THE MOSCONI REPORT. Comptroller: Julio de Vido Deputy Comptroller: Axel Kicillof

Transcription

1 THE MOSCONI REPORT Comptroller: Julio de Vido Deputy Comptroller: Axel Kicillof 1

2 Contents Section 1: YPF's Role in the International Strategy of the Repsol Group 5 Birth and evolution of the Repsol Group 5 Internationalization 6 Changes in shareholdings 9 Analysis of Repsol Group and YPF S.A. profits 10 Section 2: Repsol's Policies regarding YPF: Depredation, Disinvestment and Undersupply 24 Repsol's attitude with respect to domestic prices 26 The Second Stage of Repsol s Financial Strategy regarding YPF 36 Deepening of the Market Segmentation Strategy in the context of the drop in YPF s production 39 Repsol s Commercial Strategy regarding YPF 42 Technical Aspects of Repsol s Management of YPF 44 Section 3: The "Discovery of Vaca Muerta". The (Re)sale of the Crown Jewels. 76 Repsol-YPF s strategy regarding unconventional resources 76 A brief history of Vaca Muerta 78 Section 4: Main Conclusions 84 Exhibit 1: Classification of Environmental Issues and Progress 86 Exhibit 2: Fire Prevention Network Pictures 88 2

3 Introduction This report compiles the results of the investigation conducted from April 16, 2012 to June 1, 2012 by the team that placed YPF under government control, which was led by the Comptroller, Mr. Julio De Vido, and the Deputy Comptroller, Mr. Axel Kicillof. The purpose of this document is to provide evidence on the strategy of depredation, disinvestment and failure to appropriately supply the domestic market implemented by the Repsol Group since it took control over YPF in Such strategy was evidenced as from 2003, when the effects of the neoliberal policies adopted during the three previous decades started to be offset in Argentina through the implementation of the model of economic growth with social inclusion. The findings of this investigation conclusively prove the arguments presented in the message sent by the Executive Branch to the Argentine Congress on April 16, 2012, together with the bill that was subsequently enacted as Law No. 26,741. Government control of the Company made it possible both to obtain information that would not have been available otherwise and to channel the company's policies in accordance with the energy related needs of Argentina, thus putting an end to the strategy of depredation, disinvestment and failure to appropriately supply the market implemented by the abovementioned control group and also preventing any kind of ploy by such group. This report shows that: a. The Repsol group used YPF to support and finance its strategy for global expansion, thus predating Argentina s oil and gas resources with a short term vision that gave priority to the transfer of dividends to its headquarters over the exploration and exploitation activities characteristic of the best practices of the oil business. b. This strategy was deepened when, as from 2003, Argentina began to walk the path of reindustrialization and rapid economic growth in which oil once again became an essential strategic resource and its price became a core element in the economy, as being a fundamental lever of the country's systemic competitiveness. The inconsistency between the evolution of domestic hydrocarbon prices and their international parity led, under Repsol s management, to the gradual abandonment of YPF's exploration and exploitation activities within a context of increasing international prices. c. Soon after acquiring YPF, Repsol began a systematic process of underinvestment in Argentina with the express goal of "reducing its exposure to risk in this country". However, as a result of the convergence of an upturn in international prices and the development of new technologies, the exploitation of the so called "unconventional resources" present in the Vaca Muerta field became profitable. In the face of this scenario, instead of seeking to improve its performance in terms of production, the Repsol group started to "delineate" the Vaca Muerta field with a view to quantifying its potential in order to dispose it at a later time, either through a sale or subconcession. This new strategy by Repsol further hindered investments in conventional 3

4 resources, since the financial resources that entered Argentina were mostly used to investigate the unconventional resources that they intended to transfer to third parties. Hence, the strategy implemented by the Repsol Group as regards YPF may be summarized as follows: 1. Reduction of investments in the expansion of production to focus exclusively on extracting oil from already discovered fields, which was evidenced by the systematic decline of the Company's oil and natural gas production. 2. Interruption of all the projects aimed at increasing natural gas production since the yield was lower than the ones obtained by the company in other international businesses. 3. Liquidation of international assets and companies that YPF had acquired during its previous development. 4. Delineation of Vaca Muerta with a view to selling the business or partnering with a third party that might contribute capital, rather than investing and increasing production. 5. Gathering of as many short term resources as possible to finance the global expansion and productive diversification of the Repsol Group to the detriment of YPF and the hydrocarbon needs of Argentina. In order to prove the above statements, this report has been structured as follows. The first section describes the international strategy of the Repsol Group so as to provide a comprehensive framework to analyze its local operations in YPF. The second section describes the policies involving depredation, disinvestment and undersupply the market implemented by the Repsol Group during its management of YPF. The third section shows how this strategy was deepened as from the technical changes and price increases that caused the exploitation of the unconventional resources in Vaca Muerta to become profitable. The fourth and last section summarizes the main conclusions in the report and introduces the main goals and challenges to be faced by the new YPF, in which the government is a majority shareholder. 4

5 Section 1 YPF's Role in the International Strategy of the Repsol Group Birth and evolution of the Repsol Group The Spanish Hydrocarbons Institute (Instituto Nacional de Hidrocarburos, INH) was created in Spain in 1981 for the purpose of centralizing the management of public activities relating to hydrocarbons. Subsequently, in 1987, within the framework of the admission of Spain into the Economic Community, Repsol a corporation whose purpose was putting an end to the governmental monopoly of hydrocarbons was formed. Between 1988 and 1998, a gradual process for deregulating hydrocarbon production in Spain took place, which ended with the enactment of Hydrocarbon Law No. 34/1998. The activities related to the refining, transport, storage, distribution and sale of oil products were deregulated during this period. Thus, from the very beginning, Repsol's activity covered the exploration, production, transport, and refining of oil and gas, although it focused on the refining stage. The Group was structured as Holding Corporativo Repsol S.A. with five subsidiaries, just like the large international companies: Exploration (former Hispanoil), Oil (former ENPETROL), Butane (former Butano S.A.), CAMPSA, and Petronor. At first, Repsol Química (Alcudia) was a subsidiary of Repsol Petróleo, but it later became another subsidiary. Despite the existence of these subsidiaries, during its first stage, Repsol mainly conducted downstream activities i.e. refining and its products were mostly allocated to the Spanish market. This focus on the Spanish market resulted from a significant number of investments, such as the acquisition of interests in other Spanish refining companies and the purchase of petrochemical companies. Furthermore, from its organization as a group in 1987 to the year 1998, Repsol made several investments in reserves in the North Sea, Northern Africa and Egypt with a view to gradually expanding its exploration and production activities. Repsol s privatization began in 1989, after it went public, and the process concluded in During the first stage, the BBV Group entered the company by giving shares of Petronor and other companies in exchange for 4.2% of Repsol s capital stock. In that same year, the first stock offering to institutional and retail investors was made. Pemex entered Repsol in 1989 and received 2.9% of the shares in exchange for 34.3% of the shares it held in Petronor. Finally, in that same year, the company made a public stock offering (PSO) whereby shares amounting to 26.4% of the Group's capital stock were offered. The second PSO was made in March 1993 and was aimed at institutional investors. The government kept about 40% of the shares. In 1996, Repsol bought Astra Compañía Argentina de Petróleo. This process was completed in 1997 with the fifth and last PSO. 5

6 Immediately after the end of the privatization process in 1999, Repsol acquired 97.81% of the Argentine company YPF S.A. This entailed a US$ billion investment, even though, in fact, it used US$ billion to acquire bonds recognized at a face value of US$ billion. With this purchase, Repsol increased its capital to 288 million shares as part of the refinancing plan after the acquisition of YPF. The purchase of YPF S.A. turned Repsol into a multinational company and led to a change of its corporate name to Repsol YPF S.A. This event was the beginning of a new international expansion strategy by Repsol, mainly in Latin America, as was the case with numerous Spanish companies in that period. In fact, in 1999 it became the largest privately owned energy company in Spain and Latin America. As a result of the acquisition of YPF, Repsol began to diversify its activities by engaging in the production of electric power and transportation and distribution of natural gas, for which purpose it used YPF s synergies in the energy sector. Before the purchase of YPF, Repsol was a company with little experience in exploitation, exploration and development of crude oil and natural gas. With the purchase of YPF, the Group also acquired the assets that YPF had in turn purchased from, among others, Maxus Energy Co., thus positioning itself as a significant international player. Furthermore, the approximately US$ 13 billion disbursed by Repsol for the purchase of YPF were recovered by the Group in the short term and, in addition, the transfer of profits by YPF S.A. from 1999 to 2010 involved a similar amount. Internationalization Ever since its creation, the purpose of the Repsol Group was to compete at an international level, following the example of the multinational companies that it considered as symbols of competitiveness in the oil sector. In this line, not only did it adopt a diversification strategy, but it also modified its organizational structure emulating multinational companies and sought to expand its activities geographically. Although Repsol had already invested moderately outside Spain, the purchase of YPF S.A. was the first step towards its expansion in Latin America and the world and gave rise to its first diversification phase. One of the main objectives sought through geographic expansion was a modification in the composition of Repsol s activities, which enabled the Company to increase its exploration and production business. Later, the goal changed to the diversification of risks. This strategy was carried out within a context where the large oil companies in the world applied similar internationalization criteria, with a view to achieving vertical extraterritorial integration and sustaining and expanding markets. In early 2000, Repsol was making progress in its internationalization process with the purchase of Gas Natural SDG. In that year, it entered into agreements in Cuba, Chile, Argentina, Colombia, and Venezuela; it acquired 45% of Lipigas, a leading firm in the Chilean LPG market; and it closed deals with British Petroleum (BP) to purchase assets in Trinidad and Tobago. In December 2001, it closed 6

7 with Petrobras an asset swap, whereby it received 30% of the REFAP refinery and a network of 240 gas stations, thus becoming the second integrated oil company in Brazil. In September, it created Repsol YPF Gas Bolivia together with SAMO S.R.L. The company announced new discoveries in Libya, Spain, Argentina, Venezuela, Bolivia and Indonesia and decided to develop its electric power business both the generation and the sale of electricity through Gas Natural SDG. In 2002 and 2003, the Repsol Group started a new phase in its international expansion and diversification strategy since it reduced its share in the gas subsector (in 2000 Repsol YPF sold 23% of its shareholding in Gas Natural SDG, currently Gas Natural Fenosa) and focused on its basic business; at the same time, it increased its geographic diversification in order to reduce and diversify the country risk premium. In this respect, Repsol stated that: "Within the framework of an international scenario complicated by the serious Argentine crisis and the stagnation of the economy, Repsol has become a leading private company in the production of hydrocarbons in Venezuela". Moreover, it was authorized by the National Oil Company (NOC) of Libya to develop Block A of the Murzuq basin. In 2003, the Company increased its hydrocarbon production and reserves threefold in Trinidad and Tobago after increasing its interest in BPTT s gas reserves from 10% to 13% Futhermore, it strengthened its presence in Algeria and it became the first international company to take part in the development and exploitation of hydrocarbons in Mexico, through an agreement for the Reynosa Monterrey gas block. In parallel with this growth in the hydrocarbon production capacity in the rest of the world, the data for Argentina shows a 3.8% reduction in the production of oil by Repsol YPF in that same year, as detailed in the following section. In 2005, Repsol added new areas and businesses and intensified its presence in markets with high yield levels or future projection: Northern Africa, the Caribbean, North America, Russia and Central Asia, among others. In this respect, it bought three oil fields and one gas field in Trinidad and Tobago, it partnered with Gas Natural to develop new upstream projects directed to the production of liquefied natural gas (LNG), and it formed a partly government owned company to conduct midstream operations. As a result, it became the third largest company worldwide in terms of LNG volume managed and obtained 16 exploitation areas in Brazilian waters in the productive basins of Campos, Espíritu Santo and Santos. These blocks were added to the 8 blocks already owned in Brazil and, thus, the firm became the second largest oil company in Brazil. In late 2005, it signed an agreement to operate a regasification plant in Canada in order to supply the North American market. In 2006, the Company invested in an integrated gas project in Perú LNG to supply the west coast of the United States and Mexico through the liquefaction plant in Pampa Melchorita. In addition, it bought 10% of West Siberian Resources to participate in Russian projects and executed a preliminary agreement with Gazpom to develop joint projects in Europe, Latin America, Africa and the Russian Federation. Moreover, it acquired 28% of Shenzi, one of the largest fields in the American Gulf of Mexico. 7

