US embassy cable - 05CARACAS2807

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 002807 
 
SIPDIS 
 
NSC CBARTON 
ENERGY FOR CDAY, DPUMPHREY, AND ALOCKWOOD 
STATE FOR EB/ESC/IEC/EPC MMCMANUS 
 
E.O. 12958: DECL: 09/15/2015 
TAGS: EPET, EINV, VE 
SUBJECT: THE OIL AND GAS SECTORS: NEW DETAILS EMERGE 
 
REF: A. CARACAS 01496 
 
     B. CARACAS 02506 
     C. CARACAS 02387 
     D. CARACAS 02596 
 
Classified By: Economic Counselor Andrew Bowen for Reason 1.4 (D) 
 
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SUMMARY 
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1.  (C) The GOV announced the winning bids for Phase A of the 
Rafael Urdaneta offshore gas tender on September 8.  Five out 
of a total of twenty-nine companies that purchased data packs 
bid on four blocks.  An oil executive, who previously held 
senior positions in PDVSA, expressed surprise over the size 
of Gazprom's bids but said Chevron's bid made sense.  The 
GOV's position regarding back taxes owed by companies with 
Operating Service Agreements (OSAs) has raised a number of 
legal questions that it has studiously avoided.  Finally, the 
eight companies that signed MOUs for development of eight 
blocks of the Faja that contain heavy and extra heavy crude 
may not have received as good of a deal as originally 
thought.   END SUMMARY 
 
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Rafael Urdaneta Offshore Bid Round 
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2.  (C) The GOV announced the winning bids for Phase A of the 
Rafael Urdaneta (located beside the Paraguana Peninsula) 
offshore tender on September 8. Gazprom was awarded Urumaco I 
with a bid of USD 15.2 million and Urumaco II with a bid of 
USD 24.2 million.  Chevron was awarded the Cardon III with a 
bid of USD 5.6 million.  A Petrobras/Teikoku consortium bid 
on Urumaco III but the GOV did not accept the offer on the 
grounds it was too low.  The Italian oil company ENI bid on 
Urumaco II but lost out to Gazprom.  Although twenty-nine 
companies purchased data packs, only five actually bid. 
Vinccler Oil and Gas was going to bid on the La Vela Sur 
block but decided against it on the grounds that the block 
was too small.  Under the best conditions, the reserves in an 
area the size of La Vela Sur would have required a gas price 
well above what the GOV would have permitted in order for the 
block to be commercially viable.  Since production from 
Rafael Urdaneta is destined for the domestic market, Vinccler 
did not believe the block was commercially viable. 
 
3.  (C) An oil executive who previously held senior positions 
in PDVSA told Petroleum Attache (Petatt) that his company 
purchased a data package but did not bid because it did not 
think it could develop the blocks in an economically viable 
manner.  He stated he was mystified by the Gazprom bids 
because he believed the Urumaco I block was much better than 
Urumaco II.  He noted, however, that his company did not 
believe that either block held significant amounts of 
reserves that could be developed in an efficient manner. 
 
4.  (C) When Petatt expressed surprise that Chevron bid in 
the round, the executive said it made perfect sense.  He said 
senior Chevron executives told him the company wanted to 
significantly increase its activities in the gas sector and 
viewed Venezuela as an ideal location since the sector was 
underdeveloped.  Although Rafael Urdaneta's production is 
slated for the domestic market, the executive believes 
Chevron is willing to invest in the project since Rafael 
Urdaneta's production combined with potential production from 
Mariscal Sucre should sate the domestic market's demand. This 
would allow Chevron to export a greater percentage of gas 
production from its crown jewel, the Deltana Platform, which 
is located east of Trinidad and Tobago.  The executive 
believes Chevron will try to participate in Mariscal Sucre, 
which is located west of Trinidad and Tobago, for the same 
reasons. 
 
