Venezuela's PdV starts its recovery in the Orinoco
Venezuela’s economy is cratering but the state firm has a new development strategy for its heavy oil play
Rigs rise above the surrounding Caribbean pine forests, sinking wells into the vast oil reserves below. New well pads are being cleared and readied for drilling. Paved roads are being cut through the remote, sparsely populated region. Gas flares at new processing facilities send flames shooting into the sky. A year ago, trucks shipped the oil out. Now pipelines do the job, snaking their way through the landscape to distant processing plants and ports.
This is Venezuela’s remote Orinoco heavy-oil belt and signs of Petroleos de Venezuela’s (PdV) efforts to kick start a new wave of production growth are everywhere visible as we fly over the world’s largest oil deposit.
The spurt of new activity, seen by Petroleum Economist on a recent visit to Venezuela (as a guest of the state company), is the result of a subtle shift under way in PdV’s Orinoco strategy that could finally see significant new production – as much as 0.5m barrels per day (b/d) over the next couple of years – start to flow from the country’s heavy-oil fields. The company’s new chief executive Eulogio del Pino, a Stanford-educated geophysicist and PdV veteran, is hoping a pragmatic turn will help draw much needed investment into the oil industry, even as a steep fall in the oil price has seen oil companies around the world embrace austerity.
For years, PdV has touted an ambitious plan for the Orinoco. Along with its partners, it would invest $144bn before the end of this decade to drill thousands of wells, build six new upgraders – the refinery-like facilities that turn the Orinoco’s extra-heavy 8°API oil into a marketable medium-grade crude – construct a new refinery, lay down hundreds of kilometres of new pipelines and develop a new port on the Caribbean coast. The investment, PdV says, would eventually add 2.49m b/d of production capacity in the Orinoco, bringing the Belt’s total possible output to almost 4m b/d, or two thirds of the country’s target of 6m b/d.
Even under the best of circumstances, the plan would require a herculean mobilisation of cash and manpower, both of which are in short supply. In the US, it took an unprecedented confluence of fortuitous geological, technological, financial and political forces to produce the levels of output growth envisioned by the Venezuelan plan.
But Venezuelan circumstances right now are far from auspicious. Turning the plan into reality has been painfully slow. On top of the political and economic problems that have beset the country in recent years, PdV has struggled to find the cash needed for the sizable investments in new wells and infrastructure.
The state-owned company’s finances are under constant strain. It claims to produce 2.85m b/d of crude, although the secondary sources used by Opec said output in March was much lower, at 2.35m b/d. Either way, 0.5-0.55m b/d is sold into a domestic market that prices gasoline cheaper than water. The remainder hardly commands top dollar either. Venezuela ships 0.6m b/d to China to re-pay $50bn in oil-for loans deals – a formula established when international oil prices were much higher. Another 100,000 b/d is sold on generous financing terms to several Caribbean countries through the government’s PetroCaribe programme, which company officials insist will not be scaled back. Another 80,000 b/d or so is sold cheaply under a separate agreement to Cuba.
In total, as much as 1.3m b/d, or nearly half of the company’s total output, is either given away or sold well beneath market price.
High taxes and heavy spending on government social programmes add to the financial burden. Over the past three years, the company has spent $35.6bn funding these, though the pace of annual spending has fallen sharply from $17.3bn in 2012 to $5.3bn last year, according to the company’s most recent financial statements.
It has all left PdV relying increasingly on foreign partners for investment. These partners, including heavyweights such as China National Petroleum Corporation (CNPC), Russia’s Rosneft, India’s Oil and Natural Gas Corporation (ONGC), Repsol, Chevron and Eni, are in the Orinoco because of its world-beating reserves. The area, covering a vast 63,000 square km swathe of dusty flat plains in the heart of the country, holds a staggering 270bn barrels of crude.
