One potentially lucrative—if speculative—way to play this is YPF (ticker: YPF), which controls 40% of the total acreage in the vast Vaca Muerta shale. The U.S.-listed shares have doubled this year, to $29, but offer considerably more upside potential if the company can successfully exploit the country's energy reserves

Many investors are afraid of YPF, not least because Argentina's leader, President Cristina Kirchner, spearheaded a 2012 move by the Argentine government to expropriate a majority stake in YPF held by Repsol, the Spanish oil company. Argentina justified the seizure, arguing that Repsol wasn't investing in the Argentine energy sector. Repsol, however, had good reason not to invest heavily; domestic price controls meant poor returns. Repsol continues to hold a 12% stake in YPF.

Some U.S. institutional investors and Mexican billionaire Carlos Slim have been buying. In its third-quarter investor letter, Perry Capital, a New York hedge-fund manager, wrote, "From a valuation standpoint, our analysis shows that even excluding the development of Vaca Muerta shale, YPF's stock should be worth $35 a share, and to the extent this shale starts to realize value, the stock price could move significantly higher." Sizable YPF holders include Mason Capital, a New York investment firm, and Lazard Asset Management. Some investors think YPF's shale reserves alone could be worth over $90 a share.

YPF's market value now is about $11 billion. The stock trades for about 12 times both projected 2013 and 2014 earnings. Analysts, it should be said, are cautious to negative on the stock. None of the nine tracked by Bloomberg has a Buy rating.

Recent Price $29.24
YTD Change 101%
Market Value (bil) $11.5
Shares Outstanding (mil) 393
2013E EPS $2.48
2013E P/E 11.8
2014E EPS $2.40
2014E P/E 12.2
E=Estimate.
Source: Thomson Reuters

AN IMPORTANT RECENT development that lifted YPF to a new 52-week high was a tentative deal in which Argentina agreed to pay Repsol $5 billion for taking its 51% stake in YPF. That works out to $20 to $25 share. A deal would end a bitter dispute that Repsol took to international arbitration and that strained relations between Spain and Argentina. Raymond James Latin American strategists wrote that they viewed any deal as "highly positive…making any progress with Repsol would be key to unlocking foreign investment in the energy sector, which would be critical to help reverse the country's declining energy production trend."

Full development of the Vaca Muerto reserves, which could cost tens of billions of dollars and take a decade or more, hinges on better access to international capital markets, economic reforms, and increased foreign investment. YPF is preparing to sell $500 million of debt soon. Some progress has occurred and more could come after presidential elections in 2015, when Kirchner is ineligible to seek a third term.

Energy-Rich Country
An agreement between Chevron and YPF could be a model for the development of Argentina's significant oil and gas reserves.

Natural Gas
Country (Tcf)*
U.S. 1,161**
China 1,115
Argentina 802
Algeria 707
Canada 573
Oil
Country (bil barrels)
Russia 75
U.S. 48**
China 32
Argentina 27
Libya 26
*Trillion cubic feet. **Estimate from Advanced Resources International. Data as of June 10.
Source: U.S. Energy Information Administration

YPF bulls argue that investors' interests now are aligned with those of the government, since Argentina owns 51% of the company. That's important in countries like Argentina and Russia, where the government's wishes tend to get backed by the courts.

How do investors value YPF's shale reserves? One estimate comes from an agreement that YPF reached with Chevron (CVX) this summer in which the U.S. energy giant pledged to invest $1.24 billion for development of a small portion of YPF's land base in return for a 50% economic interest. That concession, covering about 97,000 acres, involves just 3.3% of YPF's roughly three million acres in the Vaca Muerta.

Investors then multiply the Chevron investment by 30 to arrive at a potential value of $37 billion for YPF's total Vaca Muerta acreage. That's about $95 per share. This admittedly is a crude estimate, but it doesn't seem crazy. Chevron presumably sees very high returns, or else it wouldn't have committed money to unstable Argentina.

The Bottom Line
Some big investors, including Mexican billionaire Carlos Slim, have been buying shares of YPF. Despite a big run-up, the stock has lots of room to grow.

Development of Argentina's energy reserves could lead to a virtuous cycle of reduced imports and improved balance of payments. It also could help Argentina's stock market, now classified as a "frontier" equity market by MSCI, whose indexes are the basis for significant investment. If Argentina graduates to MSCI's emerging-market index, it could lead to large investor purchases of Argentine stocks, including YPF.