US embassy cable - 05CARACAS1721

C O N F I D E N T I A L SECTION 01 OF 04 CARACAS 001721 
 
SIPDIS 
 
NSC FOR TSHANNON AND CBARTON 
ENERGY FOR DPUMPHREY AND ALOCKWOOD 
 
E.O. 12958: DECL: 06/05/2015 
TAGS: EPET, EINV, VE 
SUBJECT: OIL COMPANIES WITH OPERATING SERVICE AGREEMENTS 
FACE ADDITIONAL PRESSURE 
 
REF: CARACAS 1496 
 
Classified By: ECONOMIC COUNSELOR RICHARD SANDERS, FOR REASONS 1.4 (B) 
AND (D) 
 
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SUMMARY 
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1. (C) The foreign oil companies holding Operating Service 
Agreements (OSAs) signed in three bid rounds in the 
Venezuelan oil liberalization of the 1990's (the "apertura") 
are now facing additional pressure from the GOV to migrate 
these contracts to mixed companies/joint ventures under the 
2001 Hydrocarbons Law.  The companies have now received a 
proposed "Transition Agreement" from the GOV which would 
force them to recognize that their contracts are illegal and 
would take away their rights to international arbitration. 
In a June 6 luncheon with Codel Renzi, Royal Dutch Shell's 
General Counsel confirmed that PDVSA had asked it to sign the 
document by Friday, June 10.  Tactics to pressure the 
companies include announcements of tax increases (and bills 
for alleged back taxes) and a requirement that companies take 
in local currency money due for internal costs incurred.  GOV 
pressure also includes constant assertions of the unfairness 
and illegality of the OSAs, which oil companies fear may lead 
to a lasting negative impression of them among Venezuelans. 
End Summary. 
 
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A SERIES OF BLOWS 
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2. (C) On April 14, Energy Minister/PDVSA President Rafael 
Ramirez announced that the GOV would force the migration of 
the 32 OSAs to mixed companies by the end of 2005.  (Note: 
Under the OSAs companies have received a per-barrel fee for 
producing on PDVSA's behalf and relatively favorable royalty 
and income tax treatment, including the ability to write off 
development and operating expenses against their tax 
liability.  End note.)  At that time, Ramirez said for the 
first time that the OSA contracts were illegal because they 
had never been approved by the National Assembly and that 
they were not true "service" contracts.  On April 15, 
President Chavez announced an increase in the tax rate on oil 
projects.  On April 20, Minister Ramirez clarified that only 
the OSAs (and not the four Orinoco heavy oil belt joint 
ventures) would be subject to an increase in the tax rate 
from 34 to 50 percent and that the tax increase would be 
effective as of April 18.  On May 10, a senior GOV tax 
official stated that the OSA companies had cheated on their 
taxes to the tune of some $2 billion over the past ten years 
and that it would perform tax audits retroactive to 2001. 
(Note: Local attorneys confirm that the audits will only be 
retroactive to 2001 because of a statute of limitations 
written into Venezuelan tax law.  End note.) 
 
3. (C) Most recently, on May 15, President Chavez announced 
that PDVSA would no longer pay foreign oil company expenses 
in dollars.  And on May 25, Minister Ramirez addressed the 
National Assembly and made additional allegations against 
both the OSA and heavy oil projects.  Company officials note 
that Energy Vice Minister Bernard Mommer was at Ramirez's 
side during his National Assembly appearance and that Mommer 
is now participating in their meetings with PDVSA.  They 
credit Mommer with orchestrating the GOV strategy toward them 
and point to his career as an academic in which he studied 
how to maximize collection of oil rents on the part of the 
state. 
 
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EVEN CHEVRON TAKES A HIT 
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4. (C) Although the noise level against all the foreign 
companies in the OSAs has increased dramatically in the past 
month, it is most notable that Chevron's Boscan oil field 
contract has now been singled out by senior GOV officials. 
Despite the fact that Chevron has seemed to have the inside 
track with this government (most notably in being named, 
together with Spain's Repsol, to develop one of the blocks of 
the Deltana Platform natural gas project), in his May 25 
address to the National Assembly Rafael Ramirez stated that 
the Boscan field Operating Service Agreement had been a 
non-competitive direct award for a field producing 86,000 b/d 
) far from being a marginal field.  Ramirez's comments on 
the Boscan field have since been reiterated by Deputy Rodrigo 
Cabezas, the head of the National Assembly committee 
investigating the contracts between the international oil 
companies and PDVSA.  Cabezas has gone so far as to say that 
the contract should be revoked which has raised significant 
concern among Chevron managers in Venezuela. 
 
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CONTRACT MIGRATION 
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5. (C) Econoff met on May 23 with Eulogio del Pino, President 
of the Corporacion Venezolana de Petroleo (CVP, the PDVSA 
subsidiary which manages contractual relationships with 
foreign oil companies) who explained that the GOV now 
envisions a three-step process for the migration of the OSA 
contracts.  According to del Pino, the first step in the 
process is the valuation of the existing contract assets. 
The second step will be the valuation of the proposed joint 
venture assets, while the third would be the negotiation of 
the structure of the mixed company/joint venture.  Del Pino 
also informed econoff that during this negotiation period, 
PDVSA would not pay any OSA contract holder more than 66.67 
percent of the value of each barrel it produced, i.e., taking 
for the government the 30 percent royalty and an 
approximately three percent administrative fee. 
 
