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Chávez triumphant

Foreign oil companies that invested over $10bn in 32 field-operating contracts in the country during the apertura petrolera have meekly acquiesced to the forced migration to tough new terms. The next target could be four massive synthetic-oil projects, as Venezuela tightens its grip on the oil and gas sector, writes Robert Olson

AFTER A YEAR of turmoil, the government has battered its partners in 32 oilfield-operating contracts into abandoning the Operating Service Agreements (OSAs) that governed their relationship with the government and the state-owned oil company, PdV. They must now form new joint ventures with PdV to operate the fields.

Despite the terms of the proposed joint ventures being far from clear, the companies – with the notable exception of ExxonMobil – agreed to abandon the OSAs at the end of 2005 and to enter legal limbo while they negotiated the final terms of the new deal. That the companies that began the year vowing not to give up their contracts have fallen into line with the government, with almost no protest, speaks volumes about the balance of power between governments and their national oil companies (NOCs), and international investors.

Of course, such power is largely restricted to governments that control access to huge oil reserves, such as those of Venezuela. In most countries, companies would hardly even consider becoming minority partners with an NOC in a joint venture required to hand over a minimum of half of its revenues to the state without any consideration of the cost of production. But in Caracas, the bosses of the foreign oil companies see it as the cost of merely holding onto the possibility of expanding their operations in the future.

Whether the Venezuelan government sees things this way is another question. Investment plans have taken a sharp turn away from market-oriented projects towards those that fit with the government's foreign-policy objectives and there is less and less room in publicly available business-plan documents for the private sector. Even in the Orinoco extra-heavy oil (EHO) belt, where the majors once felt they were indispensable providers of technologies and markets, PdV now speaks of partnerships with NOCs from political allies, operated with technology purchased off the shelf.

Completing the transition
For now, the government is focusing on completing the transition from the OSA scheme to new mixed companies. As negotiations stand, PdV will hold 51-70% of the equity in the joint ventures that will take-over fields operated by the OSA operator, with the OSA operator and its partners holding the remaining equity. The mixed company will be governed by the rules of the 2001 Hydrocarbons Law, which stipulates a minimum 30% royalty rate and majority shareholding for the state. Mixed companies will also be subject to Venezuela's special income-tax laws for oil companies that call for 50% of net profits to be handed over to the state.

Under the latest version of the mixed-company contract offered by the government, an additional 3.33% royalty must be paid in addition to the base 30% royalty rate set forth in the law. It also stipulates that all combined tax and royalty payments to the state must be at least half of all revenue generated by the mixed company. In the event that these payments do not reach this level, the mixed company will have to hand over as much cash as necessary to make up the difference. While at present oil-price levels this rule is unlikely to undermine the financial health of the new joint ventures, things could be different if prices were to dip.

Until December, there was no move by investors in the old OSA contracts to sell their assets. Instead, the operators of all 32 OSAs signed the so-called transitional agreement required by the government as a first step towards making the transition to the new mixed companies. Under the agreement, OSA investors essentially agreed to give up their contracts in return for as-yet-undefined stakes in the mixed companies.

Questionable legal status
Despite the vague nature of the agreement and the questionable legal status under which the fields would be operated while the creation of the mixed company was negotiated, every firm operating in Venezuela signed the deal by the government's 31 December deadline – with one exception. ExxonMobil, the minority shareholder in the Quiamare-La Ceiba OSA, had been blocking the signing of a transitional agreement for the field. The field's operator Repsol-YPF ultimately had to agree to buy out ExxonMobil before the transitional agreement could be signed.

However, there is now more talk of investors selling out. Among the most recent developments is the decision by PdV to seek mergers between some of the 32 mixed companies that will be created in order to cut overhead costs. While in some cases this would make sense – Repsol YPF operates four fields that will be migrated, which could easily be folded into a single joint venture – other investors are concerned that their already weakened influence over the mixed company's operations will be further diluted by being forced into partnerships with firms whose interests may not be aligned with theirs.

Moreover, there is a growing conviction among investors in Venezuela that while the opportunity to secure access to the country's reserves is still worth the trouble, only large companies with geographically diverse portfolios will be able to weather future surprises. Small companies in particular, such as US independent Harvest Natural Resources, have seen their share prices buffeted by news from Venezuela. But even large firms have felt exposed. ConocoPhillips' nearly $36bn acquisition of US gas producer Burlington Resources was said to be motivated, at least in part, by a desire to rebalance its upstream portfolio, which is heavily tilted towards Venezuela, where 10% of the company's upstream capital is invested.

If this is indeed part of the US major's motivation, it may well be a well-timed move. There is considerable speculation that the government will now turn its attention to the four EHO strategic associations that together produce 0.58m barrels a day (b/d) of synthetic crude, two of which are operated by ConocoPhillips. When conceived in the 1990s, the foreign companies that backed the projects were offered special tax and royalty terms to ensure their profitability. But with oil prices far in excess of even the most optimist forecasts used when designing the ventures, the projects are producing an embarrassment of riches.

The Venezuelan government is all too aware of this. Its first move came in October 2004, when President Hugo Chávez announced the premature end of a royalty holiday that saw the ventures paying only 1% royalties on production. Royalty rates were immediately raised to 16.67% – the rate that had been in place when the ventures were formed – but otherwise the tax treatment of the ventures has remained unchanged. Since then, the government has indicated it plans to amend the Income Tax Law to revoke the clause that grants EHO producers relief from the 50% special income tax on oil companies.