But while the Orinoco offers few exploration risks below ground, it is another matter above ground. The 2007 wave of oil nationalisations still hangs over the industry, making investors nervous about putting more money into the country. More recently, Venezuela’s slow-burn economic crisis, worsened by the collapse in the price of oil – which accounts for more than 95% of its exports and half of the government’s revenues – has made operating in the country difficult.
The government has not published inflation figures for months, but many economists say it now runs at well over 100%. A combination of price controls and currency restrictions has left supermarket shelves empty. I stayed at a state-run hotel that hadn’t had milk for more than a week. The currency trades at 40 times the official rate on the black market, so gaming the country’s economic distortions is about the only viable economic activity outside the oil business. Economists expect the economy to shrink by 6%-7% this year.
Many see today’s problems as the inevitable reckoning after 15 years of late president Hugo Chavez’s profligate spending. Chavez rose to power on a promise to spread Venezuela’s oil wealth more evenly through society. The country’s poor, many of whom live in slums that perch perilously on the hills around Caracas, resented the small elite that seemed uniquely to benefit from the country’s vast oil wealth. And an unprecedented boom in oil prices allowed Chavez to spend lavishly on social programmes that delivered real benefits to the country’s poor. The poverty rate was close to 50% when Chavez took office in 1999 and he quickly brought that down to around 31% by 2006, according to UN statistics.
But there were limits to what the spending policies could achieve. The poverty rate has never fallen much below that 2006 level and was actually higher in 2013, when the economic downturn started. Almost certainly, the rate has risen sharply in 2014 and early 2015, though no data are available. The slums still cover the hillsides and a break down in the rule of law has made the capital city more dangerous than ever. Worse, there was little investment in infrastructure or other industries that could have delivered lasting benefits from the historic influx of petrodollars during the oil-price-boom years. It is a familiar tale of boom and bust that Venezuela has never been able to escape.
The economic crisis is threatening to turn into a political crisis. President Nicolas Maduro’s nightly appearances on state-dominated television, giving away cars and houses and extolling his record as Chavez’s heir apparent, belies a siege mentality that has taken over the presidential palace. Maduro blames everyone from Venezuela’s capitalist old-guard to the imperialista Americans for the country’s troubles. But he is increasingly taking the heat for Venezuela’s crumbling economy and out-of-control street crime. Protests have been common, and occasionally violent, though so far mostly contained to the committed opposition. If Maduro’s United Socialist Party suffers a setback in National Assembly elections expected later this year, many in the country expect him to be pushed aside by people within his own party. His most likely successor is the head of the National Assembly Diosdado Cabello, a dyed-in-the-wool Chavista and power broker with deep links to the military (The Atlantic recently dubbed him Venezuela’s Frank Underwood after the Machiavellian main character from the TV series House of Cards). Many were surprised that it was Maduro, not Cabello, who was selected by Chavez to carry on his legacy.
The country’s tricky oil politics sit uneasily amid the wider structural problems facing Venezuela. Del Pino appears to want to shift PdV’s focus away from the revolutionary fervour encouraged by his predecessor Rafael Ramirez, the longtime head of PdV who was ousted last September, towards the everyday business of getting oil out of the ground. But Chavez’s brand of oil nationalism still suffuses the company. Revolutionary propaganda is omnipresent at PdV’s headquarters and oil facilities. At the Jose Industrial Complex, home to the country’s four oil upgraders, a favourite Chavez slogan is spray-painted on one of the security gates: “Yankee Go Home”. US major Chevron is one of PdV’s partners at the plant.
Some see del Pino’s own position as precarious. He and his team of executives went through the internal battles at PdV during the 2002-03 oil strike, when some of the company’s old guard tried to force Chavez from power by bringing the oil industry to its knees. Del Pino and his team, lower ranking officials at the time, came out on top. Nonetheless, he does not have a strong base of political support of the kind Ramirez enjoyed. If the political winds shift, del Pino could be swept out of office. While I was in Venezuela, rumours of del Pino’s impending removal, which were ultimately unfounded, swirled around Caracas.