6. (C) Del Pino also informed econoff that the GOV would 
shortly ask the OSA companies to sign a Transition Agreement 
("Convenio Transitorio").  Copies of this draft agreement 
were subsequently received by the companies on June 2-3.  The 
agreement cites that PDVSA will only pay a maximum 66.67 
percent fee, and requires the "contractor" to pay all taxes 
owed to Venezuela's tax authorities.  Signature would also 
require the signing companies to recognize that their 
contracts are illegal and would take away their rights to 
international arbitration.  In a June 6 luncheon with Codel 
Renzi offered by the Venezuelan Hydrocarbons Association, 
Royal Dutch Shell's General Counsel confirmed that PDVSA had 
asked it to sign the document by Friday, June 10.  (Note: 
The GOV is asking companies to sign this document before they 
have received from the government the draft text of the 
proposed mixed company/joint venture agreement.  End note.) 
 
7. (C) In meetings with a number of the OSA companies in the 
week of May 30, econoffs were told that despite the fact that 
the GOV has been saying publicly that several companies are 
well advanced in this process, it is doubtful that any 
company has yet completed the initial valuation of its OSA 
assets, although Spain's Repsol is rumored to be the farthest 
along in this process.  (Note:  ExxonMobil, a minority 
partner in the Quiamare-La Ceiba OSA operated by Repsol, told 
econoffs May 31 that Repsol has not yet approached it about 
its proposed negotiating posture.  End note.)  Despite the 
fact that the GOV appears to be starting this negotiating 
process with companies such as Repsol from its favored 
country partners, it is unlikely that it will allow any one 
company to get too far ahead of the pack.  One international 
oil company president commented to econoffs that the GOV will 
probably advance the negotiations at the same pace in order 
to extract maximum concessions from all the companies. 
 
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DOLLAR PAYMENTS 
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8. (C) Econoffs were told by several companies that they have 
yet to receive their first quarter or April monthly payments 
from PDVSA (some companies receive their "service" fee on a 
quarterly basis and others on a monthly basis).  It is likely 
that this delay is linked to Chavez's May 15 announcement 
about dollar payments although it may also be linked to 
on-going tax threats.  However, a representative of Harvest 
Vinccler (80 pct owned by U.S. independent Harvest 
International) attending the Codel Renzi lunch on June 6 said 
that he had been informed that PDVSA would soon make a 
payment.  A member of the local trade press also informed 
econoff June 6 that he believes PDVSA will shortly make 
payments to the companies that will include 70-80 percent 
dollars and 20-30 percent bolivars.  He noted that PDVSA does 
not yet know how to handle Chavez's May 15 announcement. 
 
9. (C) A local attorney informed econoffs that the Venezuelan 
Central Bank law says that all obligations contracted in 
foreign currencies are payable in local currency unless the 
parties expressly provide otherwise.  Although some of the 
OSA contracts have provisions stipulating dollar payments, 
they do not use the word "exclusively," which, according to 
this attorney, could allow the GOV to get away with payments 
in bolivars. 
 
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TAXES 
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10. (C) As noted above and reported in reftel, as of April 
18, the GOV increased the income tax levied on the OSA 
operators from 34 percent to 50 percent.  On May 10, the GOV 
declared that the companies had cheated on their taxes to the 
tune of some $2 billion and that it would perform tax audits 
retroactive to 2001.  It now appears that SENIAT, Venezuela's 
IRS equivalent, will seek to assess a retroactive 50 percent 
income tax on the companies for the years 2002-2004 and that 
2001 taxes will be retroactively assessed at 67.67 percent, 
the tax rate in effect in 2001.  (Note:  the 2001 
Hydrocarbons Law, which became effective on January 1, 2002, 
increased royalties from 16.67 to 30 percent.  At the same 
time, the income tax was reduced from 67.67 percent to 50 
percent.  The GOV had previously applied a 34 percent income 
tax rate to the OSA companies because, at that time, they 
were considered to be simply supplying a service to PDVSA. 
End Note.) 
 
11. (C) Despite numerous press reports since early May that 
SENIAT has reached agreement on back taxes with multiple 
companies, econoffs have not been able to confirm this and 
believe that the GOV has leaked these reports in order to put 
additional pressure on companies to break ranks.  In 
conversations with a number of the OSA companies the week of 
May 30, company spokesmen underlined that they do not believe 
any company has yet come to an agreement with the Seniat. 
The companies also informed econoffs that SENIAT audit teams 
have been lodged full time in their offices for months. 
 
12. (C) SENIAT authorities have made comments to the press to 
the effect that as much as $744 million is being retained 
while companies make good on back taxes owed.  A local 
consulting firm notes that these monies may correspond to VAT 
reimbursements owed to the 32 operating agreement projects. 
Most recently, the press reports that Seniat will bill three 
companies whose audits have been completed.  The three 
include Royal Dutch Shell, Italy's ENI, and Harvest Vinccler. 
 
 
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COMMENT 
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13. (C) The GOV continues its pressure on companies operating 
in Venezuela's oil sector in a move to extract as much 
revenue as it can. The fallout from this is growing 
uncertainty on the part of the companies that complain that 
their reputations are being unfairly tainted and that they do 
not understand the ultimate intentions of the  GOV.  They are 
worried that they will be perceived negatively by the 
Venezuelan people and that the vitriolic rhetoric that is 
accompanying this campaign could well demonize the companies 
to such an extent that it could put company personnel at 
risk. 
 
13. (C) If taken to its logical conclusion, the claims by the 
GOV against the OSA companies, and particularly the claim 
that the contracts are illegal, could also mean that the GOV 
could refuse to pay the OSA operators again until their 
assets have been migrated to mixed companies/joint ventures 
or they sign the Transition Agreement.  Any such action by 
the GOV would only serve to underline the seriousness of what 
some in the community are now calling "creeping 
confiscation."  It does not appear that the companies will 
make the hurried decisions to sign the "Transition Agreement" 
that the GOV wants.  This may well open them up to escalating 
attacks by other Venezuelan Government entities that impact 
on their operations such as the Labor and Environment 
Ministries. 
Brownfield