Venezuelas Oil Policy Has Risk Premium

Venezuelas Oil Policy Has Risk Premium

Venezuela is the world’s fifth-largest oil exporter. 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.

A number of factors contribute to the high degree of uncertainty about the Venezuelan oil industry:

1. Oil production. Oil has always been a highly political subject. Recent history explains why the Venezuelan picture is especially complicated. Crude oil production numbers became highly politicized in late 2002 during the strike at state oil company PDVSA. This debate continues, with antagonists bringing to the table 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). Assuming just below 600,000 b/d of synthetic crude, this suggests production of 2.4 million b/d of conventional oil 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 and foreign-operated fields another 1.3 million.

These two sets of numbers are difficult to reconcile. In any case, the judgment 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, then declines. Managing the decline requires experience and skill. Improved reservoir management and new technology can be applied to reduce the rate of decline. PDVSA’s critics claim that this is not happening at the rate required to maintain 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. 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 in operation, producing just under 600,000 b/d. If further upgrading investment is undertaken, Venezuela should be able to increase its oil production considerably.

3. OPEC. Venezuela’s international oil policy and its role within OPEC is another area of uncertainty. Oil prices are at or around record levels, owing to strong global growth and constrained supply. Nevertheless, Venezuela is urging production cuts. 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.

4. Contract and fiscal terms. Venezuela introduced a new hydrocarbons law in 2001. The government’s view is that the “Apertura Petrolera” of the early 1990s, which welcomed the international industry, circumvented the constitution and thus was illegal. The next logical step was to bring all relevant contractual arrangements into line with the new law:

–Foreign operators were told last year that their operating service agreements, negotiated in good faith by these companies and the then-government, were “illegal.”

–A combination of the controversial nature of the law and issues of clarity, consistency and effective communication surrounding this process have resulted in a loss of trust and damaged relationships within the Venezuelan oil industry.

–In addition, in May, the Venezuelan National Assembly raised royalties on the four extra-heavy Orinoco crude projects from 16.6% to 33.3%.

Despite these developments, if it is accepted that events to date could be characterized as an exercise in “clearing the decks,” it is possible to take a positive view of the industry’s future in Venezuela. However, PDVSA and the government will need to grasp the opportunity to adopt a more conciliatory and constructive approach in the way they engage with their international partners.

Despite the attractiveness of Venezuela’s resource base, its 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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