which hydraulic fracturing could affect it. These mechanisms include water withdrawals at times or in locations of low water availability, spills of hydraulic fracturing fluid and chemicals or produced waters, and inadequate treatment and discharge of hy­ draulic fracturing wastewater (EPA, 2015). Moreover, the International Energy Agency and the European Union have issued recommendations for the manufacturing of non-conventional resources (IEA, 2012a). Also, the Department of Energy is collecting new information related to shale gas wastewater and its disposal.45 On April 7, 2015, the EPA published proposed pretreatment standards for the oil and gas extraction category. This regulation would strengthen existing federal controls on pollutant discharges from individual oil and gas extraction facilities by establishing pretreatment standards that would prevent the discharge of pollutants in processing wastewater from onshore unconventional oil and gas extraction facilities to publicly owned treatment works (POTWs). 46 Latin American countries have not started yet to exploit their shale gas resources at a large scale, so there is a little experience of this activity in the region. However, probably a shale gas boom over the expan­ sionary phase of a new gas-price super cycle would generate a higher requirement of water, which could put considerable pressure on water supplies at the local level in the region. Besides, exploiting shale gas within Latin America is likely to give rise to a range of additional problems. First, the risk of aquifer water supply pollution by the

41 In a report about the topic, Colley and Donnelly point out that “hydraulic fracturing has generated a tremendous amount of controversy in recent years. There are daily media reports on this topic from outlets across the United States and in a host of other countries, including Canada, South Africa, Australia, France, and England. It is hailed by some as a game-changer that promises increased energy independence, job creation, and lower energy prices. Others are calling for a temporary moratorium or a complete ban on hydraulic frac­ turing due to concern over environmental, social, and public health concerns.” (2012: 4). 42 An accident in Bainbridge in the U.S. in 2008 showed that improper monitoring of completion of shale gas wells may pollute water in the sur­ roundings. See for further details about this case Report on the Investigation of the Natural Gas Invasion of Aquifers in Bainbridge Township of Geauga County, Ohio. September 1, 2008. Ohio Department of Natural Resources, Division of Mineral Resources Management. Available at http://s3.amazonaws.com/propublica/ assets/natural_gas/ohio_methane_report_080901.pdf (last access: 10/31/2018). 43 Shale gas wastewater contains high concentrations of total dissolved solids (salts) and various organic chemicals, inorganic chemicals, metals, and natu­ rally occurring radioactive materials (NORM). 44 An example of the risk associated with wastewater from shale gas produc­ tion is what happened in Pennsylvania in 2009. The Pennsylvania Department of Environmental Protection discovered two leaks from one pipeline carrying wastewater from two shale gas wells to waste storage. Both leaks spilled 4200 gallons of wastewaters to Cross Creek Lake, causing the death of fish and vegetal life. See "Fracking brine: Gas-well waste full of radium." The Columbus Dispatch, 02/27/2013. Available at http://www.dispatch.com/content/stories/ local/2012/09/03/gas-well-waste-full-of-radium.html (last access: 10/31/ 2018). See also Rahm (2011) who explains the environmental impacts gener­ ated by shale gas production in Texas.

45 In Europe, environmental regulations have evolved to become in many respects the most demanding ones in the world, which make difficult to exploit unconventional resources in this region. For instance, in May of 2012 France, Bulgaria, Romania and the Czech Republic have suspended the operation of its deposits of shale gas for environmental reasons. Therefore, gas imports via LNG tankers and pipelines will still be needed to complement Europe’s indigenous gas production for the foreseeable future. See Weijermars et al. (2011), Shale Gas Europe (2013) and Alga~ naraz (2012) for further details. 46 See http://www2.epa.gov/eg/unconventional-extraction-oil-and-gas-indus try (last access: 10/03/2018).

