March 2007

Oil and gas in the Capitals

Chavez and the oil companies arm-wrestle over Venezuelan investments

Vol. 228 No.  3
Oil and Gas

May Day. Oil majors and stock investors are looking at May 1st nervously, since the Venezuelan government has set this date as the deadline for major oil companies to renegotiate contracts in the Orinoco basin. In early February, the Venezuelan legislature gave President Hugo Chávez long-expected special powers to rule by decree over the next year-and-a-half. This will enable Chávez to pass decrees on key sectors, such as banking, defense, energy, insurance, media and telecommunications.

In the oil sector, Petróleos de Venezuela, PdVSA, would like to increase its stake to 60% in the four major Orinoco projects from its current holdings of 30-49.9%. If BP, Chevron, ConocoPhilips, ExxonMobil or Statoil refuse to renegotiate, or if their terms are unacceptable to the Venezuelan government, these companies fear that their stakes might be nationalized outright. Their fears are not unfounded, given recent statements by Minister of Oil Rafael Ramírez that foreign companies would have their fields seized, if they miss the May 1st deadline. President Chávez has long argued that the Orinoco contracts were negotiated unfairly. Undeniably, in the last few years, he has taken advantage of a high oil price environment to assert his influence, not only in the Americas, but also globally. Before the ascendancy of China and India, the Venezuelan government was hesitant to create tension with the US, its largest buyer of oil. Now, however, Chávez is increasingly more confident that India and, in particular, China could become large consumers of Venezuelan oil.

 Investment status. The oil companies’ agenda is to stay in Venezuela, even if that means renegotiating the contracts. Not only have they already invested about $17 billion in the Orinoco, they also have sunk funds into derricks, facilities, fields and pipelines that collectively are estimated to now be worth over $30 billion. Moreover, the oil majors do not want to walk away from what some industry experts believe could be the largest
oil reserves in the world. If estimates prove to be correct, the Orinoco Belt may hold as much as 270 billion bbl of oil. Operators have limited access to other reserves around the world, so Venezuela will continue to hold interest.

A significant point of debate is whether a potential decrease in Western
foreign investment could negatively impact Venezuelan oil production, as it already has in Ecuador. Yet, Venezuela has been actively courting other partners outside the West. China’s voracious appetite could help counter any decrease in Western investment. Already, China said that it would invest $5 billion in the Venezuelan oil sector. China and Brazil have teamed up to build a refinery; Brazil has already spent about $190 million in Venezuela’s energy sector. Additionally, Venezuela has worked with Iran, possibly to build a refinery in Nigeria. With Russia, PdVSA is working on drilling the Orinoco basin to assess reserve levels.

TABLE 1. Venezuelan Orinoco Projects
Table 1

Irrespective of what other countries may have invested or promised to invest, and despite significant tension between the US and Chávez, Venezuela is unlikely
to expel Western firms. The funds that Western companies have invested far outweigh what China, Iran or Russia have invested. Additionally, even if Iran, China or Russia is interested in reducing US hegemony, these countries would not see Western contracts being revoked as boding well for any of their contracts.

Practical considerations are also key. The US is still Venezuela’s largest oil buyer.
Additionally, it certainly takes a lot less time to ship oil to the US than the weeks that it takes to ship to China. Also, unlike the US, China presently does not have the refineries to handle Venezuela oil’s high sulphur content.

Potential challenges for Chávez can already be seen in oil and gas, and in his country’s exchange rate regime. It is important to remember that in 2003, 19,000 workers with technical know-how were fired from PdVSA, due to their opposition to Chávez. Also, according to the US Energy Information Administration, PdVSA spends twice as much on education and health programs domestically, and subsidized oil for foreign nations,
than on developing Venezuelan fields. Loss of key workers and neglect of fields mean that Venezuela still depends on technology and skills from Western companies to develop its fields.

Moreover, the government earlier this year hiked gas prices to raise desperately
needed funds for state coffers. This is targeted principally toward Chávez’s recent largesse for his multiple social and political causes, particularly in Cuba and even in the US. Venezuelans have long been accustomed to receiving very subsidized gasoline. Given recent declines in oil prices, there was also talk that prices for domestic crude usage may have to be raised.

If gasoline and other oil usage prices continue rising, Chávez might have significant
social discontent on his hands. In 1989, the removal of fuel subsidies sparked riots in Caracas and helped lead to former President Carlos Andres Perez’s downfall. Administrations since Perez have asked PdVSA to sell oil domestically
at heavily subsidized rates, even at a loss for the company.

The government continues to be under significant pressure, since officials have not been able to reduce poverty. Funds being directed abroad rather than domestically are fueling discontent among the citizens. Even the objective for nationalization of the telecommunications and electricity sectors is to raise funds for the government. Negative investor sentiment and tightening exchange rate controls make it likely that Venezuela could be forced to devalue the bolívar. If that happens, capital flight and social discontent
would intensify, putting further pressure on the oil sector. WO

 Mayra Rodríguez Valladares heads MRV Associates, ( a New York-based international management consultancy. She is a regular contributor to this column.

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