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Venezuela’s Recall Referendum: August 19, 2004 Highlights The Outcome of the Chavez Referendum and its : A discussion on the Impact on Venezuela’s Hydrocarbons Sector Chavez referendum outcome and its impact on production. page 1 AN INTERVIEW WITH NELSON VASQUEZ (BAKER & O’BRIEN INC.—DALLAS, TEXAS) BRAZIL: shows strong presence in ANP 6th Round. page 1 Venezuela has long been a major hydrocarbons provider to the world and ARGENTINA: New tax incentives for particularly to the Western Hemisphere. According to most data sources, Ven- exploration activities in Argentina. ezuela presently produces approximately 2.7 million barrels per day of petro- page 3 leum (including crude and products), and exports 2.3 million barrels per day. BOLIVIA: Impact of the referendum Two-thirds—or 1.6 million barrels daily—of its exports go to the United States. on Argentine gas agreement. The nation’s economy is closely tied to its oil wealth, as the petroleum industry page 5 accounts for around one-third of Venezuela’s GDP. As seen in the crippling impact of strikes held at Venezuelan state oil com- PEMEX NEWS: New Burgos Basin bids; Cantarell field decline delayed. pany Petróleos de Venezuela S.A. (PdVSA) at the end of 2002 into 2003, the page 9 stability of the petroleum industry rests heavily on political and social factors. Venezuela’s recent Recall Referendum, held on August 15 to determine the fu- OIL & GAS: Statoil wins Brazilian oil blocks; Subsea 7 receives Petrobras ture of President Hugo Chavez’s presidency, is a key example of a major source of contract; Bolivia boosts gas tax; these political and social uncertainties. Petrobras Energia’s new find; To analyze the impact of the referendum on Venezuela’s hydrocarbons in- ChevronTexaco proposes Orinoco project; Tractebel invests in Peru; dustry and future investments into the sector, Latin America Energy Report Occidental in Peru E&P; Argentine spoke with Nelson Vasquez, who has twenty-five years of experience working at gas exports; Argentina pipeline PdVSA, and is now a Senior Consultant at Baker & O’Brien consulting firm. tenders; Petrobras’ Gasmig share. page 10-16

FUELS & PETROCHEMICALS: Shell LAER: What are the key characteristics of Venezuela’s hydrocarbons sells Peru assets; ExxonMobil eyes production chain? Its strengths and weaknesses? What are key areas PdVSA olefins plant; Enap in Libya. of vulnerability and how has PdVSA dealt with these issues? page 17 POWER SECTOR: Chile balances Vasquez: Venezuela is basically quite strong in all areas of the hydro- power demand; Mitsubishi in Mexico; carbons production chain—including production, refining, and trans- IDB finances renewables; Brazil energy law signed; Argentine utilities. portation—but some vulnerabilities do exist, especially in the refining page 18-21 of . When Venezuela nationalized its oil installations in the 1970s, the refineries it inherited were set up to process local Venezu- GOVERNMENT NEWS: Ecuador taps oil fund; ENARSA bill approved; elan crude oils and they generated considerable amounts of surplus re- Argentine oil investment. sidual fuel oils. As time went on, and the local production slate moved page 22-23 to even heavier crude oils, substantial and costly refinery upgrading COMPANY NEWS. page 24-28 Venezuela Oil Investment

