Monday, March 03, 2008

High Noon at the Orinoco River: Venezuela and Exxon-Mobil

Push finally came to shove in the conflict between the Venezuelan national oil company, PDVSA, and the giant multinational Exxon-Mobil, when the latter appealed to courts in New York and London to freeze PDVSA’s assets in February. This is just the latest chapter of a saga that started as a love affair and now appears to be heading for an acrimonious divorce.
During the 1990s, Venezuela faced a strategic conundrum: how to economically activate the enormous quantity of heavy hydrocarbon resources that were known to exist in the Orinoco Belt since the 1960s and that were fully charted by the newly formed PDVSA during the 1980s.
These resources were known to be enormous: close to 1,200 billion barrels of oil originally in situ (between 80 and 210 billion barrels of recoverable resources, depending on the recovery factor one chooses to believe). However, they were of very poor quality, at less than 10o API (indicating low gravity/high viscosity) and a high content of sulfur and heavy metals. For all intents and purposes, these reserves were commercially worthless, at least with the technology that was available to PDVSA at the time, the oil price forecast, and the fiscal regime then in existence in Venezuela.

However, given the very mature nature of the Venezuelan basins on the one hand, and the need for Venezuela to use its resources to foster economic growth on the other, the Orinoco Belt presented itself as a clear strategic opportunity for the future.

So PDVSA, with the full support of the government and parliament, set out to design an industrial and fiscal strategy that would attract the best actors within the international oil industry – actors who were capable of contributing not only the large amounts of capital and innovative strategy required, but also the access to markets that the venture called for. This strategy was familiarly known as “Apertura Petrolera.”

The chosen strategy was the production of the oil, its transportation to port and its upgrade (using different degrees of decabornization) in order to produce oil streams of commercial grade. This required the modification of the then very stringent Venezuelan fiscal regime, resulting in the reduction of royalties and tax rates. This facilitated the more than $20 billion that were eventually invested, between PDVSA and its chosen partners, for the development of a capacity of 600,000 barrels per day of synthetic crude in four different projects. These projects became unqualified successes, technologically and commercially.
Although the strategy was agreed upon and implemented in less than five years, it would take more than a decade to see the projects built and in operation. It is important to remember that prior to this effort, the Orinoco Belt was no more than an unfulfilled promise: 400 km from the nearest export port and with no real future with the policies as they then stood — it was the proverbial “middle of nowhere,” both geographically and economically.

Of course, such initiatives were not without detractors, particularly from the political opposition of the time, who could never put forward legal arguments or assemble enough political support to derail what they regarded as the denationalization of the Venezuelan oil industry.

But destiny plays tricks on even the best of intentions. With the new decade came a number of unexpected events. Hugo Chávez became president of Venezuela, and with him came political groups that had stubbornly opposed the “Apertura Petrolera.” With them came the political intention to rewind all the projects that had been previously implemented.
At the same time, oil prices started moving upward to unexpected levels, making the concessions of the previous decade appear unsustainable at best and politically dangerous at worst. The Venezuelan government then started a focused effort to modify the legal and fiscal concessions that had been necessary to realize the “Apertura Petrolera.”

The four projects in the Orinoco Belt were the last to be tackled by the government. Between 2005-2007 royalties were first increased, then the tax structure was modified, and finally, the new legislation put in place by the government called for a reduction on the share that private companies could hold in the projects. The government’s negotiating stance was simple: take it or leave it.

Most of the foreign companies reluctantly agreed to these changes, even though in the process they were the object of political abuse and public invective. One has to remember that although the vindication of the rights of the resource owner (in this case, the nation) appear logical under the light of market conditions, the government needed to appear to be getting a rematch, this time on the winning side, of a political argument they had lost in the 1990s.

Exxon, which incidentally was never a part of the “Apertura Petrolera” but inherited its presence from its takeover of MOBIL, took exception to what they saw as inadequate compensation and resorted to arbitration in accordance with the original contract. For the Venezuelan government this was like adding insult to injury, since international arbitration was one of the conditions to which they most objected in the original contracts.
EXXON and PDVSA are both engaged in an unnecessary farce that will benefit no one. In the end, Exxon’s stance will only lead to fair economic compensation, but the affair will hurt the long-term credibility of Venezuela. It will also lend support to those in Venezuela who preach that foreign companies are unrepentant vultures and that political dogmatism takes precedence over the nation’s welfare — even if takes a rewriting of history to make that political point.
Posted on march 3rd, 2008 at Focal Point: