An Argentine province is doing its part to take the country further away from the debilitating crisis that peaked in 2002. Energy rich Neuquen plans to price this Wednesday a $125 million, eight-year transaction backed by oil royalties, the first deal collateralizing onshore Argentine assets to be sold abroad since the government's catastrophic devaluation of early 2002.

Apart from contending with lingering Argentine stigma, the transaction is also a sub-investment grade BB-' from Standard & Poor's, a point unlikely to endear it to traditional structured finance investors with a taste for higher-rated paper. But sole lead Citigroup has, over the last couple of years, been lead- and co-arranging paper from high yield Argentine names like brewery Cerveceria y Malteria Quilmes, Pan American Energy and Banco Hipotecario, indicating the bank knows where to go to place sub-investment grade paper from the country. The roadshow was in Europe and New York last week, according to a spokeswoman for the province.

Neuquen Finance Minister Claudio Silvestrini said that, "this is a good moment to go out and place a bond," given that there is appetite among "large investors and economic groups." Proceeds will finance infrastructure.

The deal certainly got a breeze in its sails when S&P raised the sovereign to B+' from B' on Oct. 2, an upgrade that tightened the yield on Argentine bonds. The Neuquen transaction had been rated B+' before the sovereign upgrade, and was elevated to BB-' with the roadshow having already begun.

Argentina is now at its highest S&P rating in five years. Galloping economic growth is feeding into tax revenues, which, in turn, are fattening budget surpluses for the government.

But not everything happening on the national level is a plus for Neuquen's deal. An energy crisis has bedeviled the country for some time and critics blame the government of Nestor Kirchner, which has tried to control energy prices and intervene in the energy market in other ways in order to keep a lid on inflation. That policy, critics say, has curbed investment in the sector. In its latest directive sure to enrage producers and free market economists, the government has required oil companies, including Repsol YPF and Petrobras, to import diesel fuels to cover shortages that have hurt farmers, according to news reports.

What all this means for Neuquen is that investors are likely to scrutinize any deals that have any whiff of Argentine energy. Indeed, in the case of Neuquen, S&P cites "a challenging institutional and regulatory environment, and disappointing reserve replacement performance in the past years due mainly to low investments." But the agency has stressed the structure for substantial reductions in the price and volume of the oil that is linked to the royalties being collateralized. In the most severe case, with oil at $20 a barrel, production sliding 3.5% per quarter, and the yield on the paper at 10%, the transaction would still perform, according to S&P.

The paper is backed by specified oil royalties, equal to 12% of the oil production value at the wellhead of three designated concession areas. The royalties are paid in pesos but are effectively tied to the U.S. dollar since oil prices are greenback-based. These concessioned areas contain the most significant energy fields in the province: El Trapial, worked by Chevron San Jorge, a unit of Chevron; Puesto Hernandez, operated by Petroleo Brasileiro (Petrobras), and Entre Lomas, worked by Petrolera Entre Lomas, a unit of Petrobras. The deposits total 45% of the proven oil reserves and 44% of oil output in Neuquen. The total annual production of these fields has oscillated between five million and slightly over six million cubic meters of oil from 1995 through 2004. It slid to below four million in 2005, a casualty of the high tariffs and inadequate investments from producers and concessionaires. So far, the gas production in the three designated areas is negligible and confined to Entre Lomas.

Salta deals performing

While Neuquen is breaking ground in a post-crisis Argentina, before the crisis bottomed out, at least two other provinces, Salta and Mendoza, backed transactions with energy royalties. Salta, in particular, is an interesting case, having avoided default throughout the crisis and improving the performance on its transaction over the past couple of years. S&P dunked its $234 million 11.5% 2015 to CCC-' in early January, after pesification gutted the flow from royalties. Since then, the agency has incrementally lifted the deal to B'. Moody's Investors Service, on the other hand, has kept the deal at Caa2' since a downgrade in July 2003.

"When Argentina entered into default, we opted to keep paying," said Gabriel Chiban, secretary of international finance for Salta. "We wanted investors to know that here is a province that will always pay."

Chiban added that the province might look to bring down the yield on the transaction by negotiating with existing bondholders within the rules of the structure. "We could pay it back, but the premium makes it uneconomical," he said.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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