US embassy cable - 05CARACAS1139

C O N F I D E N T I A L SECTION 01 OF 02 CARACAS 001139 
 
SIPDIS 
 
NSC FOR CBARTON 
ENERGY FOR DPUMPHREY AND ALOCKWOOD 
TOKYO FOR SFLATT 
 
E.O. 12958: DECL: 04/17/2015 
TAGS: EPET, EINV, PGOV, VE 
SUBJECT: VENEZUELA:  PLAN PETROLEUM SOVEREIGNTY ADVANCES 
 
 
Classified By: Acting DCM Abelardo Arias; for reasons 1.4 (b) and (d) 
 
------- 
SUMMARY 
------- 
 
1, (C)  With announcements about the proposed forced 
migration of contracts to vehicles under Venezuela's 2001 
Hydrocarbons Law as well as changes in oil sector income 
taxes, the GOV has launched another strong attack against the 
legal basis of current international oil company operations 
in Venezuela.  Energy attorneys are skeptical that the GOV 
has the wherewithall to negotiate the migration of the 32 
Operating Service Agreement (OSA) contracts within the next 
eight months.  One attorney believes the tax announcement was 
intended to be a further spur for companies to line up to 
migrate their contracts.  With the exception of ExxonMobil, 
we believe the companies will cave.  Current oil prices as 
well as Venezuela's large reserves give them incentive to 
hold their tongues and negotiate.  End Summary. 
 
-------------- 
ALL OUT ATTACK 
-------------- 
 
2. (U) In an all out attack on what the PDVSA publicity 
machine has dubbed "the pernicious" Oil Opening of the 
1990's, Energy Minister/PDVSA President Rafael Ramirez 
announced April 14 that the GOV will force the migration of 
the 32 Operating Service Agreements (OSAs) to mixed companies 
under the Hydrocarbons Law by the end of 2005.  Ramirez also 
alleged that many of the companies have not been paying the 
appropriate income tax.  Thus, he said, the Ministry had 
instructed PDVSA to cap its payments to the operators at 
66.67 percent of the value of the crude produced.  Following 
Ramirez's statements, on April 15, President Chavez announced 
in a televized cabinet meeting that the taxes on the four 
projects that process the extra heavy crude of Venezuela's 
Orinoco heavy oil belt would be increased from 34 to 50 
percent.  Ramirez subsequently said that the 50 percent tax 
rate will now apply to all operators. 
 
---------- 
BACKGROUND 
---------- 
 
3. (U) In the 1990's, as an important part of its "Oil 
Opening" (Apertura Petrolera), PDVSA offered three bidding 
"rounds" of marginal oil fields to international bidders. 
The international oil companies (IOCs) that bid on these 
fields took over field operations under operating service 
contracts.  The companies did not receive equity in the 
fields.  The contract provisions for the three rounds vary. 
The first and second round contracts, for instance, 
stipulated specific royalty provisions (16.67 percent) while 
the third round contracts contained only a general reference 
to the royalty applicable under Venezuelan law.  The income 
tax levied on the projects was 34 percent, or the tax on the 
oil sector prior to the 2001 Hydrocarbons Law.  The GOV's 
refusal to grandfather these contracts was one of the 
controversies surrounding passage of the Hydrocarbons Law. 
At that time, the GOV argued that the contracts would be 
protected by non-retroactivity provisions of Venezuela law. 
Now, however, the GOV is arguing that the contracts were 
illegal because they were never approved by the National 
Assembly and that they were not true "service" contracts. 
 
------------------------ 
WHAT IS A MIXED COMPANY? 
------------------------ 
 
4. (C) Local energy attornies are skeptical that the GOV has 
the staff or the wherewithall to negotiate the migration of 
the 32 OSA contracts in the next eight months.  For one 
thing, there still is no model for what a "mixed company" 
might look like and how it might operate.  Attorneys in the 
local offices of Steel,Hector & Davis have worked for over a 
year with PDVSA to develop a draft but Vice Minister Bernard 
Mommer has now reportedly rejected it.  The list of other 
outstanding issues is long:  how would company sunk costs be 
valued for migration to a mixed company?  How would PDVSA pay 
for its 51 percent share in each mixed company?  What would 
be the tax implications of a transfer of company assets from 
an OSA to a mixed company?  How much control would the 
companies have over field operations?  What arbitration 
provisions would apply?  And so on.  It does appear, however, 
that the GOV realizes it will have to grant more acreage or a 
longer contract as compensation to the companies that agree 
to migrate their contracts. 
 
5. (C) Gabriela Rachadell, a partner in the energy division 
of Canadian law firm MacLeod Dixon, noted to econoff that it 
will be interesting to see on what legal basis the GOV plans 
to implement the tax increase on the extra heavy oil projects 
particularly.  Two of the four projects, she said, have 
provisions in their contracts that stipulate a 34 percent tax 
rate while the other two have non-discrimination clauses. 
Rachadell believes this decision could be fought, although it 
would have to be handled through quiet negotiations.  The tax 
increase for the OSAs would be more difficult to fight, she 
said, but not impossible.  Rachadell, however, believes the 
April 15 GOV announcements about tax changes were intended to 
put more pressure on the companies to line up to migrate 
their contracts. 
 
-------------- 
COMPANY OPTICS 
-------------- 
 
6. (C) In April 18 calls to a number of the IOCs, we were 
informed that they are "considering their options."  However, 
with the exception of ExxonMobil, which is now consulting its 
corporate headquarters following an unsatisfactory meeting 
with Mommer, we believe the companies will cave.  A recent 
meeting between the Ambassador and Harvest International CEO 
Peter Hill provides interesting insight.  The Ambassador 
asked Hill how low oil prices would have to drop before it 
became uneconomical for the company to operate its South 
Monagas Unit, a first round asset acquired in 1992.  Although 
Harvest was particularly hard hit by the GOV's decision in 
late 2004 to cap its 2005 capital investment program, Hill 
acknowledged that the company had just had its best quarter 
ever.  Oil prices would have to drop as low as $12-14 per 
barrel, he said, before it would become uneconomical for the 
company to continue to operate its three South Monagas 
fields.  In sum, current oil prices as well as the 
attractiveness of Venezuela's large reserves will give the 
companies the incentive to hold their tongues and negotiate. 
 
 
------- 
COMMENT 
------- 
 
7. (C) Since its inception in 1998, the Chavez administration 
has made no bones about its dislike of the contracts 
associated with the "apertura" of the 1990's.  In May 2003, 
at the Houston Offshore Technology Conference, then Vice 
Minister of Energy Luis Vierma first said publicly that the 
GOV would seek to re-negotiate the OSA contracts.  Two years 
later, with Bernard Mommer, the intellectual author of 
Venezuela's oil policy firmly in place as Vice Minister, the 
GOV is now ready to play hard ball. 
Brownfield