8 In 2007, Repsol started developing the megafield I/R together with the National Oil Company (NOC) of Libya and executed an agreement for the supply of LNG with Manzanillo (Mexico) to supply electric power plants. In 2008, Repsol sold the gas station network it owned in Ecuador and Brazil, as well as its interest in the Manguinhos refinery, located in the latter. In that same year, it also sold 14.9% of YPF to the Petersen Group for US$ billion. This transaction was financed mainly with loans from banks (Credit Suisse, Goldman Sachs, BNP, and Itau) and Repsol itself. This group's interest in YPF continued to grow later on through two subsequent transactions. In late 2008, the second purchase involving 0.56% of YPF's shares took place, and finally, in May 2011, the group acquired an additional 10% in exchange for US$ billion. As in the case of the first transaction, this purchase was financed with loans from banks and Repsol. Furthermore, in 2008, Repsol signed with NOC of Lybia an agreement to extend its exploration and production agreements in that country until Such agreement guarantees Repsol the exploitation of the substantial resources discovered in both blocks. In 2009, Repsol engaged in an international exploration campaign with 15 significant discoveries in Algeria, in the Santos basin in Brazil, in Morocco, in the Gulf of Mexico and in Venezuela. In the following year, it entered into an agreement with the Chinese company Sinopec to jointly develop deep water hydrocarbon exploration and production projects in Brazil 1. In Argentina, one of the new business drivers in which Repsol YPF focused relates to unconventional resources (tight and shale), which will be discussed in further detail in section 3. In contrast to this global expansion, in 2009, Repsol s operations in YPF evidenced a 4.2% disinvestment of capital in several transactions which were part of a "partial disinvestment policy in the Company to rebalance Repsol's asset portfolio." Following this strategy, in 2011, Repsol agreed on the sale of an additional 3.8% share interest in YPF and on the making of a PSO involving 7.1% of YPF's capital stock. 1 In December 2010, Repsol Brasil increased its capital stock to include Sinopec as partner, thus creating one of the largest private energy companies in Latin America, which is valued at USD billion. Repsol holds 60% of its shares and Sinopec holds the remaining 40%. 8

9 Changes in shareholdings After the privatization process, Repsol had a stable group of shareholders. In fact, in late 2005, it comprised: 2 La Caixa (14.1%) through Caixa Holding; Pemex (4.9%) through its subsidiary Repcon Lux; Sacyr Vallehermoso (20%); and Mutua Madrileña (2%). The rest of the capital was divided as follows: Spanish shareholders held 28.7% (18.6% belonging to institutional investors and 10.1% to retail investors) and foreign shareholders held 30.3% (13.6% belonging to investors from the United States and 16.7% to investors from the rest of the world) 3. Significant shares in the capital stock of Repsol, selected years, in percentages Year Year Caixa 10.03% 9.10% 9.10% Sacyr Vallehermosos SA 20.01% 10.01% BBVA 9.78% 5.47% Criteria Caixa Corp 14.29% 12.84% (1) Repinves 5.94% 5.02% 5.02% PeMex 4.90% 9.49% Pemex 5% 4.81% 4.83% Chase Nominees Ltd 9.83% Sacyr 20.01% Axa SA 4.21% Free float 69.25% 75.60% 61.04% Free float 46.76% 67.66% (1) for Caixa Bank. Source: Repsol financial statements for 2000, , and It should be noted that the main portion of the stock structure is free float. The 68% of shares in the free float category as of 2011 was made up as follows: institutional holders from Spain, 9.9%; foreign institutional holders, 42%; minority holders from Spain, 10.8% and Repsol s own holding, 5%. Hence, the significance of foreign capital in Repsol s stock structure is evident. 2 Data from the Annual Corporate Governance Report of Repsol. 3 Bosch Badía, María Teresa, 2008, Repsol: de empresa pública a multinacional del petróleo, Tribuna de Economía, ICE. 9

10 Analysis of Repsol Group and YPF S.A. profits Changes in Repsol Group equity and assets With the purchase of YPF in 1999, the assets of the Repsol Group showed a 242% increase with respect to the previous year. In the following 12 years ( ), the assets and net worth rose by 169% and 216%, respectively. Changes in Repsol Group Net Worth, years , in billions of euros Source: own, based on Repsol YPF S.A.'s Consolidated Financial Statements. Share in profits by the different business units in the Repsol Group In 1998, the hydrocarbon exploration and production segment only accounted for 6% of Repsol s net operating revenues (EUR 92.6 million), which was far below the amount obtained for that item in 1999 (EUR billion; 1,181% year to year increase), when YPF was incorporated into the Group's equity. Considering only the second half of 1999, YPF contributed EUR 866 million to this business area. At the time, 85% of the operating income of the Spanish Group was made up of refining and marketing activities, plus gas and electricity. Repsol s business structure was completely modified by 2007; as a result, the relative share of the hydrocarbon production and exploration activity rose to over 50% of the operating profitability. 10

11 Relative share of the business units in the operating income (loss), , in percentages Source: own, based on Repsol Group's Consolidated Annual Reports During 2011, the operations of YPF S.A. accounted for 26% of the Group's operating income (loss) for that year, which was only exceeded by the upstream segment in the rest of the world, which comprises hydrocarbon exploration and production activities in 28 countries. On the other hand, in the period, the average share of the company s business related to Argentina accounted for 25% of the total operating income (loss), which was only exceeded by the average of the upstream segment in the rest of the world. As from January 2008, the Repsol Group adopted a new organizational structure under which the integrated activities of the value chain (exploration, production, refining, logistics, sale, and chemical products) undertaken by YPF S.A. in Argentina and its subsidiaries are reported separately. In essence, most of the transactions, property, and customers of YPF are located in Argentina, although it currently has the following affiliates: 11

12 Subsidiaries and affiliates of YPF S.A., 2011, in ARS million and percentages *YPF Inversora Energética S.A., A Evangelista Construções e Serviços Ltda., Gasoducto del Pacífico (Cayman) Ltd., A&C Pipeline Holding Company, Poligás Luján S.A.C.I., Oleoducto Transandino (Chile) S.A., YPF Services USA Corp, Bizoy S.A., Civeny S.A., Bioceres S.A., Energía Andina S.A., Compañía Minera Argentina S.A., YPF Perú S.A.C. and YPF Brasil Comercio de Derivados de Petróleo Ltd. Source: own, based on data in the Financial Statements for 2011 of YPF SA. 12

13 Changes in the net income (loss) of the Repsol Group, its main company Repsol YPF S.A. and YPF S.A. This section shows the connection between the Net Profit of the Repsol Group, its subsidiary Repsol YPF S.A. and YPF S.A. based in Argentina. As shown in the chart below, the net profits of the Repsol Group grew year after year from EUR billion in 1998 to a maximum amount of EUR billion in 2010, ending the year 2011 with EUR billion in net income. Changes in the net profits of the Repsol Group, Repsol YPF S.A. and YPF S.A., , in EUR billion* Source: own, based on the Stand Alone and Consolidated Financial Statements of Repsol YPF S.A. and YPF S.A. *The rate used to convert YPF S.A. s amounts in Argentine pesos into euros was the average exchange rate for the year. 13

14 Upon substracting the income obtained by Repsol YPF S.A. from the net income of the consolidated financial statements of the Repsol Group and then the income obtained by YPF S.A. from that obtained by Repsol YPF S.A., it is clear that a major portion of the final income of the Group is derived from the income of the Argentine based company (and its subsidiaries) and, in some years, it amounts to a significant portion of the total income. Contribution by YPF S.A. to the net profits of the Repsol Group, , in EUR billion Source: own, based on the Stand Alone and Consolidated Financial Statements of Repsol YPF S.A. and YPF S.A. Looking at the ROE ratio, which links the Company s income of the year to its net worth, it is clear that from 1998 to 2001, the Repsol Group had a higher ratio than its local subsidiary; in contrast, as from that year, YPF S.A. exceeded the income margin. This means that the increase in income in Argentina, as compared to the increase in capital, was higher than those increases for Repsol. 14

15 ROE Ratio (net income/net worth) of the Repsol Group and YPF S.A., , in percentages Source: own, based on the Stand Alone and Consolidated Financial Statements of Repsol YPF S.A. and YPF S.A. This means that while the equity remained stable and even dropped in recent years as a result of the disinvestment policy, income followed an upward trend. On the contrary, the equity of the Repsol Group grew exponentially and income remained stable. Changes in the operating income (loss) of YPF S.A. and the Repsol Group Over the past few years, the operating profits of Repsol YPF S.A. and YPF S.A. were relatively stable, ranging from EUR 1.5 billion to EUR 2.1 billion and from EUR 1.3 billion to EUR 1.8 billion, respectively. That was not the case with the Repsol Group s operating profits, which were more variable. For instance, between 2009 and 2010, the Group more than doubled its operating income. 15

16 Changes in the operating income (loss) of the Repsol Group, Repsol YPF S.A. and YPF S.A., , in EUR billion * Source: own, based on the Stand Alone and Consolidated Financial Statements of Repsol YPF S.A. and YPF S.A. This is evidence of the large share of operating income (loss) over sales in YPF S.A., as compared to the same indicator of the consolidated Repsol Group. As of 2006, YPF S.A. s the ratio dropped due to a relative increase in the operating costs. 16

17 Operating profits/operating revenues of the Repsol Group and YPF S.A., , in percentages Source: own, based on the Stand Alone and Consolidated Financial Statements of Repsol YPF S.A. and YPF S.A. 17

