Oil Venezuela's lifeblood is also a political flashpoint

The 1990s Orinoco deals were reached when low world oil prices made costly exploration in such high-risk projects unattractive. Spread across an area roughly the size of West Virginia, the Orinoco Belt contains relatively shallow subterranean vaults full of thick, ketchup-like petroleum. Moving the goo to the surface requires special submersible electric pumps. And unlike conventional "light" crude, the Orinoco's extra-heavy oil must be converted into a lighter synthetic crude before it can be refined into gasoline.

In the 1990s, PDVSA lacked the financial resources to develop the Orinoco. And with oil prices as low as $12 per barrel, the extra risks and costs involved made it hard for the Venezuelans to interest international oil companies in the projects.

Only by offering the oil majors especially favorable terms, including royalty payments of just 1%, could PDVSA attract companies such as Exxon, analysts say.

"If there hadn't been all these incentives in place, the sector wouldn't have developed as it did," says Enrique Sira, a Caracas-based analyst with Cambridge Energy Research Associates.

Since that time, however, oil prices have skyrocketed and the oil companies — after investing a combined total of more than $10 billion — have profited handsomely from their Orinoco projects. The four ventures now produce about 600,000 barrels per day of synthetic crude using state-of-the-art upgrading equipment.

Squeezing the oil companies

Last year, Chavez raised the independent companies' tax and royalty payments: Income tax rates jumped from 34% to 50%, and the rock-bottom 1% royalties were replaced by a 16.67% levy. Now, the new arrangements he's demanding in the Orinoco projects will boost PDVSA's share of each of the four projects from an average 42% to 60%.

The Western oil companies grumble, though none will discuss the negotiations on the record for fear of angering the mercurial Chavez. But while financially painful for the independent oil companies, the new terms aren't so onerous as to spark a full-scale exodus from Venezuela. In a world of $65 oil prices, the restructured deals remain potentially profitable, say analysts such as Sira.

Despite Chavez's virulent anti-Americanism and ceaseless talk of "oil sovereignty," even Venezuela's tough new terms are better than those offered by other oil-producing countries with closer political ties to the U.S. After all, Venezuela will continue to permit private companies an ownership stake in exploration and production projects — something prohibited by Mexico and Saudi Arabia.

Chavez has said he doesn't want the independent companies to leave. But there are indications that he prefers to deal with state-owned oil companies from Brazil, China, Iran and even Belarus, which already have been awarded exploration contracts elsewhere in the Orinoco region. Their technology, however, is not regarded as equal to that of companies such as Chevron, Exxon or Conoco.

The new Orinoco contract terms, however, will raise the break-even price of the four projects from about $18 per barrel to $35, Sira says. And that change, coupled with the political risk associated with operating amid an uncharted socialist revolution, means the private oil companies are unlikely to make the additional investments Venezuela needs.

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