VENEZUELA: Doubts over oil policy raise risk premium

Por Venezuela Real - 18 de Septiembre, 2006, 14:32, Categoría: Petróleo/Energía

Oxford Analytic
June 15, 2006

SUBJECT: Uncertainties in the Venezuelan oil industry.

SIGNIFICANCE: Venezuela is the world's fifth largest oil exporter, with the largest OPEC reserves outside the Middle East, while a high-profile president and high oil prices keep the country in the news. Much of the reporting reveals strong views about the administration of President Hugo Chavez, which extends into reportage about the oil industry.

ANALYSIS: A number of factors contribute to the high degree of uncertainty within the Venezuelan oil industry:
1.    Oil production. Oil has always been a highly political subject, and governments and other organisations around the world have from time to time used data to match their political agendas. Recent history explains why the Venezuelan picture is especially complicated. Crude oil production numbers became highly politicised in late 2002 during the strike at state oil company PDVSA, when opponents of President Hugo Chavez sought to talk them down -- to emphasise the effectiveness of the strike -- while the pro-Chavez camp looked to talk them up to show that the strike was not succeeding. This debate continues, with the antagonists tabling a confusing range of numbers:

  • Although current production levels are uncertain, according to the BP Statistical Review, the figure for 2005 was just over 3 million barrels per day (b/d). This compares with just under 3.0 million b/d for 2004 , itself down from a peak of 3.51 million in 1998. Assuming just below 600,000 b/d of synthetic crude (from extra heavy oil upgrading), this suggests production of 2.4 million b/d of conventional oil (including orimulsion and natural gas liquids (NGLs)) by PDVSA and foreign oil companies.
  • Other views indicate that total crude production is 2.6 million b/d, of which PDVSA produces 1.3 million (including synthetic crude) and foreign-operated fields another 1.3 million.
  • These two sets of numbers are difficult to rationalise, although orimulsion and NGLs may account for some of the difference. In any case, the judgement of what to include or exclude in any stated total production number may be driven by the politics of the communicator in question.
Underlying this debate is the fact that production from conventional oil fields reaches a plateau (often just for a few years), and then declines. Managing the decline requires experience and skill, and improved reservoir management and new technology can be applied to reduce the rate of decline -- ie to produce more oil economically for a longer period -- which requires continuing investment. PDVSA's critics claim that this is not happening within their operations at the rate required to maintain -- let alone increase -- production.

2.    Reserves. Estimates of the amount of recoverable oil in the ground change, in part as technology changes. Reserves deplete but secondary recovery and other technological developments mean that recovery rates have increased significantly over time. There are arcane rules governing the formal booking of reserves (SEC, UK SORP), while, linked to this, actual booking of reserves (a key determinant of oil company value) should not take place until this oil/gas can be brought into commercial production. However, countries often choose not to be bound by SEC rules, and enjoy the freedom to follow a more relaxed approach when talking about reserves.

In the case of Venezuela, an additional factor is the extra heavy oil in the Orinoco Belt. There are four existing heavy oil upgrading joint ventures (strategic associations) in operation producing just under 600,000 b/d. Chavez recently declared that Venezuela has larger oil reserves than Saudi Arabia. Based on US Department of Energy data, PDVSA claims total reserves of 270 billion barrels -- 240 billion of extra heavy oil and 30 billion of conventional crude. Since it is reasonable to include this heavy oil production in total production figures (as long as these figures are clearly identified to avoid misunderstandings), it would also seem reasonable to book a related portion of the extra heavy oil as reserves. However, this is not yet reflected in OPEC's reserves data for Venezuela.

If further upgrading investment is undertaken, Venezuela should (subject to funding, engineering and logistical constraints) be able to increase its oil production very considerably. It has talked about total crude production of 5.8 million b/d by 2012. If this is to be achieved, most of the increase will have to come from extra heavy oil upgrading.
3.    OPEC. Venezuela's international oil policy and its role within OPEC is another area of uncertainty. Venezuela feels proprietorial regarding OPEC, as a founder member and a major player. Further, after Chavez came to power in 2000, Venezuela and Saudi Arabia decided to implement production cuts in order to increase crude oil prices.

Oil prices are at or around record levels owing to strong global growth and constrained supply (see INTERNATIONAL: Demand concerns hamper oil investments - March 22, 2006). Nevertheless, Venezuela is urging production cuts -- attracting the accusation that it wants this because because it is struggling to maintain its own production levels. However, while OPEC has enjoyed the fruits of higher prices, it does not want to be accused of plunging the world into a major economic recession. At its recent meeting in Caracas, OPEC recently elected not to cut production, despite the host's urging.

4.    Contract and fiscal terms. Venezuela introduced a new hydrocarbons law in 2001 (see VENEZUELA: Oil bill threatens future investment - September 5, 2001). The government's view is that the 'Apertura Petrolera' of the early 1990s, which welcomed the international industry for the first time since 1975, circumvented the constitution and was therefore illegal. The next logical step was to bring all relevant contractual arrangements into line with the new law:
  • Foreign operators (of the 32 mostly so-called marginal fields) were told last year that their Operating Service Agreements, negotiated in good faith by these companies and the then government, were "illegal" (see VENEZUELA: PDVSA takes control of oil operations - January 11, 2006). They were asked to accept new agreements, joint ventures in which PDVSA took the majority equity stake (60%, above the 51% stipulated by the law), board control, 30% royalty and 67% tax rates.
  • A combination of the controversial nature of the law and issues of clarity, consistency and effective communications surrounding this process have resulted in a loss of trust and damaged relationships within the Venezuelan oil industry.
  • In addition, in May the National Assembly raised royalties on the four extra heavy Orinoco crude projects from 16.6% to 33.3%.

Outlook. Despite these developments, if it is accepted that events to date could be characterised as an exercise in 'clearing the decks' -- albeit a clumsy one -- it is possible to take a positive view of the future of the industry in Venezuela. However, PDVSA and the government will need to grasp the opportunity to adopt a more conciliatory and constructive approach in the way in which they engage with their international partners, and doubts remain over future changes to contract terms and taxation. These changes in contractual arrangements are profound. Previously, operating agreements were managed by foreign partners who employed staff and operated assets in line with their international standards. Operational staff now face huge uncertainty, affecting motivation and heightening operating risks.

CONCLUSION: Despite the attractiveness of Venezuela's resource base, the oil industry faces a range of uncertainties. These include the obvious reluctance of international oil companies to invest further until the rules of the game are clearer and being followed, as well as the fact that available data may be insufficient to manage risk effectively. Uncertainty creates a risk premium, and Venezuela may eventually have to pay this cost.

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