US embassy cable - 04CARACAS546

C O N F I D E N T I A L  CARACAS 000546 
 
SIPDIS 
 
 
NSC FOR TSHANNON AND CBARTON 
ENERGY FOR D. PUMPHREY AND A. LOCKWOOD 
 
E.O. 12958: DECL: 01/29/2014 
TAGS: EPET, ECON, VE 
SUBJECT: GROWING PRESSURE FOR RENEGOTIATION OF OIL SERVICE 
CONTRACTS? 
 
Classified By: AMB. CHARLES S. SHAPIRO; REASONS 1.4 (B) and (D) 
 
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SUMMARY 
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1. (C)  There are signs that the GOV has started playing 
hardball in its efforts to force the oil companies that 
signed operating service agreements in the 1990's to convert 
these contracts into the majority GOV-owned joint ventures 
mandated under the 2001 Hydrocarbons Law.  Public claims by 
the Minister of Energy and Mines that two companies have 
already signed agreements have been disputed but Harvest 
International, a U.S. independent, is currently evaluating 
two oil and gas fields located close to its existing fields 
and hopes to negotiate the first such agreement. 
ChevronTexaco, with the largest exposure of any U.S. company, 
is dismissive of any efforts by the GOV to bring pressure in 
this area but others confirm that in addition to the "carrot" 
of potential access to new fields for those companies that 
review their contracts, PDVSA has used the "stick" of 
refusing to approve capital expenditures proposed by some 
operators in their 2004 budgets and setting production 
constraints for 2004.  For the Chavez government, a win on 
forcing companies to migrate into relationships under the 
2001 Hydrocarbons Law may be more important than a "few" 
incremental barrels from the operating agreements.  That 
said, we do not at this time expect the pressure to reach the 
point where the GOV would outright violate existing 
agreements although it could certainly make it more difficult 
for the companies to do business.  End Summary. 
 
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GOV GETS SERIOUS ABOUT PUSHING HYDROCARBONS LAW? 
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2. (C) On January 12, Minister of Energy and Mines Rafael 
Ramirez_ said publicly that international operators in 
Venezuela will not be able to increase production without 
transferring their operating agreements to joint ventures 
under the terms of the 2001 Hydrocarbons Law.  The Minister's 
comments have been followed by reports that PDVSA is not only 
refusing to approve capital expenditures proposed by the 
operators in their 2004 budgets but is setting production 
constraints for 2004.  The GOV is also still refusing to 
authorize the 2003 transfer of British Petroleum's (BP) 
operating agreements for the DZO and Boqueron fields to 
French independent Perenco and is reportedly arguing that 
while the contracts with BP were grandfathered under the 2001 
law, this would not apply if the contracts were transferred 
to Perenco.  These events have sparked concern that the GOV 
has started playing hardball in its efforts to force the 
companies that signed operating service agreements in the 
1990's to convert these contracts into the majority GOV-owned 
joint ventures mandated under the 2001 law. 
 
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BACKGROUND 
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2. (U) In the 1990's, PDVSA planned an ambitious expansion 
program to capture a greater share of global energy markets. 
An economically viable way to achieve this goal was for PDVSA 
to enter into operating contracts for the reactivation of 
marginal oil fields with foreign investors who had the 
much-needed capital.  The result was 33 "Operating 
Agreements," granted in three investment "rounds."  The 
foreign investors signed 20-year contracts to develop these 
fields at the investors' own expense. 
 
3. (U) Under these contracts, the foreign investors receive a 
fee per barrel produced from PDVSA.  Against this revenue, 
the investors may deduct the operating expenses (i.e, the 
"operating fee") incurred during the year.  A "capital fee," 
to allow the recovery of capital expenditures incurred by the 
foreign investor on behalf of PDVSA, is also recoverable over 
ten years according to a complicated formula.  The contracts 
typically provide for a maximum total fee that may be charged 
by the investor and recovered during any given year.  Any 
fees allowable for the year, but not recovered because of the 
imposition of the maximum total fee, are carried forward to 
 
 
the next year and subject to applicable interest and 
inflation rate adjustments until the costs are recovered by 
the investor.  PDVSA pays royalties on the oil while the 
investor pays a 34 percent income tax. 
 