18 The Stripping of YPF's Assets by the Repsol Group Y P F The Mosconi Report As regards the history of the company, it should be noted that in 1993 the shares of YPF S.A. were held by an heterogeneous group of shareholders: 20% was held by the Argentine Federal Government, 11% was held by the hydrocarbon producing provinces, 10% was held by its employees, and the remaining 59% was held by private investors. The Company was managed by private parties, but the Argentine government was represented in the Board of Directors and kept the golden share for the most important decisions of the company. The main goal was to make the company more professional, increase its production and expand its reserves horizon. By 1993, YPF was engaged in hydrocarbon exploration and exploitation activities almost exclusively in Argentina, except for Block 14 in Ecuador, resulting from a competitive bidding process that was opened by the government of that country in 1987 and was awarded to YPF, ELF (French company) and Braspetro (international subsidiary of Petrobras). However, after the privatization of YPF, the need to make the Company more international not only in order to expand Argentina s horizons in the search for hydrocarbons, but also to allow its employees to gain greater experience in different types of fields and access to new technologies translated into the sustained growth of the company both in Argentina and in the rest of the world. Consequently, YPF E&P Overseas was formed in 1994 with a view to partnering with YPFB in Bolivia in the Montero, Charagua, and Securé blocks. In 1995, YPF decided to acquire the shares of the Dallas based Maxus Energy Corporation for US$ 740 million. At that time, Maxus was one of the largest private (unlisted) oil and gas (O&G) companies and had operations and assets in the United States, Indonesia, Venezuela, Ecuador, Colombia, and Bolivia. The purpose of acquiring this company was, in addition to gaining ownership of its assets, to incorporate personnel with experience in offshore operations and gain access to the United States market, the main hydrocarbon consumer in the world. In 1996, Bolivia began the capitalization process of YPFB through the privatization of the O&G companies ANDINA SAM and CHACO. YPF, together with Perez Companc and Pluspetrol, acquired 50% of the shares of ANDINA and, as a result, took part in the discovery and development of some of the largest natural gas producing fields in Bolivia located in the San Alberto and San Antonio blocks which, paradoxically enough, currently supply natural gas to Argentina and Brazil. In 1997, YPF and Maxus acquired a 35% interest in Block 16 in Ecuador and a 30% interest in the Monteagudo block in Bolivia. Both blocks were operated by YPF. In Indonesia, through Maxus and YPF International, YPF partnered with Pertamina, the government owned O&G company of that country, and, by 1998, it held interests in at least 5 offshore blocks in Indonesia, many of which it operated. 18

19 In Venezuela, through the acquisition of Maxus, YPF held an interest in the Quiriquire and Guarapiche blocks. In Brazil, YPF decided to take an active part in the opening process of the hydrocarbon industry and, as part of its strategic alliance with Petrobras, it partnered with such company and became the first company to sign a joint exploration and production agreement with Petrobras. YPF became the operator of block BES 3 (offshore) and, together with Santa Fe Energy, it acquired an interest in the Carauna and BPOT 2 blocks in the Río Grande del Norte basin. The goal of the company was to secure its position in Brazil for the new competitive bidding round that the National Hydrocarbon Agency (Agencia Nacional de Hidrocarburos) was to launch in In 1998, YPF entered into a strategic alliance with Bitech Petroleum Corporation to develop oil and gas assets in Russia through the acquisition of 18.67% of such company s shares. Apart from the abovementioned countries, by 1999, YPF Internacional had operations in Guyana, Malaysia, Colombia, Peru and the Gulf of Mexico (USA). As a result of this strategy, in 1999, YPF s international production reached more than 85,000 barrels of oil per day and about 200 million cubic feet of natural gas. Furthermore, its international reserves exceeded 400 million barrels of oil equivalent. Map of the international assets of YPF S.A. as of

20 As regards the downstream segment, apart from the development of and its presence in the domestic refining, lubricant, and retail (gas stations) markets, as from 1995, YPF began a process aimed at making this business international. The oil and fuel trading business included in addition to the neighbouring countries the United States and some countries in West Africa. YPF started to sell refined fuels to the United States, thus adding value through the oil industrialization process and expanding the company's profit margins. In 1995, YPF acquired a network of gasoline stations in Chile with a market share of about 6%. In Peru, in 1996 it acquired, together with other companies, a percentage of the La Pampilla refinery, which processed over 33 million barrels per year and represented more than 55% of the oil processing activity in Peru. In 1998, YPF owned 57 gasoline stations under the name YPF. In 1997, YPF began operating in Brazil through the distribution of fuels, lubricants and petrochemical products exported from Argentina. In addition, in 1997 and as part of a strategic alliance with Petrobras, two gas stations were opened simultaneously, one in Rio de Janeiro under the YPF brand and the other one in Zarate, Argentina, under the Petrobras brand. This agreement was the first of its kind to be signed by Petrobras with any company in the world. Likewise, in 1998, YPF acquired a 29% interest in the Manguinhos refinery, which in turn had 82 gasoline stations. In December 1998, YPF acquired 51% of Global Petroleum Corp., a American company engaged in the import of refined oil products for use throughout the United States, with 41 terminals and fuel supply capacity in 9 USA states. This acquisition was part of the strategy pursued to secure markets for Argentine refined products. In sum, by the end of 1998 and prior to its acquisition by Repsol, YPF had about 1,800 employees outside Argentina, assigned to different upstream and downstream operations around the globe. YPF was considered to be a company with a brilliant present and future (twelfth O&G company listed on the NYSE based on its reserve amounts), with presence in the main oil producing countries in Latin America and with potential for growth in countries like the United States, Russia, and Indonesia. YPF was present in 12 countries in 3 continents and had gone from being an exclusively Argentine company to becoming an international company. This expansion took place in just over 4 years and in spite of the fact that oil prices at that time were below US$ 20 per barrel. However, this situation changed dramatically as from 1999, when YPF was acquired by Repsol. During the first few years after the acquisition of YPF by Repsol, the liquidity needed to pay back the debts Repsol incurred to acquire YPF translated into a process of disinvestment and sale of some assets to third party companies, mainly the assets of Crescendo in the Texas' Panhandle and the assets of Indonesia. During those years, the price of oil was below US$ 20 per barrel and these assets could be considered easier to sell or convert into cash as they were in production and were in two of the most attractive areas, based on their geographic location and geological potential at an international level. With these sales, YPF lost two of the goals set in its previous 20

21 internationalization strategy: access to the North American market and gaining offshore experience with the Indonesian assets. As from 2000, Repsol began a process through which it transferred the rest of the international assets owned by YPF or its subsidiaries to itself. Thus, YPF lost management of those assets almost immediately after Repsol s acquisition of YPF. All the exploration and production assets included in Figure 1, which YPF held as of 1999, were transferred during the first 4 years and no longer belong to YPF. The following table details the process whereby YPF s Argentine and international assets were transferred to Repsol and other companies: Process of sale and transfer of YPF s assets, in US$ million Note: data extracted from YPF S.A.'s 20F as from

22 As observed in the above table, Repsol started a massive asset transfer process from YPF to the affiliates of the Spanish group and/or in some cases decided to sell those assets to third parties. The transfer of assets for an amount of about US$ 3 billion was recorded in YPF s accounting books, but such amount was subsequently transferred to Repsol as extraordinary dividends. That is to say, not only did Repsol take advantage of its position in YPF to keep strategic assets, but it also appropriated the funds arising from these sales. Included in the asset transfers, there were certain proven oil and gas reserves which are disclosed below, together with the implied relative values paid per barrel of oil equivalent. The analysis of the information in the table and the map included above show the significant reduction of YPF s net worth as a result of the loss of its strategic assets, which translated into a sharp reduction in the reserves and production level. Thus, Repsol s actions, whether related to the transfer of hydrocarbon reserves to affiliates or the lack of investment in Argentina, caused the Company s total reserves to plummet. International reserves of YPF sold or transferred to RepsoL YEAR Country USD millon Reserves PD + PND MBOE Value/Boe 1999 USA ECUADOR VENEZUELA INDONESIA BOLIVIA INDONESIA TOTAL 2,108 1,140.4 Changes in the net reserves of YPF, in barrels of oil equivalent YEAR Argentina Rest of South America USA Indonesia Worldwide Note: amounts from the 20F of YPF with the 2005 restatement. 22

23 These amounts are better appreciated in the following chart showing the fall by over 70% in the certified proven reserves of oil and natural gas that YPF owned before being acquired by Repsol, as compared to the year Changes in Total Reserves, in barrels of oil equivalent Note: values from YPF's 20F with the 2005 restatement. 23

24 A Paradigmatic Case: the Liabilities of Maxus Energy Y P F The Mosconi Report After the mass transfer of assets carried out from 1999 to 2005, YPF lost almost all of the assets that Maxus Energy had at the time of their acquisition by YPF; however, as of December 31, 2011, YPF Holdings Inc. carried liabilities previously held by Maxus in the amount of US$ 221 million, out of which US$ 155 million relate to short and long term environmental liabilities. The rest are debts related to pension plans. In 2005, the Department of Environmental Protection of New Jersey filed a lawsuit before the Superior Court of New Jersey Law Division, Essex County in connection with the environmental liability of the Lister Site. Such lawsuit was brought against: Occidental Chemical Corporation, Tierra Solutions, Inc., Maxus Energy Corporation, Repsol YPF YPF Holdings, Inc. CLH Holdings The arguments of the State of New Jersey against Repsol and YPF are: 1. Fraudulent transfer of assets: The plaintiff holds that Repsol and YPF sought to abandon their environmental responsibilities while systematically taking from Maxus and Tierra their assets and their ability to meet their obligations in New Jersey. It also states that no reasonable market value was paid for the assets transferred. 2. Alter ego theory: The plaintiff holds that Repsol and YPF abused the corporate forms and that all the companies (Maxus, Repsol, and YPF) operated as a single economic unit. Surprisingly, it is the same diagnosis as the one presented in the current report. 24

25 Section 2 Repsol's Policies for YPF: Depredation, Disinvestment and Undersupply Much of the exceptional macroeconomic performance of Argentina in the period 2003 through 2011 resulted from a policy which made it possible to partially insulate the local economy from the high volatility of international commodity prices of both food and fuels. In fact, upon comparing the evolution of the local price of fuels with the one that would have resulted from the international marker, it can be seen that the policy of imposing duties on exports, coupled with the management of local prices, made it possible to insulate Argentina from the upward cycle experienced by fuels, which was mainly driven by the presence of speculative capital that began to see such resources as an alternative investment in the light of the collapse of other short term investment options within the context of the violent international financial crisis. Changes in domestic and international fuel prices (1) Average price of gasoline and diesel of YPF weighted on the basis of refining percentages. Source: Secretariat of Energy, Resolution No. 1,104. (2) Average real gross margin for the sector (including taxes, refining, and marketing) applied to the historical local price of oil. 25

26 As shown in the chart above, the dissociation of the local price from its international benchmark allowed local consumers (both families and companies) to pay for fuel on the domestic market, in years with strong changes in international prices such as 2008 almost half the amount that would have resulted from import parity. This means, that for example in 2008, while the average cost of gasoline and diesel oil would have been ARS 4,029 per cubic meter in the absence of a price management policy, on the domestic market the price only amounted to ARS 2,026 per cubic meter. The domestic price management policy is a natural consequence of understanding that fuel is a determining factor for the development of diverse economic activities, since it is a widely used input in Argentina's productive structure; it participates as a direct cost in a wide variety of industrial processes. Likewise, as fuel for transport, it is also involved in the marketing and distribution chain of almost every type of product. Thus, the competitiveness of local production relies to a great extent upon the cost of energy and, therefore, on the domestic price of oil. Government involvement in managing the offer and the prices of oil and gas is understood as a main driver of Argentina s economic competitiveness. However, since international markets treat oil simply as a generic product for export (a commodity), the evolution of its price is subject to the fluctuations of the global economy. Recently, for example, the international crisis impacted harshly on the international oil market, which caused the price of the barrel (WTI) to increase significantly and also to become highly volatile: while from 1991 to 2002 the price of the barrel averaged US$ 21 with an average volatility of US$ 4, between 2003 and 2011, it increased by 215% with an average of US$ 67 per barrel and an average volatility of US$ 21. It is in this context that it is possible to understand the policies applied by the Argentine Government for the purpose of managing domestic fuel prices with the ultimate goal of insulating the domestic economy from the fluctuations of international prices. 26