Del Pino’s low-key style might be out of step with Venezuela’s rough-and-tumble politics, but it could serve him well in the oil patch as he presses ahead with his plan to turn around the country’s oil production. The official Orinoco development plan is still in place, but del Pino has been more pragmatic, and is starting to looking at some creative and cost effective ways to get more oil out of the Orinoco more quickly.
Part of the plan has seen PdV tap its foreign partners to secure financing for early production. At the PetroSinovensa project, a joint venture (JV) with CNPC, the China Development Bank has loaned PdV $4.015bn to be re-invested and more could be on the way. Chevron has loaned PdV $2bn to be recycled into the companies’ heavy-oil projects. Repsol has extended $1.2bn in financing to boost production. All this has added up to about a $10bn lifeline for PdV to fund its plans.
In exchange, PdV has given its foreign partners more say over operational and financial decisions. “We are empowering the JVs more than we were before,” Ruben Figuera, PdV’s head of new Orinoco projects, said at a briefing in the company’s Caracas headquarters. “It is a situation where they see themselves not just riding in the backseat of the car, but also taking the wheel once in a while. All we ask is for them to keep it steady.”
The government has also helped by giving companies working in heavy-oil projects access to more favourable exchange rates. Maduro’s government, desperate to avoid a major devaluation and keep a lid on inflation, has created a byzantine and opaque system of tiered exchange rates, offering different rates to different people and companies. Giving foreign companies access to the Simadi exchange system, where the dollar sells for around 200 bolivars, compared with the official exchange rate of 6.3 bolivars per dollar, will bring costs way down. Del Pino said that PdV and its partners are taking advantage of the Simadi system to the tune of around $75m a month, which he expects to rise as investment rises. Although foreign companies would prefer not to have to navigate Venezuela’s complex exchange rate system at all, the improved exchange rate is a big step forward. “It is a very good incentive to sustain investment,” del Pino said.
Not that all of PdV’s partners are fully in tune with the strategy. Many would prefer to see more of the revenue from early production flow back to them, not ploughed straight back into the Orinoco. PetroVietnam has pulled out of the PetroMacareo project, where PdV says it is in talks with other potential partners, including a company already working in Venezuela. (China’s state oil companies have been keen investors in the Orinoco, and Sinopec has been in talks to develop a block adjacent to the PetroMacareo project.) Malaysia’s Petronas also pulled out of its Orinoco project, PetroCarabobo. For now, PdV has taken on the company’s 11% stake in the development, but it is looking to bring in a new partner. “International oil companies are very interested,” Figuera said.
There is disgruntlement among some other partners too. ONGC has said that it is owed more than $500m in dividends and wants to collect. PdV’s Figuera, though, contends that the JV agreement doesn’t call for dividends to be paid until commercial production starts. The dispute appears to rest on the difference between what PdV calls “early production” – by which the company means the output that is now starting to flow out of the Orinoco before full-field development – and commercial production, after the upgraders are built. It’s a distinction that seems to have been lost on the Indian firm.
The investment issue has also been a source of conflict between PdV and US independent producer Harvest Resources, which has been trying to sell its stake in the Petrodelta project for a couple of years. “Harvest is the typical example of a partner that doesn’t have the capability to be our partner,” said del Pino in a blunt assessment of the company. “They only want to get the dividend, and not to invest.” PdV, he added, would only approve the sale of Harvest’s stake if the buyer was willing to put up hundreds of millions of dollars in financing to help raise production at the Petrodelta project from 40,000 b/d to 100,000 b/d.
For Figuera, these kinds of disputes are natural. “The JVs are like a marriage. Once in awhile, not every day, but once in awhile you have a fight.” In general, he maintains, PdV’s relationships with its foreign partners are still strong.
The influx of investment and more autonomy for PdV’s partners is starting to pay off. Orinoco early production flows started slowly in 2012, but increased drilling and new infrastructure is allowing output to rise more quickly now. Output was 1.215m b/d at the end of 2013 – mostly coming from the first generation of Orinoco projects – and had risen to 1.317m b/d by March this year.