programs were required. Since 1976, PdVSA has When the Chavez administration began, new invested more than US$10 billion into upgrading management was installed at PdVSA, and the its refineries—including the Paraguaná refinery number of rigs went up. Now the rig count has complex (to which they added a 50,000 bbl/d decreased, from a peak of around 125 rigs to the hydrotreater, two delayed cokers with 145,000 bbl/ current 50-60 rigs. d capacity, a 40,000 bbl/d reformer, an MTBE In addition, after the work stoppage during plant, and other units). Many of these improve- last year’s strike, production in Eastern Venezu- ments were implemented so that the refineries ela—with its reservoirs that are easier to exploit would be in compliance with U.S. Clean Air Act and manage—recovered much more quickly than provisions and continue to serve the large and in the western region and is close to a 100 percent growing U.S. clean products market. PdVSA will production level. In contrast, Western Venezu- need to continue to invest considerable sums in ela—which possesses mostly heavier oil in more maintaining, improving and eventually expand- mature fields—has experienced several technical ing its refining capacity to convert heavy crude problems that have been somewhat of a concern. oils into clean transportation fuels. Its production level is only approximately 70-80 percent of the level reached 2 years ago. Finally, recent operational problems at the large domestic refineries have raised additional The Government recognizes that concerns about the loss of trained and experienced personnel. Whereas PdVSA was able to ramp up foreign investors are holding out on crude oil production within three months follow- their investments until they see how ing the crippling strike, it took four to five months the political situation in Venezuela to restart and bring all refining operations back pans out. on-stream. Currently, refineries are reported to be operating at over 80 percent capacity. Not much more information is publicly available.

PdVSA has also engaged in several interna- LAER: Has PdVSA taken action to attract tional ventures. To secure markets for a substan- foreign investment to boost reserve levels, or will tial part of its crude oils, the company has ac- it fund such projects itself? quired high quality refining capacity outside of Venezuela. PdVSA acquired 1 million barrels per Vasquez: Up until now, PdVSA has mostly looked day of capacity from Citgo, as well as a joint ven- to itself to boost reserve levels. The Government ture in Europe with Veba Oil called Ruhr Oel. It has taken some measures to attract investment, also has an operating agreement with Curaçao— such as holding information meetings and a refinery very close to Venezuela, as well as one roadshows, but detailed plans other than the over- with the Amerada Hess refinery (with which all Corporate Business Plan are still under devel- PdVSA has a joint venture called Hovensa), lo- opment. The Government most likely recognizes cated in St. Croix of the U.S. Virgin Islands. that foreign investors are holding out on their in- Another potential shortcoming facing PdVSA vestments until they see how the political situa- is the lack of large new oil discoveries. Its oil res- tion in Venezuela pans out, including the after- ervoir management and maintenance of reserve math of the referendum. levels, due to the recent departure of many quali- Essentially, Venezuela has generally been able fied people from PdVSA, is a concern, as these re- to maintain its reserve levels by itself in the past, serves decline by 15-20 percent annually. You can and it doesn’t see any reason why it can’t do it in see for instance that the number of rigs that are the future, unless oil prices drop precipitously for employed has been falling in recent years, even some reason. before the Chavez administration came into power.

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LAER: How do Chavez and the Opposition’s in 1982. Other than prior to that time, PdVSA has policies toward the hydrocarbons sector compare, not had real freedom to determine how it will re- as far as output levels, royalties and taxes, and invest its oil profits under any other administra- regulation are concerned? tion. Some critics point to the fact that Chavez has appointed four PdVSA presidents during his term, Vasquez: The current Government’s policy is seen but in a historical context, this is not unusual. As in the Hydrocarbons Law of 2001, which made in previous administrations, the position of the some modifications to the royalties and income PdVSA President has always been a political post. tax levels set by the previous framework. Royal- The relationship is clearly spelled out in public re- ties are now 30 percent (compared to 16.7 percent leases in what the government and the company previously) and the income tax is now 50 percent itself calls the “New PDVSA”, a product of the re- (down from 67 percent). Whether the previous organization that took place after the 2002-2003 framework or the current one is more favorable strike. depends on the specific project being considered. As far as the Opposition’s policy goes, they have not publicly announced a hydrocarbons policy, as they had been more focused on winning Even before the Chavez the referendum at this point. Even before the Chavez administration, oil administration, oil policy in policy in Venezuela has had political overtones— Venezuela has had political as is the same in many Latin American countries. overtones—as is the same in many As a result, the Opposition has commented very Latin American countries. little on any specific policies that it was consid- ering implementing.

LAER: How would you describe the current LAER: Overall, have oil companies operating in relationship between Venezuela’s Executive Venezuela’s oil and gas sectors viewed the Branch and the PdVSA management? Does Hydrocarbons Law of 2001 as conducive or not to PdVSA have the autonomy to make its own investing in these industries? What do they see as decisions, including how it reinvests its oil the benefits and drawbacks of the Hydrocarbons profits? Law?

Vasquez: The current relationship that we have Vasquez: Many foreign companies have criticized now between PdVSA and the Venezuelan govern- the law as unfavorable to new investments because ment has been clearly stated in numerous public by upping the royalty payments, which are pay- documents and news sources. Essentially, the able even if there are no profits, the Government Government—specifically the Ministry of Energy has secured itself a larger flow of money, despite and Mines—is the sole shareholder of PdVSA. the lower income tax rate under the new law. They Theoretically, PdVSA has always had the au- seem to be accepting the terms though—for ex- tonomy to make its own internal operating deci- ample, the Hamaca oil association in the Orinoco sions, and some autonomy as to where and how Belt, which is operating as of this year, accepted to invest its oil profits, but, being a national oil the new scheme with a minimum 30 percent roy- company as it is, this “autonomy” has always been alty per barrel (compared with 15 percent previ- subject to Government approval—or rejection, as ously). the case may be. Concerning the reinvestment of profits, several years ago, right after the national- Some companies such as those operating in the ization of PdVSA, the company had its own mon- Orinoco (e.g., ChevronTexaco, TotalFinaElf) have etary reserves, but those rights were taken away said that new projects could be viable if they are

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allowed to tie into existing infrastructure. This also stated recently at a meeting of foreign diplo- would allow companies that are already operat- mats that more than 100,000 troops would be de- ing in the Orinoco Belt to cut costs and make a ployed during and after the vote. profit using the infrastructure that they already have, as opposed to incurring the enormous costs associated with greenfield projects. LAER: What steps have foreign oil companies operating in Venezuela taken to guard against such interruptions at their facilities? In general, what is their view regarding the Referendum? Foreign operating companies in the country … are planning for Vasquez: I have indirect references from some of business as usual, but with the foreign operating companies in the country relatively low exposure (i.e. that they are planning for business as usual, but additional investments) until the with relatively low exposure (i.e. additional in- post-referendum situation has vestments) until the post-referendum situation has been clarified. In general, foreign oil compa- been clarified. nies are fairly confident that this situation will not escalate to the severity of the strike situation, dur- ing which there were civil disturbances and seri- ous disruptions to Venezuela’s hydrocarbons pro- LAER: What is the probability that disruptions to duction chain. The American Embassy and oth- Venezuela’s hydrocarbons output and exports will ers have issued safety warnings, but this action is occur in the aftermath of the referendum? What customary in this type of situation. impact on hydrocarbons production is the Referendum expected to have? LAER: Prior to the Referendum held on August Vasquez: Not very probable. The Venezuelan gov- 15, observers identified three possible outcomes ernment, through Vice President Jose V. Rangel, to the Recall Referendum: says it will guarantee oil exports and prevent vio- lence regardless of the winner of the August 15th 1) Opposition wins by a large margin; referendum vote. Both President Chavez and the 2) Chavez wins by a large margin; and opposition have repeatedly stated that they will 3) Contested results (due to narrow margin of abide by the Referendum results. On the other votes for the winning party, lack of hand, most of the Opposition sympathizers—who transparency in the process, or evidence of might lead any potential unrest—are already out fraud). of the oil industry. There might have been more eventual unrest if the Opposition had won both Which of these outcomes has taken place, and the recall referendum and the general election that what are the predicted effects on Venezuela’s would have followed, but as of this moment, this hydrocarbons sector? seems unlikely. Vasquez: Even though the National Electoral Council practically declared Chavez the winner LAER: What steps have the government/PdVSA of the vote (by 58% approximately on August 16th), taken to prevent interruptions to oil installations as of August 19th, the Opposition is contesting this during the Referendum like those that occurred result. However, international observance during the strike in late 2002 and early 2003? through former U.S. President Jimmy Carter and the Organization of American States has endorsed Vasquez: Installations have already been milita- the results but has also agreed to conduct selec- rized should anything happen. The vice president tive audits. The Opposition decided not to attend

