Ironing Out Ups and Downs

The oil industry has a huge and all-pervasive presence in Venezuela. Oil accounts for more than 80% of export earnings, 40% of government revenues and 25% of the country’s GDP. If the oil price goes up, the government typically spends heavily on employment and social programs. If the oil price falls, as it did last year, the government is saddled with a fiscal deficit, overall confidence plummets, and inflation and recession become problematic.

These are the conditions that now exist, despite the fact that oil prices have recovered this year and are higher than the government expected when it prepared the year’s budget. It initially expected an average price of $18.50 a barrel for Venezuelan oil, which it subsequently lowered to $16 a barrel. But the average so far this year is more than $19 a barrel. Confidence, to be sure, has suffered more from political instability than from oil price fluctuations. But the fate of the wider economy is linked to the fate of the oil industry in a way that is often hard to understand from the perspective of more balanced economies.

The role of the state oil group in the events that led up to the April presidential coup are one example of this inextricable link. During March and early April, President Chávez first replaced the board of directors at Petroleos de Venezuela SA (PDVSA) with his own men, then fired several senior managers live on television. The insult to Venzuela’s biggest corporation was shared by hundreds of thousands of demonstrators who took to the streets on April 11 and precipitated the brief removal of the president from office. “This was something that I don’t think had been seen here or anywhere else before,” says José Toro, a board member at PDVSA from 1995 to 1998 and now a businessman and university lecturer. “Society took to the streets to support the management of an oil company.”

If PDVSA really does have a place close to the hearts of Venezuelan people, one reason is that it has previously tried to avoid involvement in politics. Since its creation in 1976, it has earned a reputation as a well-managed, professionally focused, integrated oil company. Its core operations include exploration and production, refining, transport and distribution; it also has business interests in chemicals, petrochemicals and coal.

But despite its crucial contribution to the economy, PDVSA has found itself under fire from Chávez. When he was a presidential candidate, Chávez called the company a state-within-a-state during campaigns for his first election victory. He has often threatened to force it to sell its overseas interests, including refining and distribution assets in the US, though he has never done so. Chávez’s policy of making Venezuela a driving force behind Opec, the Organization of Petroleum Exporting Countries, has forced the company to cut back production to levels well below its capacity. Production in June, for example, was just 2.75 million barrels per day (bpd), out of a capacity of 3.4 million bpd. Production has fallen by nearly 300,000 bpd since December because of reductions in Venezuela’s Opec quota, according to Luis Dávila, finance director.

Toro says following the Opec line is preventing PDVSA from fulfilling its role in Venezuela’s economy. “I believe that the aim of national oil policy should be to use oil to provide the highest increase in GDP,” he says, “not to achieve the highest oil price.”

Investment Key
That, Toro says, means investing in the oil industry. “Every time we have had high GDP growth during the past 50 years, it has been because investment in the oil industry has been high, not because the oil price has been high,” he says. He argues that investment in the oil industry translates into real jobs and wider investment in the economy as a whole, whereas high oil prices merely result in bigger government revenues and more spending in unproductive areas.

It may be a surprise, then, that many observers inside and outside the oil industry welcomed the appointment in May of Alí Rodríguez as PDVSA’s new president. Rodríguez was formerly oil minister and comes to the job from the presidency of Opec itself. But while many of PDVSA’s private sector partners dislike the government’s support for Opec, they have welcomed Rodriguez’s appointment because he is regarded as a safe pair of hands. Says one executive at a major multinational oil company in Caracas who asked not to be identified, “The appointment is very positive. It brings stability to PDVSA, which is what’s needed now above all else.”

Less pleasing to the foreign private sector is the petroleum law introduced among the package of 49 laws Chávez decreed last November. The law allows private sector involvement in the industry, but stipulates that PDVSA must take a 51% stake in – to finance its any joint venture. This not only means that private sector partners cannot take control any projects; it also means PDVSA must raise capital majority stake. The law also forces the industry to pay higher royalties to the government.

The law has been met with outrage in many quarters. “It’s absolutely crazy to restrict oil investments at a time like this,” says Alejandro Grisanti of Santander Central Hispano in Caracas. Luis Dávila defends some aspects of the law and says it may be possible to get around others. He points out that, before the new law, PDVSA could not enter partnerships with the private sector at all, although there were many exceptions in significant areas such as expansion of the heavy crude fields in the Orinoco Belt.

“Most development before the new law was being done entirely by PDVSA,” Dávila says, “Now we can lower our commitment to 51%, so the amount of investment is lower. Of course there is a lot of discussion now because the private sector would like to have more than 49%, but that is all the government allowed. There may also be ways to get around that [restriction]. The participation of Venezuela [ie PDVSA] in joint ventures may be conceived in different ways. It may be possible for the private sector to be part of that, or it may be possible to use golden shares [to give PDVSA nominal control with a minority investment].”

The company plans to raise production capacity to 3.9 million bpd by 2007 from 3.4 million today although expected production by the private sector has been reduced from 1.9 million bpd to 600,000 bpd.

José Toro says private investment will suffer both from the new law’s limits on participation and from the changes it makes to royalty payments that private companies must pay to the government. These have been increased to about 30% from 16%. Although the amount that companies pay remains about the same because of compensating changes in taxation, the private sector complains that the new regime will hit cash flow (because royalites are paid monthly, unlike annual taxes) and that the new regime is inflexible. “Under the old system the rule was that royalties were 16% of revenues,” says Toro. “But if an investment was of high interest to the country we could be flexible. When PDVSA opened access to the Orinoco Belt, we reduced royalties to 1% for eight years. Now the minimum is 20%. That will affect any new investment.”

Honoring Terms
The government says it will honor existing agreements, although many companies would be happier with a written commitment. Most of the world’s major oil companies are heavily committed to extracting heavy crude from the Orinoco Belt, where predicted reserves of 300 billion barrels, if proven, would make Venezeula’s deposits the biggest on the planet. Proven reserves are currently around 78 billion barrels.

But there is little chance that any new investment will take place while the law remains in force and the uncertainty engendered by the Chávez government persists. The situation could be very different. Says Toro, “Venezuela has the greatest potential for recovery of any Latin American country. A few years of rational policies would restore us to the position of the safest and most strategically important oil producer in the world. As has been proved in the past, when that happens the economy will expand rapidly, and we will be able to solve our social problems.” w