27 Repsol's attitude with respect to domestic prices Y P F The Mosconi Report The measures aimed at managing domestic energy and fuel costs and supplying the domestic market were interpreted by Repsol as a threat to the extraordinary profits that it intended to obtain in Argentina. In its 2011 financial statements, the Company stated its position in the Argentine affiliate (YPF S.A.): "The main economic risks faced by Repsol YPF as a result of its operations in such country (Argentina) are: limitations in its capacity to transfer to domestic prices the increase in the international price of crude oil, other fuels, and other costs affecting operations, as well as the impact of foreign exchange fluctuations; restrictions on the volume of hydrocarbon exports resulting mainly from the requirement to satisfy domestic demand with the subsequent impact on the Company's previously assumed commitments to its customers; the need to extend the concessions, part of which will expire in 2017; labour union strikes and interruptions; potential alterations of the current regulatory framework through government measures and/or legislative changes that could affect the Group's operations and the profits expected from them (increase in taxes on oil and gas exports, setting of rates for acquiring goods or services which are necessary to perform activities; renegotiation and termination of agreements; changes in policies affecting trade and investments, etc.); the evolution in the exchange rate of the Argentine peso and restrictions on access to the foreign exchange market in order to pay obligations and dividends abroad. It subsequently claims that "in addition, YPF has had to sell on the local market a portion of its natural gas production that was originally intended for export, so it has been unable to meet contractual export commitments in certain cases ( ). This means that, as Repsol was unable to increase domestic crude oil prices in Argentina, it put into practice a clear country exit strategy and a predatory policy both in terms of hydrocarbon production and disinvestment. However, it should not be believed that profits were insufficient because, as already shown, YPF income collected by Repsol was substantial. The problem is that the Repsol Group compared this income to other business opportunities which, at the prices prevailing on the international market, were even more profitable and, therefore, it neglected local exploration and production activities. 27

28 Evolution of YPF S.A. oil and gas production, , in m 3 and millions of m 3 Source: own, based on Energy Secretariat data. The above chart evidences that Repsol adopted a production strategy based almost exclusively on the existing wells (which were discovered in years before the privatization, as is the case of the megafield of Loma La Lata), since oil and gas production between 1999 and 2011 fell by 39% and 31%, respectively. However, what is most remarkable about the disinvestment, market segmentation and ongoing pressures to increase fuel prices by Repsol is the fact that the Group itself was one of the main parties responsible for the shortage of oil and gas in the market a shortage that, far from affecting the Company's profits, clearly contributed to a strategy aimed at making domestic prices converge with international prices. This strategy is reflected in the classified and restricted reports found after the Company was placed under government control, in which Repsol made explicit references. In a classified presentation about its business plan, Repsol argued that the much sought after (by the Group) "convergence between domestic and international prices of oil and gas would be completed by the year It is interesting to understand the mechanisms whereby this convergence would effectively take place. In a confidential document (see figures below) in which Repsol mentioned the main guidelines of its business plan, a potential date was mentioned for the desired equalization of domestic and external prices that would apparently take place as a result of the free supply and demand of fuels. However, that same business plan states that the Company's action tends to consolidate a situation in which domestic supply is always below demand. 28

29 Repsol's business plan poses as a work hypothesis an equalization of the price of crude oil on the domestic market with its import parity arising from an alleged but not substantiated "evolution of crude oil export duties that would allow our domestic prices to increase. That is to say, far from this being a natural consequence of the free market, Repsol prepared its business plan on the basis of the alleged total elimination of oil export duties in 2014 and partial eliminations in 2012 and As to natural gas, Repsol's plans are even more revealing. Based on this confidential business plan, domestic gas prices would increase as a result of the upward pressure on the cost of the fuel imposed by higher import levels. 29

30 However, and as proven by the current report, the need to import fuels was directly generated by the actions of Repsol at YPF, whose disinvestment led to a fall in oil and gas production and to the subsequent need to buy these fuels abroad. This business plan created by Repsol for YPF also helps understand the causes of the disinvestment in exploration and exploitation of hydrocarbon resources by the Company. The document recognizes that Argentina's economic growth since 2003 is "among the highest in the world" and that, consequently, demand for fuels expands at annual rates over 5%. This increased growth imposes pressures on hydrocarbons supply as it generates a need for more investment in both the upstream and downstream segments with a view to expanding exploitation and refining capacity in line with the increase in demand while at the same time preventing production from depleting the fields and causing a reduction in oil and gas reserves. However, Repsol's disinvestment created exactly that effect on domestic supply: the lack of investment entailed an increasing need to import fuels and the abandonment by Repsol of exploration and recovery activities meant the depletion of YPF's oil and gas reserves. According to this confidential business plan, the clearly expanding demand could only be satisfied by a similar increase in domestic supply provided that the "regulatory framework would ensure sufficient margins throughout all links of the value chain of the sector. Two points should be made in this regard. Firstly, reference to sufficient profit margins "throughout all links of the value chain of the sector" clearly reflects the way Repsol understood business. As discussed in further detail in the subsection devoted to analyzing the Group's marketing and pricing strategy, its profit calculation method completely disregarded the vertical integration at YPF. That is to say, Repsol computed a revenue margin in, for example, its marketing segment, in the same way as this could be done by a company exclusively engaged in marketing fuels. The marketing segment computed its fuel "acquisition cost" as if the product were bought at market prices thus applying a marketing margin on fuels whose cost already included refining, exploitation, and exploration margins. In this way it multiplied profits throughout the whole productive chain. 30

31 Secondly, it should be asked whether the profit margins obtained by Repsol at YPF were not "sufficient. As shown, the profits obtained by Repsol at YPF were far from "insufficient" since they allowed the group to leverage its international expansion as well as to make a very good deal through the acquisition of YPF. Therefore, it is possible to believe that the profits obtained by Repsol at YPF were "insufficient" in some other sense. Repsol's own business plan shows that this insufficiency arises from a very specific calculation: comparing the profit obtained by the Group on the domestic market with the profit that the Group could have made if domestic fuel prices had been the same as international prices. As pointed out at the beginning of this section, the export duties and price management policies implemented by the Argentine Government entailed differences of up to 100% between the domestic price and the theoretical import parity. Although a preliminary analysis could suggest that these differences only impacted negatively on Repsol's profits in YPF, the Group's performance during the period 1999 through 2011 disproves such an assumption. In order to understand this apparent contradiction, it should be borne in mind that although the Argentine Government's macro and microeconomic policies were the reason for the dissociation of domestic fuel sale prices from international prices, those policies also dissociate the evolution of domestic prices from the costs of the rest of the world. Therefore, Repsol deliberately failed to mention that, apart from domestic fuel prices departing from international fuel prices, there was also thanks to the policies implemented by the Argentine Government, which were criticized by the Group dissociation between domestic and foreign costs thus enabling the hefty profits mentioned above. It also disregarded the fact that such policies underpinned the important growth in the economy and, consequently, the Company's prosperity. The disinvestment process of Repsol in YPF was consequently not the result of the "insufficient" profitability obtained by the Group at YPF, but rather of continuously comparing such profitability with the theoretical value that could have been attained if domestic prices had risen, such rise being promoted by Repsol's own policy at YPF as it reduced oil and gas supply to a domestic market that was clearly expanding. This domestic disinvestment process becomes evident upon analyzing the level of remittance of earnings, as the Repsol Group chose to maximize earnings in Argentina in order to subsequently transfer them abroad. 31

32 Changes in YPF S.A. net earnings and dividends paid , in ARS billion Source: own, on the basis of the Annual Report of YPF and its subsidiaries. The chart shows how earnings remittances increased as from 2008: in the period 2008 through 2011 the Company paid dividends similar to those paid during the previous 10 years ( ). It should also be noted that the Repsol Group as a whole distributed dividends in the amount of US$ billion during the period , an amount which is almost equivalent to the amount remitted from the Argentine affiliate. In other words, the international expansion of the Group was mainly based on the depredatory policy implemented by Repsol in Argentina within the framework of a process of sharp disinvestment and asset stripping in relation to the main company of Argentina. 4 As explained in the first section, Repsol started off as a downstream (refining, sale, and distribution) company and in just a few years it expanded internationally. The main companies in the group, their interests and results for 2011 are shown below: 4 Message by the Federal Executive, Law No. 26,

33 Main companies of the Repsol Group December 2011, in percentages and EUR billion Company Country Activity Interest Income (loss) for 2011 (in EUR million) YPF S.A. Argentina Exploration and production of hydrocarbons 57.43% 1, Repsol Sinopec Brasil S.A Brazil Exploration and marketing of hydrocarbons 60.10% 82.2 GAS Natural SDG SA Spain Gas distribution 30.10% 1,021 Repsol YPF Bolivia SA Bolivia Holding company % 5.8 Repsol Petróleo, S.A. Spain Refining 99.97% Repsol Internacional finance BV Holland Financial and holding of interests % Repsol Portuguesa, S.A. Portugal Distribution and marketing of oil products % Repsol Química S.A. Spain Manufacturing and sale of petrochemical products % Repsol YPF Tesorería y Gestión Financiera, S.A. Spain Treasury services rendered to group companies % Repsol Exploración, S.A. Spain Exploration and production of hydrocarbons % Petróleo del Norte (PETRONOR) Spain Refining 85.98% Repsol YPF Perú B.V Holland Holding company % 4.70 Repsol Overzee Finance, B.V Holland Holding company % Compañía logística de Hidrocarburo Spain Transportation and storage of oil products 10.00% Repsol Butano S.A. Spain Marketing of LPG % Repsol Italia Italy Marketing of oil products % 4.80 Repsol Comercial de Productos Petrolíferos S.A. Spain Marketing of oil products 96.67% 277 Other interest Source: financial statements of Repsol YPF for 2011 In 2008, the Repsol Group segmented the Company into the following business units. The first three are the so called "integrated strategic businesses". Upstream (hydrocarbon exploration and production); LNG (midstream phase operations (liquefaction, transportation and regasification) of natural gas and marketing of natural gas and liquefied natural gas); Downstream (refining, marketing of oil products, chemical and liquefied petroleum gas). And two strategic interests: YPF, including the operations of YPF, S.A. and all its group companies in all businesses (as of December 31, 2011, the Group held a 57.43% interest in YPF). Gas Natural Fenosa, whose main activities are natural gas marketing and electric power generation, distribution and marketing (as of December 31, 2011, the Group held a % interest in Gas Natural Fenosa). 33