These two changes provoked little opposition from the operators other than ExxonMobil's announcement that it was reserving the right to seek international arbitration over the royalty increase at a future date. Once again, future access to Venezuelan reserves was the main factor behind keeping the operators quiet, as well as the higher-than-expected oil prices of the last five years, which have allowed the ventures to repay debt far in advance of their most optimistic predictions, while still paying out massive dividends to their backers.

However, there are signs that the government is preparing to take another step towards forcing the EHO ventures to migrate to the terms of the Hydrocarbons Law, just as it did with the OSAs. Senior government officials and members of the ruling party say there is growing support within the Chávez administration to force a further increase in royalty rates for EHO production to the 30% level stipulated in the Hydrocarbons Law. The 200,000 b/d Sincor project is already paying the 30% rate on all output above 114,000 b/d, the level the government claims was originally approved by Congress. Total and Statoil, the private-sector partners in the project, say they agreed to pay the higher royalties while the issue is resolved, indicating just how strong the venture's cash flow is.

How investors in the projects would react to a forcible transition to 30% royalties for all production is unknown, but there is considerable speculation that ExxonMobil, operator of the Cerro Negro venture, will either seek arbitration or sell its 41.67% stake in the project. Repsol YPF is already known to have made an unsolicited offer to buy the stake, which ExxonMobil rebuffed, but the supermajor appears the most determined of all the investors in Venezuela to stand up for the sanctity of contracts, if only to dissuade other governments from going down the path Chávez's administration has chosen. Other investors are likely to allow the royalty rate to rise while generating as much cash from the ventures as possible.

The expansion of the existing ventures could also be complicated by the government's determination to use the remaining areas of the Orinoco EHO belt to court favour with foreign governments. Twenty-seven EHO blocks have been designed and at least seven have been reserved for companies linked to governments Chávez wants to court, including Brazil, Iran, Russia, Argentina, Spain, China, India and Uruguay. Companies from these countries will be expected to participate in a reserves-delineation programme over the next two years before the blocks are awarded, but it is obvious that Caracas intends to use its billions of barrels of heavy oil as bait to secure diplomatic alliances.

Appetite for state control
The country's growing appetite for state control over the oil sector is also spreading towards gas projects, which, until recently, had been subject to far less regulation and fiscal scrutiny than oil projects. The announcement in September that PdV would take over responsibility for the construction and operation of all new gas pipelines and export facilities, including liquefied natural gas (LNG) plants, was the first sign of the government's determination to tighten its control over the gas business. Since then, a proposed pipeline to supply Brazil and Argentina with Venezuelan gas has been transformed from a long-term possibility into the centrepiece of the government's natural gas plans. Given that such a massive pipeline would require huge volumes of gas to achieve economies of scale, Venezuela's LNG export plans look less certain to be realised.

And it is far from certain that Venezuela has enough proved non-associated gas reserves to supply such a pipeline, even with recent discoveries in the Plataforma Deltana area, in the waters northeast of the Orinoco river delta. It is even less clear how willing the companies that invested in the Deltana blocks are to export production to Brazil by pipeline, rather than to the US as LNG – which was the original impetus behind the exploration drive. Although the realised prices for gas in Brazil and Argentina would be far lower than in the US, Chávez has insisted that the pipeline project move ahead as part of his broader effort to build ties between Venezuela and its South American neighbours.

For now, Chevron, the most active company in the country's offshore gas sector, is continuing with its downstream market-research efforts. But even bringing the 5-7 trillion cubic feet (cf) the firm has found in Deltana blocks 2 and 3 into production within the next few years as scheduled could be difficult, given the government's assignment of the task of building an offshore gathering and transport network to PdV, which has no experience of such a project. PdV has held exploratory talks with Russia's Gazprom over a partnership to take on the offshore pipeline work, but no concrete deal has been signed.

Compounding the problems for gas investors are the government's latest changes to the rules for calculating gas royalties. While under the previous scheme, set up only in 2001, royalties were to be calculated based on a netback to the wellhead, the government is now limiting deductions for production and processing costs to 15% of the price, effectively raising the royalty rate on offshore production.

The decision has been greeted with disappointment by offshore operators, who say the rule change goes against the government's stated desire of increasing offshore production. "This is a really negative decision and it could seriously affect future gas projects," says one executive of a company involved in the Venezuelan offshore.

For all of the grandiose rhetoric of massive new pipelines and Venezuela's emergence as the energy supplier to the rest of South America, only one project, in either the oil or gas sectors, has been conceived and brought to completion during Chávez' seven years in power. Phase one of the Yucal-Placer gasfield development – awarded to a consortium led by Total and Repsol YPF in the 2001 onshore gas round – has been completed, with 100m cf/d of production sold to PdV's domestic marketing arm. A second phase is being studied, but it too could be delayed by the new royalty rules as the gas in Yucal-Placer has a high carbon-dioxide content and would require costly treatment before it can be injected into the pipeline network. With the constant changes in the rules of the game and Venezuela's own long-term political strategy, it is difficult to see any bigger projects being finished soon.

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