Business, Finance & Economics

Venezuela's complex oil terrain


CARACAS — Earlier this month, on the same day that a law was passed sanctioning the nationalization of companies working in Venezuela that provide services to the oil industry, troops began seizing installations belonging to foreign firms on the oil-rich Lake Maracaibo in the west of the country.

As the national anthem played and workers clad in the revolutionary red of Hugo Chavez’s "Bolivarian Revolution" chanted his name, the president said the move was a triumph for Venezuelan sovereignty and socialism over capitalism.

“You are no longer going to be exploited,” Chavez told his supporters. “It was capitalism that exploited you for 12 years, 15 years, some of you for 20 years, without social security, exploiting the workers, exploiting the country and getting rich. Who? The bourgeoisie that had taken control of these services. Today we are taking them back.”

In mid-May, Venezuela’s state oil company Petroleoes de Venezuela (PDVSA) took over more companies operating in the east of the country, increasing the total number of nationalized companies to 74, said Rafael Ramirez, Venezuela’s oil minister and president of PDVSA.

The companies will be compensated at book value. Venezuelan law allows PDVSA to pay them with bonds rather than cash.

The expropriations mark a new chapter in the government’s hostility toward foreign investment. In 2007, a similar wave of nationalization swept across the country as Chavez ordered that Venezuela should have a majority stake in any venture in the country. Exxon Mobil and ConocoPhillips decided to abandon their multi-billion dollar stakes in oil projects rather than agree to the changes in their contracts, while Statoil, BP and Chevron acquiesced to the demands. Exxon and Conoco are still seeking compensation through an international arbitration process.

But Caracas is sending mixed messages to the oil industry. Late last year it launched its first oil bidding round since 2000. Some 19 companies have expressed interest in purchasing the rights to explore for oil in seven blocks of the Orinoco Belt in the east of the country.

Venezuela has so much oil that despite frequent changes in the rules of the game, international oil companies remain interested. By the end of last year, Venezuela’s proven oil reserves had swelled to 172.3 billion barrels. That figure meant that the South American nation leapfrogged Iran, Iraq, Kuwait and the United Arab Emirates in terms of proven reserves, making it level with Canada behind Saudi Arabia. Venezuelan officials believe the country may have between 260 and 300 billion barrels, which would make it the country with the greatest reserves of oil in the world.

“In terms of reserves, Venezuela is in the first league, not only because of their conventional reserves but more importantly because of the heavy crude oil,” said Roger Tissot, an analyst with Gas Energy Latin America. “There are only two huge sources of heavy crude in the world — the Canadian tar sands and Venezuela's Orinoco. It's much cheaper to develop from the Venezuelan Orinoco because of the technical conditions; the Canadian tar sands have to be mined."

But "what has made Venezuela's Orinoco expensive to develop," Tissot said, "is the policies and the politics."

If Venezuela is to exploit its abundant resources it needs investment from the capitalist oil companies it openly criticizes, said Piero Pitts, editor of the Caracas-based magazine Latin Petroleum.

The Carabobo fields will require four $5 billion upgraders to convert the extra heavy crude oil into a marketable commodity. Production costs are relatively low, but the initial outlay will be massive — about $10 billion for each of the three projects. In addition, Venezuela is demanding that partners finance the state oil company’s 60 percent share.

PDVSA does not appear to have the money to finance the projects alone. Despite record revenues of $134.6 billion and a healthy $12.5 billion profit in 2008, a preliminary version of PDVSA’s 2008 annual report revealed that the company owes $8.5 billion in tax payments and $13.9 billion to its providers.

The debts are signals of cash flow problems and partly explain the short-term motives for nationalizing the service industries, said Maikel Bello, an analyst at the Caracas-based financial consultancy firm Ecoanalitica.

After riding high for five years thanks to record oil prices, Venezuela’s gross domestic product shrunk to just 0.3 percent for the first quarter of this year. If prices don’t rally soon to at least $80 per barrel, Venezuela — which depends on oil for 90 percent of its exports and more than half the government’s budget — faces difficult times, Tissot said.

The long-term prospects are also reason for concern. Oil production appears to be in steady decline since an oil strike in 2003 that paralyzed the entire country. Chavez won the strike, but he also fired 12,000 of PDVSA’s 38,000-person staff, replacing them with workers who are loyal to his cause, but who lack experience.

Since then, PDVSA’s operations have been marked by a lack of transparency. In a first stab at accountability, PDVSA released production figures to OPEC which it allowed to be audited by an independent agent in London. The figures suggest that production is greater than the total claimed by the International Energy Agency, the U.S. State Department and OPEC itself. But at about 2.6 million barrels per day, production is still fall far below the 3.3 million barrels per day Venezuela claims to produce.

The figures also obfuscate the company’s true profitability. An estimated 917,000 of these barrels are sold on the internal market at a subsidized rate, according to the trade paper Oil Market Intelligence. The government is believed to be losing about $8 billion per year subsidizing Venezuelan gasoline consumption, which at 18 cents per gallon is the cheapest in the world.

Another 180,000 barrels are sold to allied countries in the region under the Petrocaribe scheme, which allows Caribbean countries to pay using a low interest 25-year credit system, further eating into PDVSA’s profits.

Venezuela’s best oil customer is also public enemy No. 1 here: the United States, which buys about half of the country’s oil at market price and, crucially, pays on time. Chavez has looked to diversify sales to other countries. Last month he visited China and signed an accord to increase sales to 1 million barrels per day from 380,000 by 2013.

Whether Venezuela will be able to increase its production to meet this demand will depend largely on whether it can persuade foreign investors to help it fulfill the enormous potential in the Orinoco Belt.

The French giant Total has already spoken about forming a consortium with the China National Petroleum Company, while a consortium of Russian companies are believed to be toying with the idea. U.S.-based Chevron, which has managed to maintain amicable relations with Chavez’s government, is also believed to be interested.

But the sticking point will likely how confident these companies feel that Venezuela will honor their contracts and not change the rules of the game.

A recent report by the Economist Intelligence Unit ranked Venezuela 81 out of 82 countries in terms of a welcome environment for foreign investment. So why would international companies bother with the Caracobo bidding round, considering the risks? Venezuela’s potential is simply too great, Pitts said.

“If you look at this long term, then companies will be thinking, ‘Let's get in for whatever the price it might take and be there, letting the government do whatever they want to do,’” he said. “They will take a back seat, throw in whatever money is needed and hope that in the future Venezuela reverts to them to help them run these operations.”

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