34 BASES ANTARTICAS ARGENTINAS Permanentes Jubany Orcadas Esperanza Marambio San Martín Belgrano II Temporarias Brown Primavera Decepción Melchior Matienzo Camara Petrel Y P F The Mosconi Report The Group s market penetration worldwide is shown in the following graph: Repsol s presence worldwide by business unit, 2010 Source: 2010 Consolidated Annual Report But even after the marked disinvestment process that Repsol carried out in YPF, the importance of the Company to the Group is still evident. Despite the significant decrease in the reserves of oil and gas that Repsol generated in YPF, the existing oil reserves in YPF exceeded even those held by the whole Repsol Group. In fact, by 2011 Repsol s estimated proven reserves (excluding YPF s) according to the Securities Exchange Commission s (SEC) methodology totalled billion barrels of oil equivalent (BBOE), of which 393 MMBOE involved crude oil and the rest, 774 MMBOE, involved natural gas 5. By late 2011, YPF s proven reserves totalled BBOE, of which 585 MMBOE involved crude oil and 427 MMBOE were natural gas. This means that in spite of the deliberate divestment, reduction in reserves and decrease in production caused by Repsol in YPF, the latter reserves as of 2011 accounted for 60% of the Group s reserves and 36% of its natural gas reserves. In this regard, YPF s strategic importance, its reserve levels, production levels, export and commercialization capacity help understand the significant changes that Repsol Group experienced following its acquisition of the local company, acquisition that would later go on to exhaust in order to finance its global expansion. This fact can be illustrated simply by comparing the main variables of the Group s economic-financial equation before and after the acquisition of YPF. The following table shows these variables for 1998 and Source: 34

35 Repsol s income before and after the acquisition of YPF, in US$ billion Source: own, based on YPF data. An analysis of the above table makes Repsol s strategy clear: in order to finance an expansion of 142% of its assets through the acquisition of YPF it had to increase both its short (267%) and long term (349%) debt. YPF s acquisition by Repsol allowed the Group to significantly increase its income (38%) and particularly its operating income (59%), resulting in cash flows that later enabled Repsol to finance the diversification strategy in the rest of the world with the liquidity it extracted from YPF. In fact, looking longer term at the performance of the Repsol Group in YPF clearly shows that the economic financial business was done at the expense of the Company s production performance. The following graph shows the changes in YPF s net and operating profits, net worth and oil and crude oil production for the period This clearly shows that when comparing the year in which Repsol took over the Company with the year 2011, the two profit indicators improved significantly, while net worth, as well as the production of oil and gas, drop sharply. In fact, while between 1999 and 2011, operating profits multiplied by 2.6 times and net profits did so by 1.3 times, net worth decreased by 41%, oil production fell 43% and gas production dropped 31%. As already mentioned, Repsol s financial business was done at the expense of a reduction in YPF s oil and gas production and exploration. 35

36 600 YPF: Change in selected variables, (with base index number 1999=100) Net Profit Operating Profit Net worth Oil Production Gas Production Source: YPF Annual Report 36

37 The Second Stage of Repsol s Financial Strategy for YPF The second stage of Repsol s financial strategy for YPF was marked by the Group s plans to sell the Company thanks to the business opportunity created by the enhancement of the Vaca Muerta field (for a thorough description of this point, see Section 3). For this reason, the last two years show an increase in the divestment strategy implemented by the Group, along with an increase in debt that left YPF in a financially delicate situation. Below is a description of the main aspects of this second stage of Repsol s financial strategy in YPF that can be characterized as an acceleration in its exit from the Company. First of all, during 2011, the Company s shareholders equity dropped almost by 7%, from US$ billion to US$ billion. This reduction is explained by an increase in the Company s total liabilities, which increased by 26% over the course of those two years, from US$ billion to US$ billion. YPF s shareholders equity, in US$ Million Source: own, based on YPF data. 37

38 At the same time, this increase in liabilities was mainly the result of dividend payments that largely exceeded YPF s payment capabilities. As seen in the graph below, while during 2011 the net profits earned by the Company amounted to US$ billion, the payment of dividends exceeded this amount by 16%, reaching US$ billion. Changes in net profits and in dividend payments in YPF (Consolidated), , in US$ billion Source: own, based on YPF data. Even in spite of its divestment policy, the prevalence of the payment of dividends in the Company s setting of short term objectives deteriorated its finances and caused the net debt to multiply threefold in just three years. In fact, the cash flow generated by the Company during the period was insufficient to sustain the capital expenditures (which explains part of the deterioration in the exploration and production business mentioned earlier) and the payment of dividends, and the only way of continuing to make those dividend payments was through indebtedness. 38

39 YPF Statement of cash flows (Consolidated), , in US$ billion Cash generated in operations Investing activities Net indebtedness Payment of dividends Net change in cash Source: own, based on YPF data. YPF s Statement of Cash Flows (Consolidated), , in US$ billion Source: own, based on YPF data. 39

40 Changes in Repsol s level of indebtedness in YPF, , in US$ billion Billions of US dollars Source: YPF, Annual Report for 1997 through At the same time, in this second stage the indebtedness strategy was clearly short term in nature, given the imminent sale to foreign capital by Repsol Group, as much of the indebtedness is shortterm. The deterioration in operating income experienced by YPF in recent years as a result of the deliberate divestment by Repsol and the concentration of the debt structure in the short term makes it clear that the Group was planning an imminent sale of the Company. Deepening of the Market Segmentation Strategy in the Context of the drop in YPF s Production The market segmentation strategy pursued by Repsol was even more evident after certain findings by the Comptrollership. In fact, the evolution of production, the import of fuels and the increase in prices by Repsol in YPF are the clearest evidence of the Company s market segmentation strategy, which aimed to keep the premium market segment for itself in a context of divestment and waning domestic production. 40

41 In fact, the divestment implemented by Repsol in YPF led to a significant increase in operating costs, mainly due to the growing need to import fuels, which was not only the result of the lack of exploration and production of new fields, but which also enabled Repsol to continue applying pressure towards the convergence of domestic prices of fuels with their international benchmarks. As shown in the following graph, YPF's operating costs in 2011 increased 32% if compared to 2010, and 57% if compared to 2009 (which is when the international crisis and the domestic economic slowdown minimized the need of the Company to import fuel). Change in YPF operating costs (consolidated), , in US$ billion Source: own, based on YPF data. Thus, within the context of YPF's waning domestic production of crude oil and gas and a genuinely expanding domestic market, Repsol s strategy aimed to cover part of the increase in its demand with greater fuel imports. The greater import volumes clearly deteriorated the Company's operating income, whose revenues increased as a result of the mere effect of higher sales prices, in a context in which production amounts and even sales were falling. As an example, between 2010 and 2011, while the sales of gasoline and diesel increased only 9% (mainly the result of the higher import amounts of premium fuels, in both gasoline and diesel), the average prices of these fuels increased 21%. With regard to fuel oil, the situation was even more dramatic, since while the amounts dropped 46%, prices rose 22%. 41

42 Changes in domestic market Domestic Market vs 2011 amount price total amount price total amount price total amount price total MUSD % Diesel Oil 8, ,486 7, ,228 7, ,828 7, ,603 1,117 32% Euro Diesel % Premium Gasoline , % Super Gasoline 2, , ,041 2, ,255 2, , % Normal gasoline (67) 100% Sub total of gasoline and diesel oil in thousands of M3 11, ,698 11, ,631 11, ,904 12, ,678 2,980 63% Curde in thousands M % Natural gas in thousands M3 15, ,153 14, , , ,007 (146) 13% Kerosene in thousands M % Aero Kerosene in thousands M % LPG Up in thousands of Tn (312) 100% LPG Down in thousands of Tn % Lubricating oils in thousands of M , , (71) 21% Base lubricants in thousands 103 2, , , (150) 71% Fuel Oil in Thousands of Tn 42 1, % Fertilizers and grains in thousands of Tn (75) 19% Asphalt in thousands of Tn % Residual carbon in thousands of Tn 1, % Petrochemicals in thousands of Tn (31) 7% Sub total 7,931 6,978 8,770 11,113 3,182 40% Others % TOTAL DOMESTIC MARKET 8,306 7,344 9,179 11,530 3,224 39% At the same time, and as shown in the following table, Repsol s strategy also involved neutralizing the fall in income from exports as a result of decreased production and the fall in external demand with price increases throughout the period

43 Changes in YPF sales to the export market Y P F The Mosconi Report Domestic Market vs 2011 amount price total amount price total amount price total amount price total MUSD % Diesel Oil in thousands M (264) 78% Virgin gasoline in thousands of Tn (192) 100% RON2 gasoline in thousands of M (284) 100% Sub total of gasoline and diesel oil 1, (739) 73% Crude in thousands of M (186) 100% Natural gas in millions of M (231) 74% Petrochemicals in thousands of Tn (105) 100% LPG in thousands Tn (31) 18% Aero kerosene in thousands of M % Fuel Oil in thousands of Tn 1, (240) 45% Lubricating oils in thousands of M3 69 1, , , , (38) 38% Flour and Oils in thousands of Tn % Sub total 3,163 1,496 1,626 1,788 (1,375) 43% Others % TOTAL EXPORT MARKET 3,175 1,504 1,639 1,806 (1,369) 43% TOTAL SALES YPF 11,481 8,848 10,817 13,335 1,854 16% Source: own, based on YPF data. Lastly, when the changes in both markets, domestic and export, are compared, there is an evident marked increase in the prices of both destinations, along with a higher import of fuel oil. Repsol s Commercial Strategy regarding YPF Worldwide, Repsol Group had a great deal of experience in the commercialization segment, but not in the downstream area, and much less so in the upstream area. Thus, it directed the commercial area to be largely independent from the rest of the Company, a feature whose consequences took the form of higher prices, a greater segmentation of the market, clear disregard for the nature of YPF as a vertically integrated company and, consequently, greater appropriation of income by the Company. This was also reflected, internally, in the way in which each one of its areas determined its costs, which always included the related segment's profits, such profits being included as an additional cost in the subsequent segment. In other words, the upstream area calculated the exploration, extraction and transport costs, to which it added a rate of profit (generally, around 12% on the assets committed to the operation, in addition to the related depreciation) and thus determined the "sale price", which the downstream area was to compute as a cost. In turn, the downstream area did the same with the refining and transport costs, adding the related profit for the segment, so that these "costs" would later be computed by the commercial area. Finally, the commercial area allocated the costs of the upstream and downstream areas (which of course included the rates of profit for each one of these segments) and added the related marketing margin (that could reach gross values of up to an additional 30%). Thus, the final sale price of fuels included the rates 43

44 of profit of each one of these three segments as if they were independent companies. This particular pricing method meant that in 2011, YPF had a production cost" per barrel that ranged between US$ 100 per barrel of oil equivalent, when the price on the international market for that same year was USS 103. In fact, the Comptrollership was able to prove that the Company s commercial area determined its costs of acquisition of crude oil in the same way as a company that does not have its own production and refining processes, and which must acquire fuel from another production company. This pricing method meant that Repsol was obtaining extraordinary income from YPF, which income could be realized thanks, at the same time, to the retraction in supply generated by Repsol itself, that enabled it to set up a market with a structural deficit, with the consequent pressures to increase the domestic price. Thus, the rationing of quantities supplied by Repsol in YPF, the market segmentation in favour of the premium segment and the consequent increase in prices allowed the Company to compete through prices with other companies, which did not have vertical integration like YPF. The Comptrollership has verified that in many instances the pricing method described above was plainly and simply replaced by price increases that sought to "follow the competition", so as not to create a price gap that would redirect demand from the rest of the companies to YPF. These kinds of price increases created an extraordinary profitability in YPF, even above the profitabilities that each one of the segments assessed in an absolutely independent manner. Why was the company not using the advantages from its vertical integration to increase its market share against the other companies, thus appropriating the demand segments from others for itself? The explanation for this phenomenon has at least two central aspects. First of all, this strategy would have required a significant increase in the quantities sold by YPF which, in order to maintain this comparative advantage, should have come from its own oil wells and not from the import of fuels. Accordingly, capturing a greater portion of the market would have required substantial investments in exploration and production, which was clearly the opposite of Repsol s economic financial strategy in YPF. At the same time, YPF s concentration in the premium segments of demand offered higher rates of return than those obtained by the Company in the non premium segments. In fact, in a context of continuous shrinkage of domestic supply (brought about, as already mentioned, mainly by the deterioration in production in YPF itself) YPF began to position the brand in the premium segment, so that in the future the Company would be in a favorable position to fight its competitors for this high profitability segment of the market. This also explains that a significant portion of the Company's financial resources went into improving the image of its service stations and the positioning of the YPF brand through aggressive advertising campaigns, as part of its positioning strategy for the premium segment. Repsol also aimed at appropriating the right sales points for that strategy, that is to say, the best strategically located service stations. Through the financial strangulation of third party service stations, it was able to acquire the stations considered key to its commercial strategy. In the same regard, many third party service stations located in middle to low income areas were forced 44

45 to shut down due to a shortage in the supply of non premium fuels. These shutdowns, far from dragging down Repsol s profitability in YPF, were key in its geographic concentration in areas with sufficient purchasing power to absorb larger quantities of premium fuels. Technical Aspects of Repsol s Management of YPF The arguments given in Law No. 26,741 aimed to expose Repsol s asset stripping, divestment and depredation of YPF s oil and natural gas resources. The investigations conducted by the Comptrollership, make it possible to present this type of conduct by the Group in great detail. Fall in the Production of Oil between 1999 and 2011 Since Repsol took over control of YPF in 1999, the Company experienced a substantial loss in the production of oil in Argentina that totalled 39%. The reasons for this decline are explained mainly through the policy used by the Group to maximize the primary production of oil and gas to the detriment of other production alternatives that involve the recovery of the longer term investment, but which at the same time guarantee a higher final recovery factor. 45

46 Changes in the production of oil YPF Source: Argentine Secretariat of Energy Additionally, this situation was made worse by minimum exploration activities, insufficient investment in surface facilities and a delay in the implementation of secondary recovery projects. In fact, the small changes in 2008 and 2009 in the decline curve are due to the incentives created by the Federal Government (mainly, the Petróleo Plus Program) which caused intense work to be performed on optimizing the basic production of fields (although it continued the trend by Repsol not to invest in secondary recovery and surface facilities). Once this optimization of baseline production was achieved, the only way of continuing to maintain a production level that would allow receiving the benefits of Petróleo Plus was to drastically increase drilling activities. 46

47 Lack of Investment in Facilities The investigations conducted by the Comptrollership found that starting in 2004 there are indications that some mature fields of significant production for the Company began to show the effects of the lack of investment and maintenance in surface facilities and wells, which was reflected by an increase in production losses and shortages. The policy of maximizing primary extraction, postponing secondary recovery and not making investments in maintenance noticeably affected the useful lives of the fields, with a loss in the final recovery and in a manner contrary to the industry s best practices. Among the fields that were affected by this exploitation strategy are Vizcacheras, Barrancas and La Ventana in the province of Mendoza, Señal Picada Punta Barda, Chihuido de la Sierra Negra in the provinces of Neuquén/Río Negro and Los Perales in the province of Santa Cruz, as well as other fields in the Golfo San Jorge basin. As an example, the graph included below shows the drop in production due to the decommissioning of production wells that existed prior to 2010 in the Vizcacheras field, Papagayos formation, which contain a larger percentage of water, to allow the entry of new wells with lower percentages of initial water. The reason for this well decommissioning is the lack of capacity in the facilities to handle total fluid volumes (oil and water), with the consequent loss of total production. The graph also shows the subsequent drilling campaigns. Vizcacheras Papagayos Source: own, based on YPF data. 47

48 This lack of investment is also evident in the following example, where in four significant fields of the cuyana and neuquina basins (Barrancas, La Ventana, Vizcacheras, Señal Picada, Punta Barda) there is a great difference between the needs for investment in facilities shown by the business in the Strategic Plan (SP), which is the plan pledged before the Secretariat of Energy (PLAN) and the one that was actually carried out in the last few years. As shown in the graph below, during 2009, Repsol failed to comply with its plan, investing 81% less than what had been estimated as necessary by Repsol itself and, moreover, investing 61% less than what they had promised to invest to the application authority, the Secretariat of Energy. The same thing happened in 2010, when Repsol invested 64% less than its forecast and 53% less than what had been promised to the Secretariat of Energy. Changes in total investments in surface facilities at the Barrancas, La Ventana, Vizcacheras and Señal Picada Punta Barda areas Source: own, based on YPF data. The current condition of these facilities, which have not been duly maintained and conditioned, is the effect of an operating strategy that sought to maximize profit margins, prioritizing well drilling due to the shorter return times and jeopardizing the accumulated return that is obtained at the end of the field s life. In the particular case of these four fields, the damage in terms of loss of proven reserves only with relation to the events of 2012 is estimated at 750,000 m3. This fact not only significantly affects the supply of Argentina s fuels, but is also clearly detrimental to the future value of the Company. Thus, these facts constitute irrefutable evidence that Repsol s interest was centered around obtaining the maximum profit possible in the short term, a strategy that is explained, in turn, by the Group s interest in divesting itself of YPF once it had used it to leverage its international expansion strategy and could obtain a greater benefit than expected from selling it 48

49 thanks to the enhancement of the Vaca Muerta formation (see Section 3). Resolutions 785 and 1460 The investigation carried out by the Comptrollership also focused on understanding the main aspects of the analysis of the condition the surface facilities were in 2011, year in which Repsol studied the condition of the Tanks and Pipelines of the operating fields based on Resolution 785 (Tanks) and 1460 (Pipelines), consequently coming up with an investment plan. The analysis carried out by Repsol involved an assessment of the criticality of the condition of all E&P tanks. The table below shows that as of that date there were 254 tanks in a critical state (marked in red) and 625 tanks in a semi critical state (orange) out of a total of 2042 tanks. 5 Excessive High Significant Low Considerably lower Highly unlikely Unlikely Likely Highly likely Possible With regard to Resolution 1460, the Company performed the criticality assessment on all of the pipelines covered by the regulation. The criticality matrix included below shows that 13 of them (36%) are in a critical state (red), which accounts for 412 km out of 961 km, that is to say, 50% of the existing pipelines. 5 Excessive 4 High 3 Significant 2 Low 1 Considerably lower Km 1 59 Km Km 0 0 Km Km 0 0 Km Km 0 0 Km 0 0 Km Km Km Km 0 0 Km 0 0 Km 2 11 Km Km 0 0 Km 0 0 Km 0 0 Km 0 0 Km Km 0 0 Km 0 0 Km 0 0 Km Highly unlikely Unlikely Likely Highly likely Possible

50 Based on this analysis made in 2011, the Company prepared an investment plan of about US$ 1.5 billion for the purpose of adapting the facilities with the profile shown in the table below, and which was entered in the Company s Resource Database, the main management tool for these kinds of actions. Evolution in investment in facilities Argentina Source: own, based on YPF data. 50

51 As shown, in 2012 the investments approved were approximately 50% lower than required. Given the above, we conclude that currently 54% of the tanks are not in optimum conditions for use, while 76% of the pipelines also require investments to make them meet the regulation s standards. In view of this, the Company is already working on the goal of minimizing the risks associated with this situation and restoring optimum operating conditions for the Company s Tanks and Pipelines. Evolution in Exploration As shown in the following graph, exploratory well drilling activities in Argentina dropped significantly in Although this abrupt fall in exploratory activity is partly explained by the significant drop in the WTI price of oil during 1999, it is evident that the activity never again regained a momentum similar to the one it enjoyed during the years prior to Repsol s administration, in spite of significantly higher oil prices. Drilled exploratory wells (Argentina Gross) Analyzing the graph in further detail, there are 3 distinct stages: Source: Form 20F The first one between 1993 and 1998, where the average number of exploratory wells drilled was 77 per year. A second stage followed between 1999 and 2004, in which the average dropped to 26 wells a year, which accounted for a 70% contraction in activity. 51

52 A third stage between 2005 and 2010 in which activity again dropped to an average of 13 wells drilled per year, leading to an 84% contraction with regard to the reference period ( ). Only 2011 shows a slight recovery in exploratory activity related mainly to the drilling of Vaca Muerta wells (Shale Oil), although the values reached continue to remain below the average activity carried out between 1999 and 2004 (see Section 3). If the fall in exploratory wells is analyzed from the point of view of the changes in the ratio between the investments in exploration and total investments in Exploration and Production (see graph below), no defined policy can be distinguished; rather, they seem to be random variations in terms of the efforts invested in exploration, which clearly shows the lack of a plan to incorporate replacement reserves from exploration activities. Analyzing the phenomenon on an accumulated level, the budget earmarked for exploration accounts for only 6.7% of the total budget intended for E&P, well below the values that previously enabled the reserve replacement and organic growth to be achieved. Furthermore, as already indicated in Section 1, Repsol favoured its international exploratory projects to the detriment of its projects in Argentina. Changes in the % of investment in exploration over the total Argentina budget Source: own, based on YPF data. A review of this information leaves no doubt as to the priorities set by Repsol in the different Annual Plans carried out in Argentina during the years in which it ran the Company, giving absolute priority to the monetization of the already discovered reserves over the incorporation of new volumes, thus reducing the risk investment that is typical of a healthy business practice in terms of the replacement of reserve volumes. Thus, the effects of low exploratory investment significantly 52

53 influenced the drop in YPF s reserves (which is shown further ahead in this section) and affected the future production profile of the Company. For these reasons, the Company is already working to ensure that this situation is reversed. Delay in the Secondary Recovery Projects The best practices in the development of the reserves of a field entail the use of coordinated techniques of primary recovery, secondary recovery and tertiary recovery. These recovery methods must begin as soon as possible so as to have an earlier response, to maximize the final recovery of the field s oil and gas and to optimize the use of surface facilities. Acting contrary to these basic practices of the oil and gas business, Repsol s policy was to favour the drilling of production wells with rapid payback, to the detriment of a balanced development and better recovery of reserve volumes. A way of illustrating this policy followed by Repsol is to study the following graph, which shows the change in the ratio between the injection and production wells on the western flank of Golfo San Jorge Basin (Las Heras). The change in this ratio could reach a maximum notional limit of 0.5 (2 production wells for each injection well) and a practical limit of between 0.3 and