4. (SBU) The Chavez government, however, has rolled back the 
expansionary policy of the 1990's and made clear it 
particularly dislikes the operating agreement contracts. 
This distaste was codified in the 2001 Hydrocarbons Law that 
stipulated that future private sector investment in the 
Venezuelan oil sector must be through joint venture 
agreements in which the GOV will take a minimum 51 percent 
stake.  The law also increased most royalty payments from 
16.67 percent to 30 percent and changed other aspects of the 
tax structure.  Finally, the joint venture will not be able 
to commercialize the oil it produces, which must instead be 
sold through PDVSA or some other state entity.  Although the 
joint venture model would potentially give a company an 
equity stake in the oil it produces that it does not have 
under the current service agreement model, the companies 
claim that the economics simply do not support investment in 
projects under the 2001 law.   There have, to date, been no 
investments under the law and the GOV continues to complain 
about the administrative costs of managing the contracts and 
that the oil produced under the operating agreement contracts 
is "high cost" oil. 
 
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VINCCLER & TEIKOKU DISPUTE MINISTER,S REMARKS 
--------------------------------------------- 
 
5. (C) In his January 12 remarks, according to press reports, 
Ramirez_ went on to add that two companies, Japan's Teikoku 
and Vinccler, a majority Venezuelan-owned company with a U.S. 
component, had already negotiated conversion of their 
operating agreements to joint venture agreements with PDVSA. 
In subsequent conversations with econoff, executives with 
Vinccler and Teikoku confirmed on-going discussions with the 
GOV concerning new gas (not oil) opportunities in their 
fields but denied that any contracts have been signed. 
Vinccler Technical Manager Emilio Sanchez_ said the Ministry 
had proposed to the company in July 2003 that its current 
operating agreement for the Round II Falcon East block be 
converted into a gas license for the entire area of the 
block.  Noting that the field produces less than 1,000 b/d, 
Sanchez_ said Vinccler is most interesting in expanding its 
business into the production of associated gas and, 
eventually, the development of off-shore gas.  In these 
circumstances, work is ongoing on an agreement to modify the 
operating contract into an agreement for associated gas and 
liquids, under which Vinccler will be paid a flat fee for the 
liquids.  Sanchez_ flatly denied, however, that Vinccler would 
agree to the 51-49 percent structure mandated by the 
Hydrocarbons Law. 
 
6. (C) Matsuro Manabe, President of Teikoku Oil de Venezuela, 
confirmed to econoff on January 23 that Teikoku's current 
interests in Venezuela are also focused on gas opportunities. 
 Teikoku currently has two operating agreements:  the East 
Guarico field acquired in the first round and the second 
round Sanvi-Guere field.  Production from the two fields 
totals about 6,000 b/d.  Manabe explained that the company is 
already producing associated gas from the East Guarico field 
and that seismic data by PDVSA/Teikoku on an adjacent area 
north of the field shows great potential for further gas 
development. 
 
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A U.S. COMPANY HOPES TO BE THE FIRST 
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7. (SBU) A U.S. independent, Harvest International, does hope 
to be the first to negotiate a contract under the terms of 
the Hydrocarbons Law.  Harvest has an 80 percent share in 
Benton-Vinccler, that has operated three small oil fields in 
southern Monagas state since signature of a first round 
operating service agreement in 1992.  In November, Harvest 
announced that it had signed an agreement with PDVSA to 
undertake a six-month evaluation of two oil and gas fields 
(Temblador and El Salto) located close to its existing 
fields.  Any agreement on the two new fields is likely to be 
 
 
accompanied by re-negotiation of the original operating 
services agreement. 
 
8. (C) In a November conversation with econoff, Harvest CFO 
Steve Tholen said that Benton-Vinccler has one of the most 
profitable operating service contracts in Venezuela.  Thus, 
it would be a public relations victory for PDVSA and the 
Ministry if they were able to announce that Harvest had 
agreed its operations could be profitable under the 
provisions of the 2001 law.  The most complex part of the 
negotiation will cover the corporate structure.  Tholen 
emphasized that Harvest would insist on a structure that 
would allow the joint venture to focus on project economics 
and would allow Harvest to both book the reserves and have 
operating control (i.e., of such issues as the accounting 
rules).  According to Tholen, Harvest envisions a structure 
where a majority government-owned joint venture company would 
in turn contract actual field operations to a company in 
which Harvest would hold the majority share.  Benton-Vinccler 
employee John Paul McKee told econoff January 28 that the 
transfer of data from PDVSA needed for evaluation of the two 
fields has gone more slowly than anticipated but that the 
review is on-going. 
 