4 © WorldTrade Executive, Inc. 2004 August 19, 2004 Venezuela Oil Investment

these audits since it considers them rigged (they LAER: How would you sum up the investment point to a sample of all areas whereas the Oppo- conditions in Venezuela’s hydrocarbons sector, sition says specific problem areas should be tar- given the current situation with the Referendum geted) and has called for additional protests. and taking into consideration the sector’s history? What impact this will have is not clear, since all international entities involved and most countries Vasquez: Venezuela has been a major oil producer have recognized Chavez’s victory. Therefore we for over ninety years, and it will continue to sup- are experiencing a mixture of Scenarios 2 and 3, ply a substantial portion of the world’s energy re- but once final figures are given, barring the dis- sources, particularly that of heavier crude oil. The covery of something significantly wrong regard- opportunities for profitable business will continue ing the vote counting (the opposition has made to be present in Venezuela for the foreseeable fu- allegations and is compiling evidence on the sub- ture. Stability has often been difficult to maintain ject matter), Scenario 2 is the most probable one. and uncertainty has existed for the past 15 years The feeling of a transparent result will lead to a (since the population rebelled in 1989 in what was more stable political climate once audits are con- known as “El Caracazo” riots and looting, result- cluded and opposition concerns are addressed. ing in 500 estimated deaths). However, this un- If Scenario 2 results, the outlook for foreign certainty cannot be totally attributed to either the investment will remain pretty much the same as Chavez administration or to the Opposition’s ef- it is now, unless there is a direct confrontation with forts to derail Chavez’s “Bolivarian Revolution” the U.S. Such a confrontation seems unlikely, and the “New PdVSA.” since Venezuela and the U.S. have important mu- Given current high oil prices, and assuming tual strategic/economic interests: the U.S. has a that they stay that way for some time, Venezuela— clear strategic need for Venezuelan crude oil and unlike many of its fellow countries in Latin products, and Venezuela needs the foreign cur- America—has the opportunity to stabilize its rency from its largest oil customer. At PdVSA, economy and pay down significant portions of its the role of the pro-Chavez present management foreign debt—if it properly manages and invests will clearly be strengthened. Most of the former its newfound wealth. Venezuela’s instability, as it employee groups could disband and go into other exists, stems largely from its political and social lines of business or exit Venezuela. Foreign com- problems. Proper fiscal management of its natu- panies will continue their investment plans until ral resources can help to resolve both. As it moves the next political hurdle, when the opposition will to resolve these issues, there is no reason why Ven- attempt to have Chavez removed in the 2006 elec- ezuela cannot continue to be a reliable supplier of tions, still over two years away. The potential for energy to the rest of the world and offer good busi- political unrest and economic disruption under ness opportunities for outside investors. In sum, Scenario 2 circumstances appears to be relatively regardless of the referendum’s final outcome and low. This is especially true if oil prices continue potential political struggles to come, there should at their present high levels. remain many opportunities to invest in Venezuela’s hydrocarbons sector.

Nelson Vasquez (BS in Chemical Engineering,MBA, MS at Rensselaer Polytechnic Institute, in Troy, NY) is a Senior Consultant at Baker & O’Brien Inc., an independent professional consulting firm for the oil, gas, chemical and related industries. His areas of expertise include refinery planning and economics, supply and trading, exploration and production, project evaluation, and financial analysis. Prior to joining Baker & O’Brien, Mr. Vasquez worked for 25 years in Venezuela’s oil industry at Petróleos de Venezuela S.A. (PdVSA) and its subsidiaries including Citgo Latin America. For questions regarding this article, he can be reached at the Dallas office of Baker & O’Brien. Tel: (214) 368-7626. Email: [email protected].

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