54 Change in the ratio of injection wells/production wells Las Heras Source: own, based on YPF data. The ratio curve between both wells shows that starting in mid 1996 and through late 2000, there was a strong increase which was due to the mass implementation of new secondary recovery projects. Subsequently, this curve remained stable through late 2006, which evidences the change in policy by Repsol and a slowdown in the implementation of new secondary recovery projects, in spite of being far from developing the maximum secondary potential in the analyzed fields. By late 2006, there was a sharp drop in the ratio, which was the result of a pitiful maintenance policy that caused the loss of integrity in the injection wells and the shut down of approximately one third of them by the Department of Environmental Affairs of Santa Cruz. The subsequent recovery entails a slow recovery of the number of active injection wells and a fall in production wells. In another example, involving the Manantiales Behr area in the province of Chubut (see the graph below) the effort is observed to have been centered almost exclusively on the drilling of new wells, parallel to a delay or stagnation in the amount of injection wells. The number of wells in late 1999 was 187 production wells and 25 injection wells and in late 2011 they numbered 473 production wells and 59 injection wells. This shows that the production/injection ratio not only became stagnant, but it decreased over time, showing a preference in the development of primary projects above that of secondary ones, which are, basically, the projects that maintain baseline production in the long run. 54

55 Manantiales Behr Source: own, based on YPF data. The Production Potential of the Concessions When analyzing to what degree the production potential of the concessions controlled by Repsol reveals that, systematically, the plans carried out were below the reserve exhaustion profiles presented according to the affidavit to the Secretariat of Energy. This phenomenon is clearly evident in the following graph, which shows the changes over time of the different exhaustion profiles and the actual activity of the entire southern flank of the Golfo San Jorge Basin. It is evident that, as the years went by, the activity that was not carried out in prior years was postponed, mounting on subsequent years until in some cases it reached projected activity levels that are not compatible with the equipment available, the limit of the concession and the availability of other resources. This practice was aimed at incorporating volumes in the book of reserves, which the Company evidently had no intention whatsoever of developing. 55

56 SOUTHERN FLANK New Real Wells vs. Projected Y P F The Mosconi Report Repsol s strategy in the natural gas business in Argentina This section deals with the main guidelines related to the strategies adopted by Repsol with respect to natural gas exploration and exploitation and how they were modified over time, particularly with respect to the Neuquén basin, where the Company has the main natural gas production areas. The following graph compares the changes in natural gas production for YPF Operated Areas from 1999 through 2011 (Loma La Lata, El Portón, Rincón de los Sauces) and the changes in production for non YPF Operated Areas in the Neuquén basin (Aguada Pichana, Aguada San Roque and Lindero Atravesado), where the natural gas exploitation strategy is established by the operator of areas to which YPF is associated. 56

57 Neuquén basin Actual changes in gas production Operated and non operated areas (SEC volume) Y P F The Mosconi Report Source: own, based on YPF data. It is obvious that, while production in non operated areas has remained at an annual average production plateau from 20 to 23 Mm3/d as from 2001 (demand contraction peak due to the country s economic crisis), the production curve performance in Operated Areas has shown a pronounced reduction since 2004, considering a yearly average from 36 Mm3/d to 20 Mm3/d in 2011, with a net production loss representing a 45% fall in a 7 year term. After analyzing the physical activity in operated areas, the graph below shows an increase in activity between 2007 and 2008, decreasing abruptly from 39 drilled wells per year in to only 1 drilled well in This effort is closely related to the commitments assumed to perform contracts for the provision of gas to third parties under delivery or pay clauses, which were significantly reduced in 2009 and subsequent years, as shown in the second graph below. Summing up, upon expiration of the material delivery or pay commitments, the Company gave priority to the monetization of Bolivian gas reserves or to the sale of LNG over drilling and the development of fields operated in the country. 57

58 Neuquén basin Drilling activity Operated, non operated (SEC volume) Y P F The Mosconi Report Source: own, based on YPF data. Changes in gas sale contracts plus own consumption. Period Source: own, based on YPF data. 58

59 In contrast, if we observe the changes in the physical activity curve in Non operated Areas from 2008 to date, it is clear that there was quite a consistent activity comprising around 20 wells per year. Note that a good portion of this activity is related to the development of Gas Plus projects in the area of Main Aguada Pichana, Cañadón de la Zorra and Las Cárceles, where gas is sold at prices of up to 6.5 US$/MMBTU. The following graph shows the production of gas in Loma La Lata, El Portón and Rincón de los Sauces fields until late 2011 and its projection with no subsequent drilling, while the line shows the production forecast included in the 2008 Strategic Plan (2008 SP), as well as the drilling activity that sustained this increase in production. This increase was basically supported by the Tight Gas Lajas project designed to reach a sustained gas plateau of 5 Mm3/d. This project required a sale price of 6 US$/MMBTU, which is similar to that in other unconventional gas projects (Gas Plus) developed at the basin in order to be monetized. As observed in the graph, far from increasing, the actual activity performed in 2009, 2010 and 2011 decreased abruptly. It is obvious that the Tight Gas Lajas project ceased to be a development priority for the Company, which preferred to replace this project with the import of its own gas from Bolivia and LNG, since these types of businesses showed more profitability for Repsol in the short term. PE2008 forecast Expected and performed activity / Operated areas (SEC volume) Source: own, based on YPF data. 59

60 The following graph shows an annual comparison between incremental production volumes related to the projects that formed part of the 2008 Strategic Plan portfolio and the volumes provided by LNG vessels. This comparison shows that if the Tight Gas Lajas project had been developed, Repsol could have postponed the LNG project until 2011, which would have also implied an estimated saving of US$ 780 million for the Federal Government. This difference arises from the gap between the rate at which gas from the Tight Gas Lajas project would have been offered and that of the LNG project. PE2008 projects v. LNG project Source: own, based on YPF data. Summing up, the abovementioned arguments are sufficient proof of the total responsibility arising from the failure to develop unconventional gas fields since the Group focused on maximizing its short term profits, a strategy that in turn contradicted what had been implemented by the remaining operators in that basin. 60

61 Environmental management policy Oil and gas land deposits In order to evaluate Repsol s environmental management policy in YPF, the main obstacle found by the Comptrollership was the fact that there were upstream centralized data available only as from 2008 onwards, such data enables an analysis of the tendency of polluted (with hydrocarbons) land accumulations within repositories. The main contributions to repositories derive from land polluted by spills, land created from remediation if environmental liabilities and drilling cutting with oil based mud (the latter in the provinces that still allow such practice.) The following graph shows the changes in volume. According to preliminary calculations, generated accumulation implies a cost of about US$ 115 million for YPF (1,764,000 m3 x US$ 65), which should be invested for the treatment and final disposal thereof. Volume of O&G accumulated soil in repositories Source: MASC Upstream Monthly Report 61

62 Environmental management policy Spill frequency ratio Y P F The Mosconi Report This indicator, which has been measured since 2006, shows a decreasing trend until As from 2009, there was a significant increase in the number of spills, totalling over 4,500 spills in 2010 and 2011 and making a significant contribution to the increase in the volume of oil and gas soils in repositories. Source: MASC Upstream Monthly Report / Year 2012 comprises only until March NOTE: Spill frequency ratio = (Number of incidents comprising spills/ Gross volume produced + Injected water) x In addition, in the last six years the main identified reason for pipeline leakage is corrosion, which results from the lack of investment to replace pipes in poor condition or from flaws in managing the integrity of critical assets. 62

63 Percentage distribution of spill causes in December Year 2006 [GRÁFICO] Corrosion Operating errors Other Joint/connection failures Material failures Percentage distribution of spill causes in December Year

64 Percentage distribution of spill causes in December Year 2011 The following graph shows the actual investment in oil pipelines based on the annual investment plan and the total amount reported to the Secretariat of Energy pursuant to effective resolutions. The differences between both magnitudes speak for themselves. Source: own, based on YPF data. 64

65 Environmental management policy Upstream and downstream environmental issues and environmental liabilities Environmental issues are classified according to their magnitude, risk and management complexity as specific and general. Specific environmental issues amount to 76 and are grouped into 40 management projects. General environmental issues recorded total 1,426, out of which 1,353 are included in the probable or potential category. Exhibit 2 includes a classification by type of environmental issue, both specific and general. Distribution of environmental issues Source: own, based on YPF data. In addition, the total provision as of 03/31/2012 for environmental issues included in the relevant record is US$ 94 million (stated in US dollars at the average equivalent exchange rate of the year under analysis). The following chart shows the allocation booked as provision: Distribution of environmental issues booked as provision Source: own, based on YPF data. 65

66 The changes in amounts booked as provision shows that since 2007, when an amount of US$ 101 million was booked as provision, there was an annual increase until 2009 of US$ 117. As from 2010, the provision began to decrease up to US$ 94 million in Q The net balance resulting from decreases (disbursed amounts) and increases in the provision, is worth noting, as in the last three years the balance is negative, i.e. the provision is not increased, not even to maintain historical amounts. PROVISIONS (in US$ million) Initial Inflows Outflows Net flow Final Source: own, based on YPF data. From 2007 through 2010, there was significant systematic non compliance in annual scheduled disbursements, especially in period 2010, when 56% of expected amounts was not complied with. Amounts booked as provision, scheduled and executed by YPF (in US$ million) Source: own, based on YPF data. 66

67 Environmental management policy Overall commitments assumed with application authorities Situation in the province of Santa Cruz In March 2011, the Environmental Action Plan (PAMA) was submitted to application authorities in Santa Cruz, setting the following goals: Organizing the annual environmental management to be performed at the Santa Cruz Business Unit, based on a long term Strategic Environmental Plan. Promoting the enhancement/modification of methods and treatments implemented in environmental operations through the development of new techniques, improvement of existing techniques and coordination with research institutions. Creating a tool to provide application authorities with quick and specific answers to their requirements, as a result of proactive management. Serving as a basis and supplement for the compliance with and management of plans and programs required under Law No Allowing for the execution of works in a continuous and planned manner, anticipating and forecasting resource needs. Progress made as of 12/31/2011 in the different aspects of the plan is detailed in the following table (in thousands of Argentine pesos), showing 37% non compliance in the total amount, which is mainly related to environmental aspects (remediation, emergency pits, waste, water resources, and environmental studies and audits), 69% of which were not complied with. BREAKDOWN SANITATION EMERGENCY POOLS WASTE WATER RESOURCES ENVIRONMENTAL STUDIES AND AUDITS FACILITIES MAINTENANCE AND INTEGRITY TOTAL COMMITED AS OF 12/31/ , , , , , , , REAL ACCUM. TECHNICAL AMOUNT AS OF 12/31/ , , , , , , ,

68 Environmental management policy State of upstream fire prevention networks As part of internal audits, a survey was made in 23 facilities of upstream business units, which disclosed a series of deviations, especially in response times and in monitor failures, with water pollution in certain cases. In addition, deficiencies were found in water provision, the automatic switch on of emergency pumps and facilities coverage. For the purpose of their analysis, the failures observed were classified as follows: Water connection for another use / Insufficient water Monitor failures (lack, breakage, lack of reach, pollution) Problems with automatic switch on of pumps Staff, personal protective equipment, personal protection items, labor security conditions Lack of brigade members Water provision delays Uncovered facilities Lack of foam traceability Failure/lack of hydrant hoses The following graph shows the percentage allocation of failures according to audited facilities. This shows a significant deviation as to an essential aspect for the protection of assets and personal safety. It also represents a clear statutory non compliance. Exhibit 3 includes photographs in this regard. 68