Del Pino said that by the end of 2015 Orinoco production would rise by another 150,000 b/d to reach 1.483m b/d. It would, he said, at last start to offset declining output from Venezuela’s mature oilfields and help lift PdV’s overall output to more than 3m b/d – a turnaround after years of falling output.
Getting more of this early production to market without building new upgraders will be crucial to sustaining this growth. The Orinoco’s crude is too heavy to transport on its own and too heavy for refiners. So the existing projects rely on a closed loop system in which naphtha is piped to the field to be mixed with the heavy crude resulting in a lighter diluted crude that can be piped to an upgrader on the Caribbean coast, 200 kms away. There it is turned into a marketable medium-grade oil for export. The naphtha is then separated out at the upgrader and put back into the pipeline system to be sent back to the field.
The problem for the new generation of projects is that there is limited excess capacity at the existing upgraders and new upgraders will each cost at least $5bn to $6bn to build. Construction will also take years.
PdV thinks it has come up with a neat solution. It plans to mix the new heavy-oil production with light crudes to produce an exportable medium-grade oil. The model has already been used successfully at the Sinovensa project with CNPC, which has been a bright spot in the Orinoco in recent years. Unlike the existing Orinoco projects, Sinovensa sends its crude to a blending plant, where it is mixed with light oil produced from Venezuela’s mature oilfields in Maracaibo. PdV then exports the medium crude to China. Output from the project has risen steeply, from 20,000 b/d a couple years ago to 170,000 b/d today, and the companies plan to increase this to 330,000 b/d by 2017. It is the sort of production surge that Venezuela has long been hoping for across the Orinoco, but has proved elusive. “Sinovensa is the growth model for the new JVs,” Figuera said.
But there is another part of the plan. PdV doesn’t produce enough light oil of its own to mix with the new heavy-oil production so it is looking abroad, to fellow Opec members Algeria, Angola and Nigeria, which produce a sufficiently light grade and could ship it to Venezuela. Officials from those countries were in Caracas in April and del Pino said they were receptive to the proposal. PdV officials sold it as a win-win for all the exporters, allowing them to recover market share lost in the US to that country’s own surging light tight oil production. While West African and other light crudes can hardly compete in the US Gulf with light oil coming from nearby plays like the Eagle Ford, demand from Gulf refiners for medium and heavier crudes remains robust and a blend of Algerian or West Africa light crude with heavy Orinoco oil could produce a medium oil that fits the bill. PdV says that it would need around three barrels of light oil for every 10 barrels of heavy to create the new export grade.
Even if it works out a deal, PdV will face strong competition in the US Gulf. Years of ideologically driven retreat from what has historically been its most important market has allowed heavy oil from Canada to emerge as a rival. A decade ago, PdV was shipping as much as 1.6m b/d to the US, nearly all of which went to the Gulf refineries. Today that is down about 1m b/d to 0.6m b/d. In the same time, Canadian exports to the Gulf have risen from just 32,000 b/d to a high of 412,000 b/d in January this year.
It will be difficult to claw back that market share. While lobbying for approval of the Keystone XL pipeline, which would ship another 830,000 b/d heavy oil sands crude to Texas, Canadian diplomats have demonised Venezuelan oil as unreliable and politically unpalatable. Caracas’s complete absence from the debate, and deteriorating diplomatic relations with the US, have only served to reinforce the message. PdV’s Citgo refineries, with a total capacity of 757,000 b/d across Texas, Louisiana and Illinois, give it a solid foothold in the key market, but it will need to do more to re-establish itself – physically and politically – in the US.
New Venezuelan barrels would also have to find room within Opec. Venezuela needs an oil price of $117/b to keep its budget in the black, according to Deutsche Bank, and because of that has been a relentless hawk in recent years, pushing the group to cut supply and support prices. But it isn’t the only member with plans to lift output in the next few years. Iraq and post-sanctions Iran should both steadily add production before 2020, and Saudi Arabia, the group’s biggest member, has already swiftly lifted its own output in recent months. If Venezuela is able to ramp up production, it could be pumping barrels into an already over-supplied market.
