Venezuela: Risky oil partnerships

FROM THE ECONOMIST INTELLIGENCE UNIT

Against a backdrop of the continued decline in Venezuela’s oil production and investment in the energy sector, the government is welcoming back foreign oil majors. However, the companies’ willingness to partner again with the government required the offering of several concessions ahead of a bidding process concluded in February. Even so, there are still risks: officials could yet backtrack on the terms, and the preliminary agreements announced might not translate into final contracts.

In mid-February auctioned stakes in the Carabobo field, part of the vast Orinoco region that is believed to contain the largest untapped oil reserves in the world. The authorities awarded exploratory rights to two groups of international consortia, headed by Spanish firm Repsol and Chevron (US), for Blocks I and III respectively in the Carabobo field. Both of these firms are already involved in existing extra-heavy crude projects, which is significant as it had appeared that these companies would be less welcome as investment partners following the nationalisation of the industry in 2007.

Just days before the Carabobo auction, a Russian consortium of Gazprom, Lukoil, TNK-BP and Rosneft, sealed a deal for a 40% stake in the nearby Junin-6 block for US$600m. Similarly, Eni (Italy) offered US$650m to partner with PDVSA in the neighbouring Junin-5 block. Although the government offered significant concessions in advance of the Carabobo auction, it appears that both sides remain far from reaching final deals, and government backtracking on some issues could preclude firm agreements.

Ambitious goals

According to the authorities, the auctioned Carabobo fields will result in 400,000 b/d of extra-heavy oil coming on stream by 2013, with the projects reaching their full potential after 2017, when two large upgrading facilities will be built to process a combined 800,000 b/d of bitumen into lighter “synthetic crude” that can be refined at standard refineries. Each of the upgraders will require investment of some US$12bn and, overall, each of the projects could cost as much as US$20bn to complete.

In line with government’s 2007 nationalisation of the oil sector, the auctions mandate a majority role (60%) for the state oil company, Petróleos de Venezuela (PDVSA), with private-sector partners holding minority stakes. The government got the private companies to agree that they would invest sufficient funds to raise recovery rates from the extra-heavy fields from the single-digit levels of existing Orinoco Tar Belt projects to closer to 20%, through the use of steam re-injection.

Government sweetens the deals

Yet the government had to offer important concessions of its own to secure the oil majors’ finance and expertise. Some of these are technical in nature, such as the decision to extend the period until 2017 when they will be permitted to export tar in blended rather than upgraded form, to help generate cash-flow while the synthetic crude upgraders are built. The government also relaxed what were seen as largely unrealistic timelines for the construction of the upgraders, and spaced out the period for the payment of the signing fee.

Many of the concessions involve more politically sensitive measures. Most importantly, the authorities have included an international arbitration clause in the preliminary agreements. President Hugo Chávez has repeatedly denounced such clauses as mechanisms for exploitation, but the inclusion of these provisions represent an acknowledgement that foreign oil companies—whether multinationals or state-owned—are unlikely to invest substantial sums without recourse to an international adjudicator, particularly given Venezuela’s weak contractual framework. During the auction process, bidders also made it clear that it would be impossible to raise project finance by issuing bonds without an international arbitration clause to reassure potential investors.

There were several other concessions on the part of the government, including exemption from the oil-sector windfall profits tax (which currently stands at 50% of extra earnings when oil prices rise above US$80/b and 60% when prices rise above US$100/b) and a lower royalty rate (20% of the gross value of oil drilled, rather than the usual rate of 33%). This is likely to reflect the high cost of exploiting the extra-heavy fields. The preliminary agreement would also allow the private-sector firms to book their share of the reserves as oil assets: a symbolically loaded concession implicitly acknowledging foreign ownership of Venezuelan oil reserves.

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Marriage of convenience

Rather than representing a genuine shift towards a more welcoming policy to foreign investors, recent energy agreements have been forced onto an ideologically hostile government by the sheer need to generate cash to finance public spending. They also represent an official recognition that PDVSA lacks the technical capacity and the ability to raise capital on the scale needed to exploit Venezuela’s oil reserves.

The strains generated by this marriage of convenience are already evident: even after painstaking negotiations, the auction process was only partially successful, with block 2 in the Carabobo field receiving no bids. This reflects the reality that even including the arbitration clause, the political and economic backdrop raises significant risks for foreign oil companies. There is virtually zero exploration risk involved in the project; the block is located in the heart of what the US Geological Survey has recently certified as the area with the largest oil reserves in the world. Yet the failure to secure partners for its development demonstrates the scale of investors’ misgivings.

In addition, there is growing uncertainty about whether the preliminary agreements made after the auction will translate into final contract terms. It appears that there has been some backtracking already, related to operational control and the scope for international arbitration. Given the government’s poor track record in terms of respecting contractual rights, there is a risk that the initial concessions may be rolled back. This raises the possibility that some of the international companies involved in the initial bid might pull out.

If they remain, Repsol and Chevron will be counting on their long experience in the country, their deep webs of personal connections at PDVSA and the energy ministry, as well as on the government’s need for investment dollars. To date, both firms have been careful to bid as lead partners in consortia in order to share the risk with other companies. Repsol, while contributing most of the management and technical expertise on Carabobo-1, has only an 11% share, the same as Malaysia’s state-owned Petronas and ONGC of India. (Two state owned Indian firms account for the remaining 7%). Chevron has a 34% stake in Carabobo-3, with two Japanese firms taking up 5% of the project and a private Venezuelan firm, Suelopetrol, accounting for the remaining 1%). Suelopetrol is the first private Venezuelan firm to be allowed outright ownership of underground oil deposits in Venezuela in 75 years.