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hazardous chemicals involved in shale gas extraction is likely to be an essential source of local objections. Second, most unconventional gas deposits are located in indigenous territories, so any decision to imple­ ment a project must consider the consultation and consent of indigenous people affected.47 In this regard, Latin American countries should consider the U.S. experience and strengthen their institutional capabilities around two issues. First, it is necessary to create specific regulations related to the technical aspects of the exploration and exploitation of hydrocarbons using hydraulic fracturing. Second, it is critical to creating a specific environmental standard that allows achieving optimal levels for the preservation and care of the environment and biodiversity. Therefore, we will briefly analyze how regulations are currently applied in Argentina, Mexico, and Brazil to assess whether their insti­ tutional systems can handle a possible boom in shale gas activity when a new super cycle in gas prices occurs. On the first point, Argentina and Brazil have issued technical standards related to the exploration and exploitation of unconventional hydrocarbons, which regulate aspects related to the well structure and water injections. On the second point, they do not have yet specific environmental legislation to holistically regulate the potential environmental impacts of shale gas exploitation (Arroyo and Perdriel, 2015). As we mentioned before, in Argentina gas resources are adminis­ trated by provincial governments in their territory, which are also in charge of regulating water issues. Underground water resources in Argentina are widely used for agricultural irrigation. Shale gas operators would have to be careful when handling wastewater discharge and develop adequate wastewater treatment capacity to avoid social con­ flicts related to the agricultural use of water. However, given the ongoing political and economic crisis in Argentina, provincial govern­ ments would not have the capabilities to monitor and control the com­ plex process of shale gas extraction due to the lack of trained personnel and funding. Another problem that might affect shale gas regulation is the lack of national water law. Without a water law, inter-provincial water conflicts would be more challenging to resolve if shale deposits were exploited across various regions. Finally, the diversity of environmental regula­ tions in different provinces makes it challenging to accomplish the de­ mand for more stringent wastewater discharge regulations and the disclosure of chemicals used in the fracking process (Stratfor Global Intelligence, 2012). Therefore, as explained before, the political envi­ ronment in Argentina could be self-defeating for the development of shale gas. This situation could also make it difficult to develop and apply new environmental regulations for shale gas activities, given the legal differences across provinces. Besides, the likely participation of the Argentinean state-owned company in the shale gas business would not guarantee that environmental standards be met if obscure political in­ terests were behind shale gas extraction. This situation is similar in Brazil, where the government is using its control over Petrobras to boost natural gas production based on con­ ventional or unconventional resources. Even though the absolute con­ trol of Petrobras over the Brazilian energy sector has legally ended in the 1990s, it still has a virtual monopoly, which makes it difficult for smaller independent companies to operate in the shale gas industry (NewsBase, 2012).48

In some countries of Latin America where Petrobras operates, there are cases in which the company has not complied with environmental standards. 49 There have also been problems with the environmental regulator, the Brazilian Institute of Environment and Natural Resources (IBAMA), which has been blamed for not enforcing the environmental laws properly because of political interference and corruption. 50 Therefore, as in the case of Argentina, in a shale boom scenario, the Brazilian state-owned company might not comply with environmental standards to achieve the political objectives of the governing political party. In Brazil, there is in place now a dominant narrative in the public opinion regarding the uncertainties and the risks involving fracking activity, which may deter the future concessions of new areas for shale gas exploration in the country.51 In the case of Mexico, there is also a state-owned company, PEMEX, heavily focused on developing oil resources, despite the large Mexican shale gas potential mentioned before. PEMEX has a history of having caused several environmental disasters (Barneda, 2012). According to Jacott et al. (2011), the environmental damages caused by PEMEX are due to some problems like the adverse conditions of old state-owned pipelines and irregular licenses with companies that conceal oil spills. These problems might be reflecting the lack of incentives that PEMEX has for achieving environmental standards since it has the constitutional mandate to afford the national budget. In summary, it seems that the most important countries in Latin America with shale gas resources will be not sufficiently ready during the likely next gas price super cycle to push forward energy policies oriented to attract foreign investors to develop shale gas projects. Be­ sides, the institutional capabilities of regulatory institutions and the energy nationalism sentiment in these countries are not strong enough to guarantee a minimum level of environmental monitoring to avoid accidents such as explosions, gas leakages, and wastewater contamina­ tion associated with shale gas exploitation. Authors like Laffont (2005), �squez Cordano (2012) and V� Va asquez Cordano et al. (2013b) have pointed out that government failures such as corruption,52 tight budgets to support regulatory agencies, weak compensation schemes for regu­ lators, inadequate liability limits and a lack of coordination among regulatory agencies are essential factors that weaken the enforcement of environmental laws and safety mandates. These failures are especially relevant in developing countries such as the ones analyzed in this paper. Reforms in Argentina and Mexico have somehow opened the possibility to develop unconventional reservoirs, either through direct allocations to private operators or through state-owned companies participating in competitive auctions with the private sector. These reforms must be implemented in conjunction with a strategic environmental assessment. Otherwise, government failures when regulating shale gas exploitation