But PdV officials are sanguine, dismissing concerns that there won’t be sufficient demand for new Venezuelan production. Del Pino said that he expects strong global consumption growth, particularly from India, and a sharp drop in US shale oil output. It’s an optimistic view of global consumption heard among many big oil producers, although the kicker is that to spur faster demand growth in the coming years international prices may have to stay low, hurting economies like Venezuela’s that depend so heavily on high prices.
Back in the Orinoco, the wider market uncertainties aren’t making much difference. To get the early production out of the country, PdV is pushing ahead with plans to build a new oil terminal at Punta Cuchillo, on the Orinoco River, where Panamax oil tankers would bring in light oil and ship out the blended crude. The terminal could be finished by 2017. In total, Figuera said that the strategy would allow for 300,000 b/d of new production from the Carabobo section of the Orinoco and 200,000 b/d from the Junin area.
The JV partners appear to be behind the proposal and are starting to ramp up their investment. At the Chevron JV Petroindependencia, the companies plan to spend $400m this year to increase output from 12,200 b/d to 30,000 b/d by the end of 2015. The project’s general manager, Jesus Ernandez, said they intend to reach 50,000 b/d by 2016 and could be producing up to 260,000 b/d after four or five years. The companies will have to drill 600 wells, each costing $3m to $4m, to reach the peak production of 400,000 b/d.
The PetroCarabobo project, a JV with Repsol, ONGC, India Oil and Oil India, plans to increase production this year from 17,000 b/d to 30,000 b/d, del Pino said. Across the Orinoco’s oilfields PdV is connecting 60 new wells a month, with plans to increase the number to 90. Del Pino said it would spend $1.2bn on new central production facilities this year alone.
The push for early production, hopes PdV, will spark a virtuous cycle of investment in the Orinoco, as output generates cash flow and the revenues can be put back into the project to support more oil and more income. In the process, rising production could help shore up PdV’s finances and convince foreign companies, and their shareholders, that the Orinoco is a safe investment.
Although these projects are moving ahead with early production, none has yet taken a final investment decision on full-field development, including the construction of the upgraders. To keep the ambitious targets in sight, most of those decisions will need to be taken over the next year or two. PdV officials say that the significant investments already made by the JV partners are a sure sign of their commitment. But crucial decisions still await. A Chevron official, for instance, said that the company could ultimately decide to stay with the blending production model, rather than build a new upgrader, if it is more cost effective.
The low oil price – Venezuela’s exports presently fetch around $53/b, a slight discount to WTI – will no doubt affect that kind of decision. Optimistically, PdV officials argue that the lower oil price actually works in the firm’s favour. “At these prices we have a strategic advantage because we are a low-cost producer,” PdV’s Figuera said. Production costs are around $9-10/b, with a breakeven of $40/b, once upgrading is included. But if oil prices stay low, even deep-pocketed Asian national oil companies will be sparing in their investments.
PdV is certainly doing its best to persuade investors that its growth plans are serious and they will be a welcome part of them. Throngs of workers decked out in PdV red greeted us as our plane touched down at sites across the Orinoco. Not many journalists have been out to the play in recent years, and our hosts wanted to make a good impression. But among the PdV workers there was also genuine enthusiasm to show off the work being done.
The Orinoco certainly feels a long way from Caracas. The tangible, if tentative, progress in the region stands uneasily against Venezuela’s economic and political troubles. Keeping the momentum going won’t be easy for del Pino and the company. Few think Venezuela’s present financial situation is sustainable and PdV, as the country’s economic engine, will inevitably remain at the centre of any upheaval. But if PdV is going to revive its fortunes – and its country’s – the heavy lifting will start on the ground in the Orinoco.