Argentine provinces are geographically well placed to contribute to and benefit from the global energy transition process. Provinces in the northwest (Salta, Jujuy, and Catamarca) account for 21% of global lithium reserves, while southern Neuquén and potentially neighbor provinces of Rio Negro and Mendoza benefit from the development of Vaca Muerta, the world's second-largest shale gas reserves in the world. Moreover, there are numerous public and private renewable energy projects. In the northwest, provinces have been expanding their solar energy supply, while in the south, provinces are adding wind energy to the national grid.

We do not expect direct revenue from these resources to be a game changer for provincial finances, and we broadly expect ratings to remain stable. Their direct contribution will be limited by the scale of the projects and relatively low royalty rates for mining--3% of the pithead value for mining for existing projects and 5% for those initiated after the recently approved national Ley Bases (law 27,742). This contrasts with the hydrocarbon royalty rate of 12% of production value.

That said, their development could somewhat lessen reliance on national government transfers and support diversification and further development of the local economy and employment. Well managed, natural resources could help finance the closing of some infrastructure gaps and address social needs.

The overall creditworthiness of the provinces of Argentina reflects various factors, such as the system's institutional framework and predictability, the quality of the provincial management, fiscal performance, liquidity, and capacity to tap different funding sources, as well as their debt burden.

Macroeconomic volatility has led to generally limited planning capacity and pressures on fiscal outcomes for Argentine provinces that, in the current context of lack of market access, underscore vulnerabilities despite low to moderate debt levels. Provinces also rely on access to central bank reserves because most debt is in foreign currency, which means that the country's external liquidity woes also limit our ratings on local governments.

Natural Resources Have Enabled Market Access, But Repaying Debts To Finance These Projects Has Mixed Success

Neuquén's natural gas royalties have facilitated its market access in recent years.   Natural gas and oil royalties represent 35% of Neuquén's total revenues and enabled the province to issue US$100 million of debt in 2023 in the domestic market--while it was closed to many provinces for such high amounts vis-à-vis provincial revenue and in foreign currency. The province expects natural gas production to double by 2030, which could mean that roughly half of revenues could over time be linked to the U.S. dollar, increasing its natural hedge for U.S. dollar debt. Neuquén did restructure a secured bond (backed by royalties) in 2020, amid weak liquidity and financing options and when essentially all other provinces also defaulted and restructured their debt. However, the market seems to value the Neuquén story and prospects of oil and gas despite its track record of fragile finances. As long as Neuquén takes advantage of this broader set of financial options while avoiding significant fiscal slippage, this could improve its capacity to repay its commercial debt in the future.

In the past, favorable market conditions facilitated provincial access to global capital markets to finance renewable energy--but also traditional infrastructure projects.   In 2017, several provinces tapped international markets for the first time after the sovereign cured its default and accessed external markets. Among these, the provincial Cauchari solar farm in Jujuy and the Parque Arauco wind farm in La Rioja were designed to generate hard currency revenue that provided a partial hedge for their debt service. Nevertheless, the 2020 economic recession, delays in construction, and an inability to tap global markets while the sovereign negotiated its own debt restructuring forced the provinces into a broad-based restructuring of their global bonds in 2020--despite some natural resource backing. After project delays, Jujuy started to receive around US$48 million in annual cash flows in 2021, which enabled it to expand the project, adding solar generation capacity, and partially cover debt service. In contrast, delays in La Rioja wind farm production postponed cash flow generation to 2024. The mismatch, along with several other factors, led to a default on the green bond in February 2024. These cash flows contribute to debt service coverage, but overall capacity to repay the bonds ultimately depends on other factors such as fiscal performance, liquidity management, and market access.

Energy Investments Could Improve Fiscal Autonomy

Royalties reduce reliance on federal transfers, notwithstanding increased exposure to commodity price and exchange rate swings.   The provinces with longstanding natural resources have benefited from higher own-source revenues. This has helped reduce the exposure to federal transfers, which are subject to changes in the national government's taxation decisions. In Neuquén, for instance, roughly 80% of revenue generation is own source, somewhat insulating it from adverse measures taken at the national level such as the reduction in the taxes contributing with coparticipation (and discretionary transfers) in 2023-2024. In contrast, La Rioja, with less than 15% of own-source revenues, defaulted on its global bond for the second time in February 2024, given heightened pressure on its fiscal accounts.

Lithium and renewable energy are emerging as an alternative revenue stream for provinces that have been historically dependent on national government transfers.   At present, in Salta and Jujuy, hydrocarbon royalties are well below 1% of operating revenues. However, Salta's emerging lithium sector, with production planned to start in late 2025, will support the province's revenues. Despite Jujuy's two active lithium projects, their revenues are incipient. Besides generally low royalties, associated revenue generation includes ad valorem and fixed fees, and land concessions, supporting the revenue base. At the same time, province-financed renewable energy projects have contracts in U.S. dollars and provide cash flows that we expect to represent 4.5% of revenue in Jujuy and 3.5% of revenue in La Rioja by 2026.

Royalties Are Set To Increase

Generally stable national tax regulation for mining has favored the development of large-scale energy investment in a context of high uncertainty, but it limits local governments' flexibility to change rates.   Per the national constitution, natural resources belong to the provinces. However, for some resources, the regulatory framework is set at the national level. Recent national mining legislation has raised royalties to 5% from 3% of the pithead value of the extracted mineral for the projects initiated after the law's approval. More specifically, the means to collect more revenues from the mining sector could only be the result of the individual negotiation between the province and the companies operating in the sector. In contrast, for oil and gas, royalties are higher at 12% of the production value, potentially more lucrative for the provinces.

Provinces have become more pragmatic toward mining considering potential benefits to their local economy.   However, in some places, local regulation and communities could limit mining potential and, with it, related own-resource revenue generation. Even though the majority of the provinces allow mining extraction, in the case of resource-rich La Rioja, mining activities are effectively limited by restrictions on water usage set in the provincial constitution and by local communities' resistance to extractive activities.

Energy Resources Could Bolster Socioeconomic Profiles

The major benefit from lithium, natural gas, and renewables may come more from development of regional economies rather than direct fiscal collection itself in the near term.   Even though the small scale, specialized skills and investment needs somewhat limit the development of manufacturing in the lithium sector, the supply of related services benefits the surrounding communities. Salta and Jujuy have developed a formal registry for local services providers. This could reduce informality, which on average accounts for 61% of the provincial workforce.

Renewable energy and lithium resources could help diversify reliance on public employment.  Lithium investments are significant compared with the size of the local economies where they are developed and raise the prospect of economic diversification. Given limited private investment opportunities in some provinces, the public sector has driven local economies and employment. Historically, the public sector has been a significant employer in the Northern region, where it contributes to almost half of the registered workforce, compared with the 39% Argentine average. The view of the public sector as a key employment generator puts a lot of pressure into provincial finances and leads to low productivity and salaries.

In 2021, Neuquén's real GDP increased by 27%, well above the national average. The natural gas sector has already bolstered Neuquén's growth. Well managed, the growth could potentially strengthen the provincial socioeconomic profile, with local GDP per capita already doubling that of the sovereign.

Natural resources won't improve provinces' creditworthiness by themselves, but provinces favored by their availability could take advantage of those resources to gradually increase fiscal autonomy, widen funding options, and accelerate their economic development.   Nevertheless, individual financial management capabilities to manage those potentially volatile resources appropriately and build resiliency are needed for those benefits to materialize and ultimately improve provincial credit quality. This would have to be coupled with an improvement in Argentina's macroeconomic and external profile, as well as higher certainty on market access.