49 In Argentina, Petrobras has been accused of donating much money to some communities to silence complaints against its operation. In Bolivia, PetrobrasBolivia suspiciously won a license to operate in an area considered natural reserve in 2001. Finally, in Colombia, where Petrobras-Colombia operates in Guando field, the population has reported that the irrational exploitation of water resources has destroyed its water supply (SERVINDI, 2012). 50 See “Corrupci� on Deforestadora,” available at http://www6.rel-uita.org/a gricultura/ambiente/corrupcion-desforestadora.htm (last access: 10/29/2018). 51 For further details, see Environmental Justice Atlas. Anti-fracking movement and Petrobras Shale Gas Exploration Field AC-T-8 – Vale do Juru� a, Brazil. Avail­ able at: https://ejatlas.org/conflict/petrobras-shale-gas-exploration-field-ac-t8-vale-do-jurua-brazil (last access: 10/29/2018). 52 If we look at the Corruption Perception Index elaborated by Transparency International, which categorizes 174 countries from the most transparent (po­ sition 1) to the most corrupt (position 174), we notice that Argentina, Brazil and Mexico are ranked 102, 69 and 101. This indicates that these countries are perceived as suffering from moderate to high levels of corruption. Further in­ formation is available at http://www.lavoz.com.ar/noticias/politica/corr upcion-argentina-reprobada-indice-transparencia-internacional (last access: 08/19/2019).

47 International Convention No 169 on Indigenous and Tribal Peoples of the International Labor Organization (ILO) issued in 1989. 48 In a report of Business News Americas, the executive secretary of Brazilian independent oil producers’ association (ABPIP), Anibal Santos, claims the lack of interest of the government to increase their participation in the country’s natural gas sector. ABPIP was expecting an announcement to increase the participation of small and medium-size independent companies, but it did not happen, even though it is a legal obligation. This situation benefits the domi­ nant position of Petrobras (Business News Americas, 2013b).

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may likely cause higher risks of having accidents with adverse envi­ ronmental consequences. Considering the U.S. and European experience, we consider that the measures needed to increase the environmental regulatory capabilities in Latin America to face a shale gas boom over an expansionary phase of the next gas price super cycle would be the following. First, regulators should implement data collection and management systems to monitor critical aspects of shale gas extraction in advance. This measure would be valuable for operators working on several shale gas regions since simplification and standardization of reporting across states would lead to reductions of regulatory compliance costs. On the other hand, regu­ lators would want more data and disclosure from operators regarding their water use and cumulative assessments of the environmental im­ pacts of shale gas operations to improve their monitoring capabilities. The availability of data upon which to base regulations has been a key challenge for U.S. and European regulators (Accenture, 2012; AEA, 2012), and it is expected that the same situation will be an issue of concern in Latin America. Second, in Latin American countries with federal systems, such as Argentina, Mexico, and Brazil, we observe that environmental regula­ tions vary considerably between states, with different requirements for well casing, disposal of drilling fluids and wastewater management. Therefore, national and local regulators should achieve a balance be­ tween their policies to enforce national and local environmental regu­ lations. Coordination across regulatory agencies (natural resources, environmental, and water agencies) within a region should also be essential to achieve regulatory coherence for shale gas exploitation �squez Cordano, 2012). (Va Third, differences in the geology of a particular shale play will determine waste management options available to operators for a particular region. On the other hand, the local regulatory landscape, the local infrastructure, and the regional water availability will shape how shale gas regulations will be applied. Thus, to establish an efficient and effective regulatory environment in this context, regulators should require that operators set early clear directions for the development of shale gas. Regulators should also explain to operators that investments in water treatment are economically worthwhile and likely to give them a competitive advantage in the long run because having water treatment management at an early stage of shale gas extraction would mean fewer penalties and future requests for liability compensations in court. Finally, Latin American governments should reinforce the autonomy and the technical capabilities of its safety and environmental regulators to strengthen the enforcement of regulations applied to shale gas pro­ duction. This target can be achieved by adopting the following policies. First, governments should provide regulators with enough budgetary resources to implement an adequate monitoring system to control the safety and environmental risks associated with shale gas. Second, reg­ ulators should strengthen the capabilities of their personnel through training and education in the supervision of unconventional shale gas extraction. Third, governments should reinforce the compensation schemes of public officials in charge of supervising and monitoring shale gas activities to attract the most talented people for the job and to avoid regulatory capture. Fourth, it is necessary to increase the technical ca­ pabilities of the regulators by providing them with relevant monitoring technologies. Finally, governments should shield regulators from the political interference of the government through measures of adminis­ �squez trative autonomy from the executive power (Quintanilla, 2006; Va Cordano, 2012; V� asquez Cordano et al., 2013b).