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LAWYERS AGREE THAT RE-NEGOTIATION WOULD BE TOUGH 
--------------------------------------------- --- 
 
9. (C) Econoff discussed the complexities of re-negotiating 
the operating agreement contracts with several local 
attorneys whose practices focus on energy law.  They all 
agreed that it would be particularly difficult to quantify 
the sunk costs not yet re-paid under the capital fee.  Steel 
Hector & Davis attorney Alfredo Anzola, however, confirmed 
February 9 that his firm has been contracted to draft a model 
joint venture agreement to guide CVP in its discussions with 
companies.  Anzola added that CVP is "under a lot of pressure 
to advance this as quickly as possible" and said the model 
agreement would be provided to CVP that day.  Anzola 
specifically informed econoff that the CVP had said "no" to 
what he called "sham structures" that would allow the private 
investor to control the joint venture operations. 
 
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CHEVRONTEXACO NOT CONCERNED... 
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10. (C) Econoff discussed the issue with ChevronTexaco de 
Venezuela President Ali Moshiri who confirmed that he has 
been asked informally if ChevronTexaco would be willing to 
convert its contracts.  (Note:  With substantial investment 
in the Round Two Boscan field, and the LL-652 field acquired 
in Round Three, ChevronTexaco could have more to lose than 
any other U.S. company from any push by the GOV to force the 
migration of the operating agreement contracts.  End Note.) 
Moshiri said bluntly that he believes Ramirez_ was simply 
trying to make political points in his remarks of January 12. 
 He added that he believes neither PDVSA nor the Ministry 
have legal staffs capable of handling such negotiations. 
(Note:  Steel Hector & David attorney Anzola confirmed that 
the legal staff at CVP are all new hires; he does not know 
yet whether CVP will contract out the negotiating process.) 
When econoff informed Moshiri that the CVP has contracted 
with outside legal counsel to draft a model joint venture 
agreement, Moshiri emphasized that the important issue will 
not be the terms and conditions of any agreement but the 
economics of the deal.  Saying "if we get equity barrels, the 
deal may not be bad," Moshiri said he would be interested to 
see what kind of offers would be made.  He emphasized, 
however, that ChevronTexaco will not accept a deal that 
prejudices the economics of its operations. 
 
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BUT OTHERS ARE SOMEWHAT MORE SO 
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11. (C) Moshiri was also dismissive of reports that PDVSA is 
not only refusing to approve capital expenditures proposed by 
the operators in their 2004 budgets but is also setting 
production constraints for 2004.  Moshiri said "they,re 
telling us to produce."  In subsequent conversations, 
 
 
however, ExxonMobil President Mark Ward and Williams General 
Manager Tim Penton confirmed these reports of problems with 
approvals of capital expenditures to econoff.  (Note: 
ExxonMobil and Williams have non-operational shares in the 
second round Quiamare-La Ceiba and third round La Concepcion 
fields respectively.)  Petrobras, which operates the La 
Concepcion field, reported in the January producers luncheon 
that PDVSA had approved its 2004 budget with severe cuts in 
capital and expenses as well as setting production limits 
below its current production level. 
 
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COMMENT 
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12. (C) There might seem to be a discrepancy between the 
GOV's need for every barrel it can lay its hands on versus a 
strategy in which it would take possible production cuts in 
order to force the producers to accept contract negotiations 
under the 2001 law.  We believe, however, that for senior 
officials of the Chavez government a win on the 2001 
Hydrocarbons Law may be more important than a "few" 
incremental barrels from the operating agreements.  PDVSA 
may, indeed, be losing money on some of these contracts.  We 
do not at this time expect the pressure to reach the point 
where the GOV would outright violate the existing agreements. 
 That said, however, the GOV could definitely make life more 
difficult for the companies. 
 
13. (C) Companies other than Harvest are sure to bite if the 
carrot, perhaps in the form of payment of monies owed by 
PDVSA on their existing investments or new fields, is big 
enough.  Steel Hector & David attorney Anzola believes Shell 
is likely to be the first company approached with the model 
draft, followed by Repsol. 
SHAPIRO 
 
 
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      2004CARACA00546 - CONFIDENTIAL