69 Fire prevention network failures Source: own, based on YPF data. 69

70 Environmental management policy Well abandonment Until 2009, the well abandonment activity did not follow any defined methodology to determine its progress, while the pace at which new wells were drilled exceeded that of well abandonment, which increased the stock of wells to be abandoned. As from 2009, Repsol prepared a well abandonment plan that contemplated 2 scenarios: Scenario 1 Declining Profile, which implies: Abandonment of all wells whose decreasing production finishes before the end of the concession (2027); it is also assumed that all new wells drilled subsequently as from 2010 shall not be abandoned before the end of the concession. Argentina: 16,162 wells (Southern area: 11,133 wells / Western area: 5,029 wells.) Scenario 2 Abandonment of 100% of wells, which implies: Abandonment of all wells until the end of the concession (2027); it is also assumed that all new wells drilled subsequently as from 2010 shall not be abandoned before the end of the concession. Argentina: 21,187 wells (Southern area: 14,152 wells / Western area: 7,035 wells.) The plan carried out at present shows at least a 50% deviation with respect to estimates, tending to increase the deviation due to the use of resources in other activities. See graphs below: Changes in number of abandonment rigs Source: own, based on YPF data. 70

71 Changes in 2009 abandonment plan Y P F The Mosconi Report Source: own, based on YPF data. 71

72 Environmental management policy Photographs of spills 72

73 73 Y P F The Mosconi Report

74 74 Y P F The Mosconi Report

75 75 Y P F The Mosconi Report

76 76 Y P F The Mosconi Report

77 77 Y P F The Mosconi Report

78 Section 3 The Discovery of Vaca Muerta. The (Re)Sale of the Crown Jewels. Repsol-YPF s strategy for unconventional resources The Vaca Muerta formation extends over an area of about 30,000 km 2, in which Repsol YPF holds interests in about 12,000 km 2 (40% of the total area.) The first tests seemingly indicate that 77% of its area contains oil and the rest wet gas and dry gas. Repsol YPF has been working in a limited area of under 1,000 km 2, which is equal to only 8% of the area held by the Company. The Company hired Ryder Scott to perform an external audit that disclosed the following analysis of resources and reserves: Vaca Muerta resources and reserves, February 2012, in MBBL, MBOE and TCV Gross (100%) Net YPF Resource Type Oil Condensed Gas Total Condensed Oil (Mbbl) (Mbbl) (Mbbl) (Mboe) (Mboe) (Mbbl) Gas (Mboe) Total (Mboe) Prospective resources* 5, ,038 21,167 3, ,161 12,351 Contingent resources** 1, , ,213 3P reserves Possible Probable Proven Source: Ryder Scott 1 bep = 5,615,000 cubic feet of gas * Prospective resources: They include the oil and gas quantities that are potentially recoverable based on an accumulation for which preliminary data are available; however, no discovery wells have been drilled there yet. ** Contingent resources: They include the oil and gas quantities that are potentially recoverable based on a previous exploration activity that includes discoveries. These resources cannot be deemed commercial at the time of evaluation (i.e. they may be economically viable, but are subject to an exploitation permit, the application of certain technologies, etc.). Out of the 1,525 million barrels of oil equivalent MBOE (in an area of 1,100 km2 established by YPF), only 33 MBOE were deemed proven reserves, which are equivalent to 2% of the contingent resources and 0.16% of the prospective resources. In addition, YPF operated part of the field. As of December 31, 2011, over 700,000 BOE (barrels of oil equivalent) from the Vaca Muerta formation had been produced, which accounted for 2% of the proven reserves. This increase in shale oil production was also minimal with respect to daily production, as the maximum amount reached represented 0.5% of the domestic production. The following graph shows these changes. 78

79 Changes in shale oil production in Neuquén, , in m3/day Source: Mendiberry H. Valdez A., Giusiano A., Reservorios no convencionales. Cálculo de recursos. La visión desde la Provincia de Neuquén (Unconventional reservoirs. Calculation of resources. A vision from the Province of Neuquén). Oil and Gas and Energy Department of the Government of the Province of Neuquén. In a press release summit during February 2012, Repsol described that, for the purpose of this exploitation, it relied on the cooperation of leading companies in shale oil development in the United States, which decided to become associated with YPF in different areas for their exploration due to the expectations generated by Vaca Muerta. In addition, it stated that developing this project, including exploration, delineation and development start up phases, required over US$ 300 million. It also assessed that it would be required to carry out an investment plan of about US$ 28,000 million (gross at 100%) in the next few years to perform almost 2,000 oil production wells, for which 60 drilling rigs would be required, apart from those existing in the country. 79

80 The Company stated that this project would require international capital inflows into Argentina in the next few years as a source of financing for the huge economic resources required and it considered that this was an essential condition for a project of this magnitude. In this regard, certain media publicized the Company s search for alliances with oil companies in the United States, Europe, Russia and China. A brief history of Vaca Muerta Below is a breakdown of the significant announcements made by YPF S.A. with respect to Vaca Muerta: In early 2010, the Government of the Province of Neuquén announced the existence of unconventional gas in such province (equivalent to twice the quantity in Loma La Lata.) Almost simultaneously with the provincial government, in late 2009 YPF submitted its Production and Exploration Development Program. Following confirmation of the basin potential, YPF announced investments in the exploration of Vaca Muerta and the assessment of reserve levels. The Company highlighted the increase in the basin value as follows: YPF s strategy is being valued positively by international investors and has attracted increasing interest in markets, which generated significant transactions involving YPF securities in Wall Street, and in the current process to incorporate YPF into the Latibex index in the Madrid Stock Exchange 6. In late 2010, Repsol YPF and the Brazilian mining company, Vale, announced investments for US$ 5,000 million to develop unconventional gas in Neuquén, which would supply energy to the Río Colorado Potassium Project in Malargüe, Mendoza. Repsol continued performing exploration activities in the Vaca Muerta basin in Early that year, apart from the announcements regarding shale gas potential, it reported the discovery of technically recoverable shale oil resources equivalent to 150 million barrels of oil and identified potential tight gas resources in Loma La Lata. In late 2011, the Company confirmed a volume of recoverable resources of 927 million barrels of oil equivalent in unconventional oil and gas, out of which 741 million barrels were high quality crude oil barrels (40 45º API) and the remainder was associated gas, in a surface of 428 km 2 in Loma La Lata northern region, Province of Neuquén. It also announced that it would begin exploring another area in Vaca Muerta (502 km 2 ), the wells of which showed similar production and quality levels. At the same time, Repsol gained concessions to operate unconventional resources in the United States. 6 Repsol press release,

81 In early 2012, the Company entrusted Ryder Scott (an international company specialized in oil and gas reserve and resource certification) to perform an external audit of its unconventional reserves and contingent and prospective resources from the Vaca Muerta formation, located in certain concession areas of the Neuquén basin. The study performed by Ryder Scott comprised a total area of 8,071 km2, where YPF held a net acreage of 5,016 km 2 in the Neuquén basin (equivalent to 42% of the area granted under concession to the Company.) In February 2012, Ryder Scott s audit estimated, in a 1,100 km2 area, 1,115 MBBL oil contingent resources and 410 MBEP gas contingent resources, i.e. a total of 1.5 BBOE. With respect to YPF s share, these contingent resources would imply 883 MBBL of oil and 330 BBOE of gas, i.e. a total of 1.2 BBOE. As to current exploration and production, in late January 2012, YPF had drilled 28 new wells and had recompleted an existing well in Loma La Lata and Loma Campana blocks, thus advancing in its plan for delineation of unconventional resources in the Vaca Muerta formation. At present, 20 of these wells are producing through natural flow high quality crude oil. Based upon results, which were deemed positive by Repsol in view of the number of resources and their high quality (even exceeding those of shale resources in the United States, according to the study), the Company reported the continuity of field exploration and production in 2012 and considered that it would perform the activity on its own account in some cases and jointly with different partners in other cases. The facts described show that YPF s strategy in Vaca Muerta was only an announcement and did not reach the investment stage, since it only invested US$ 300 million to develop shale oil in Vaca Muerta, which is scarce when compared with the US$ 1,000 million US dollars that Repsol itself invested in unconventional fields in the United States 7. This delay in actual investment is due to the fact that the Company bet on a convergence between the internal price and the international price of hydrocarbons, while that it intended to obtain a favorable pricing signal for its interests. The first aspect that should be highlighted with respect to this alleged discovery by Repsol is that, from the beginning of the exploration in Loma La Lata in the 1960s, the Vaca Muerta formation was included in most drilling tests, which led to awareness of its oil and gas generating capacity, as well as the existence of oil and gas in such formation. In such basin, over 500 exploration wells were drilled up to Vaca Muerta formation. The Bajada del Palo.a 7 well is one of the best known precedents of oil production from VM, with over 25 years of continuous production that has accumulate over 700 KBBL of oil. 7 See de prensa/ultimas notas/ repsolproducira hidrocarburos no convencionales en eeuu.aspx 81

82 In the 1970s, the U.S. Energy Department began a series of studies (Shale Gas Project) for geological and geochemical characterization purposes, as well as engineering studies aimed at developing stimulation treatments. In the 1980s, when shale economic production began, the Gas Research Institute (GRI) evaluated gas potential to improve production in Devonian and Carboniferous shale formations in the United States. These technical advances explain why the development with horizontal wells, as well as the shale oil boom, is relatively recent, novelty also accounts for the relatively recent application of hydraulic fracturing massively to unconvential rocks, characterized by their low porosity and permeability. As already mentioned, in the local sphere, YPF began the analysis of source rocks from the unconventional perspective in Thus, in 2007 and 2008, geochemical and geological information on the main source rocks of the Argentine producting basins were collected. The data collection comprised information to determine mainly relevant ranges of organic richness and maturity levels, as well as thickness, area continuity and depth. Those parameters were useful to generate aranking and define the unit with more shale gas reservoir potential in Argentina. Thus, the Vaca Muerta formation was defined as the unit with most potential and entailing more interest in view of its geochemical characteristics, area distribution and depth. Therefore, in 2009, Repsol focused on maturity conditions of the units to define targets in YPF operated blocks within the gas window, as such fluid was initially the main goal of the project. With that clear goal, Repsol ellaborated three scenarios or blocks that had the maturity required to make a shale gas project viable. There were two defined interest blocks: Loma La Lata and Chihuido de la Sierra Negra. Based on thermal maturity conditions in Vaca Muerta, both fields thought to be within the wet gas window. In both cases, there are production facilities due existing production of oil and gas in those blocks. Still another block, Cerro Arena, was considered as being in the dry gas window and, in principle, it had optimum conditions for shale gas productivity. However, based upon project feasibility in the short term, Repsol considered that the best option was Loma La Lata due to the availability of gas treatment facilities that would favoured mainly evaluation, as well as a potential development as a result of proven overpressure conditions for Quintuco Vaca Muerta in that sphere. Once Loma La Lata was selected to begin the Shale Gas Pilot Project, two pilot projects were designed and focused on Shale Gas and Shale Oil, respectively, both of them with positive results. Based on these results, the exploration campaign that continued was clearly insufficient to realize the potential of the area, only 11 additional wells were drilled with the purpose of delineating a 428 Km2 area where a potential development would occur. Investment commitments are yet to be fulfilled. 82

83 YPF The Mosconi Report BASES ANTARTICAS ARGENTINAS Permanentes Temporarias Jubany Orcadas Esperanza Marambio San Martín Belgrano II Brown Primavera Decepción Melchior Matienzo Camara Petrel Thus, the explora on ac vity con nued in the rest of the basin for the sole purpose of of this, which led to the drilling and on of evalua ng the produc on wells to date. 12 expl 83