found in oil prices after World War II. In the case of the European and Asian gas prices, we verified the existence of one super cycle, given the shorter span of the gas price database available for these regions. This super cycle co-moves with the last U.S. gas price super cycle with a lag of 5 years. The co-movement between super cycles of the different energy commodities analyzed in this article is explained by the demand shocks for raw materials gener­ ated by the expansion of economies such as Japan and Europe in the 1950s and 1960s after World War II, and the industrialization of large developing economies such as China and India in the last decades. The industrialization process of these economies over the years generated a simultaneous demand increase for several raw materials (such as min­ erals, oil, and natural gas), stimulating the occurrence of commodityprice super cycles like the ones found in this study. Our assessment of the future scenarios for gas prices indicates that an expansionary phase of a new super cycle might occur in the early 2020s, which indicates that Latin America may have an economic opportunity to develop its unconventional gas deposits in the coming decade. However, weak institutions, political cycles tightened to the boom-bust cycles of commodity prices, a widespread nationalist sentiment about the possession of natural resources, the recent expropriations of energy assets in the region, and corruption scandals in countries with significant unconventional gas reserves might generate a fragile business climate and regulatory framework. These factors can discourage oil & gas in­ vestments and increase the probability of accidents producing adverse environmental impacts. The main problem identified to attract foreign investments for developing shale gas resources in Latin America during the next likely gas-price super cycle in the 2020s is the political and economic uncer­ tainty that predominates in the region. This uncertainty is deterring investment in shale resources. Countries like Argentina and Brazil are under political turmoil because of the corruption scandals related to the cases of Petrobras, Odebrecht, and other Brazilian construction com­ panies. Argentina is now facing macroeconomic problems related to debt imbalances and exchange rate depreciation. Brazil is experiencing a recession due to macroeconomic imbalances and the political instability related to the presidential election. Mexico has been affected by the decision of Trump’s administration to review the Nafta trade agreement. �pez The new presidents of Brazil and Mexico (Mr. Bolsonaro and Mr. Lo Obrador, respectively) have introduced a radical view to execute energy policies, which might discourage shale gas investment in their juris­ dictions. On the other hand, environmental regulations in the region are lagging far behind the regulations implemented in the U.S.A., so it is uncertain if Latin American countries are ready to face the challenge to regulate shale gas exploitation and processing. In this context, Latin American countries have the challenge to create a pleasant investment environment to attract foreign oil companies that have access to the technology and personnel to exploit shale gas re­ sources. Besides, these countries need to upgrade their environmental regulations to control any environmental risk related to shale gas exploitation. Therefore, well-thought energy and environmental regu­ latory reforms may be needed in Mexico, Brazil, and Argentina to attract the necessary investment to develop unconventional gas and reduce the risk of having significant environmental impacts due to technology, mismanagement and government failures (such as regulatory capture and corruption). There has been a renewed interest in commodity prices over the past decade. Evidence on the presence of super cycles in gas prices should be valuable for national and state governments, financial institutions, and oil and gas companies in Latin America alike. On the governmental level, countries that rely on the import or export of energy commodities such as Chile, Peru, Argentina, Colombia, and Brazil need to consider the presence of super cycles in gas prices in order to define their investment and environmental policies. At the firm level, the explorationdevelopment-production-distribution cycle of energy projects often spans several decades, as do super cycles. Hence the investment decision

4. Conclusions In this paper, we identified the presence of super cycles in the U.S. natural gas prices using the band-pass filter proposed by Christiano and Fitzgerald (2003). We found the existence of three super cycles in the following periods: a) 1948–1970, b) 1970–1994, and c) 1994–2017. These gas price super cycles are strongly correlated with the super cycles 16

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made by these oil and gas companies and the regulatory policies implemented by Latin American states should take into account the presence of such super cycles. Our analysis indicates that the unstable political situation, the widespread corruption in the region, weak institutions, the govern­ mental intervention through nationalization and state-owned oil com­ panies, and the lack of transparent investment rules can deter foreign oil companies from investing in shale gas projects in Latin America. Simi­ larly, the fragile environmental regulations, high capital expenditures to develop LNG export projects and the exploration of shale resources, the unconventional gas resources discovered in offshore areas in Brazil, and social opposition against fracking make uncertain that the shale gas boom achieve a significant impact in Latin America during the coming gas-price super cycle in the 2020s decade. �vez, and Edison Cha �vez I thank Tatiana Nario, Paola Rojas, Thais Cha for their valuable research assistance. A previous version of this article titled “Where are natural gas prices heading and what are the environ­ mental consequences in Latin America?“ was presented at the 2016 Annual Congress of the Peruvian Economic Association held at PUCP. I � thank GERENS Graduate School of Lima, Peru for its partial financial support to develop this paper under Research Grant No 001-2016-EPG� GERENS.

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A.L. V� asquez Cordano and A.M. Zellou

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Colorado School of Mines. Available at. https://pdfs.semanticscholar.org/076a/56 a6d7fde44550b20e84ea05bdc2555238db.pdf?_ga¼2.144567733.1460904032.1565 393209-1883152400.1565393209 (last access 06/07/16). Zoback, Mark, Kitasei, Saya, Copithorne, Brad, 2010. Addressing the Environmental Risks from Shale Gas Development. Briefing Paper 1. Worldwatch Institute. Available at: http://www.worldwatch.org/files/pdf/Hydraulic%20Fracturing%20 Paper.pdf (last access 06/07/16).

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