Events in Venezuela throw into sharp relief three major categories of risk central to international oil and gas investment decisions: politics, price, and geology. Political conditions for investors in Venezuela have been deteriorating since the mercurial Hugo Chavez was elected president in 1998. For many companies, however, oil prices have risen enough to compensate for government assaults on the economics of Venezuelan ventures, for which geologic risks remain low.
Thirty years after nationalizing its oil and gas industry, Venezuela is again confiscating oil company interests. Petroleos de Venezuela SA has taken over oil fields operated by Total and Eni, which hadn’t met a government demand that they renegotiate service contracts into joint ventures with the state concern. In another field, Statoil has reached an agreement for PDVSA to assume its minority interest. Earlier, ExxonMobil Corp. sold its interest in a Venezuelan oil field rather than submit to the new terms.
Dismantling apertura
These developments flow from the Chavez government’s dismantling of the apertura, a predecessor’s initiative in the 1990s to reopen Venezuelan exploration and development to international capital. While apertura deals varied according to the type of project, most were hybrid service contracts.
The Chavez regime formalized its unraveling of the apertura in 2001 with a new hydrocarbons law that raised royalty rates in service contracts, promised PDVSA majority control of all new projects, and prescribed joint ventures as the participation model for new Venezuelan investments by foreigners. In 2004, the government raised royalty rates on production of Orinoco heavy oil. Last year it set the requirement for conversion of existing service contracts into joint ventures with PDVSA as majority partner. Meanwhile, the government has reinterpreted tax rates in apertura-era deals and has been dunning international oil companies for “back taxes” estimated to total $4 billion.
Not all foreign operators have balked at Venezuela’s surprises. The energy ministry says 17 of them have renegotiated contracts into joint ventures with PDVSA. Most companies hit for back taxes have paid up. And the government says a number of firms remain in negotiations for new Orinoco development projects.
Elevated prices surely take the economic sting, if not the annoyance, out of Venezuela’s heavy-handedness. Some companies may be sticking with old projects despite the diminished values in hopes of better treatment with the gas and heavy oil ventures the government is promoting. To some, conversion of service contracts into joint ventures offers might even improve the allure of Venezuelan projects. The new structure provides equity interest in production, for example. And PDVSA as senior partner offers political cover of sorts.
Operators wouldn’t see so many reasons to stay aboard if oil prices weren’t high enough to keep projects attractive despite the diminished company control and increased government take. So what happens if prices drop? The price threshold for project viability must have risen substantially in most cases. Price risk thus has spurted along with political risk.
Those risks, moreover, are fused. The government’s expropriations are no doubt very good for PDVSA. But the subsidized oil sales it’s making throughout Latin America are very bad. So is the heavy domestic spending of cash that PDVSA soon will wish had stayed in its oil fields and processing plants. That PDVSA has been sapped before helps explain the apertura. For now, high oil prices hide a multitude of errors. But with government claims on its cash rising, PDVSA faces the same rising risk of adverse price movement that its now-junior private partners do.
Sturdy potential
Thanks especially to undeveloped heavy oil and gas resources, Venezuela’s production potential remains sturdy at any given level of investment. A government can’t alter geologic risk much. The question is future investment.
Unilateral deal changes and expropriations of property say much about a government’s commitment to the rule of law. They’re regrettable wherever they occur, whatever the price of oil, and at least doubly so where they occur twice. They raise risk, and rising risk discourages investment. That doesn’t mean investment will cease in Venezuela. It means that at any given level of future investment there could have been more.✦