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TAXES 
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5.  (U) As reported in Reftels A and B, oil companies with 
OSAs are facing a GOV audit. The GOV claims the companies owe 
substantial back taxes because the oil companies are acting 
as "oil producers" rather than "service companies".  Service 
companies have a 34 percent tax rate, do not pay royalties, 
and are subject to municipal taxes.  Oil producers have a 50 
percent tax rate, are required to pay royalties, and are not 
subject to municipal taxes. 
6.  (C) According to an international oil company's (IOC) 
general counsel, oil companies operating under an OSA do not 
take title to hydrocarbons.  The companies under the OSA were 
required to purchase capital goods on behalf of PDVSA.  Under 
the OSA, the companies' compensation is based on the 
following formula:  Prorated capital expenses plus operating 
expenses plus interest expense plus production incentives. 
Since companies' compensation is limited by a maximum total 
fee, they are permitted to roll over capital expenses over a 
period of 20 years.  Companies earn interest on capital 
expenses that have been rolled over.  The companies' profits 
come from operating expenses and production incentives. 
Since the operating expenses are based on a formula rather 
than actual expenses, differences due to operating 
efficiencies are pocketed by the companies as profit.  The 
GOV bases part of its claim that the OSA companies are oil 
producers on the fact that their compensation fluctuates 
rather than being a set fee. 
 
7.  (C) The GOV has, in the finest tradition of Nelson, 
studiously turned a blind eye to a number of logical 
conclusions that its position reaches.  If companies with 
OSAs are oil producers, then they should be subject to paying 
royalties.  However, the general counsel noted most of the 
OSAs would no longer be economically viable if they were 
subject to royalties.  It appears GOV officials have 
completely avoided the issues of royalties in discussions 
with the oil companies. 
 
8.  (C) The GOV's position also raises doubts about the 
status of independent service companies such as Schlumberger 
and Halliburton.  Up till now, the GOV position appears to be 
that these companies are clearly service companies since they 
receive a fixed fee for their services.  However, senior 
service company officials have told us that PDVSA has 
approached them about providing oilfield services on a risk 
reward basis rather than a traditional fee for services 
basis.  If the independent service companies did decide to 
provide services on a risk reward basis, it is conceivable 
under the GOV's current definition of "oil producer" that the 
service companies could be opening themselves up to higher 
tax rates.  If PDVSA and the GOV are serious about enticing 
independent service companies into taking on more risk, the 
GOV's tax policy may very well have shot this initiative in 
the foot. 
 
9.  (C) The GOV's drive to treat companies with OSAs as oil 
producers appears to have had unintended consequences for 
municipal governments.  As noted above, oil producers, unlike 
service companies, do not have to pay municipal taxes. 
According to industry insiders and the press, Repsol, which 
has signed a transitory agreement to migrate its OSA to a 
joint venture company in which PDVSA has majority control 
(Reftel C), has apparently told municipal governments that it 
will no longer pay municipal taxes.  In addition, Repsol's 
legal counsel told Econ specialist that the municipal 
governments will have to forfeit the taxes that they have 
collected in the past.  Since municipal governments 
frequently receive more in municipal taxes than they do from 
central government funding, the impact on municipal 
governments could be huge.  Deputies from affected areas have 
already made statements in the press claiming the oil 
companies must continue to pay municipal taxes.  The Repsol 
counsel was pessimistic about the company's chances to press 
their claim for back municipal taxes due to the politically 
explosive nature of the claim.  It is not clear whether other 
oil companies will follow Repsol's lead. 
 
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DEVELOPMENT OF THE FAJA 
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10.  (C) The GOV announced, as part of its hydrocarbon plan 
"Siembra Petrolera" (Reftel D), signed MOUs with eight 
foreign firms for the development of eight blocks of the Faja 
area of the Orinoco basin.  The area contains major reserves 
of heavy and extra heavy petroleum.  (Note: Classifying the 
236 billion barrels of Faja reserves as petroleum and 
combining it with the 77 billion barrels of proven reserves 
would give Venezuela the largest liquid hydrocarbon reserves 
in the world. End Note).  Under the MOUs, the firms must 
first carry out studies to certify the reserves in the eight 
blocks.  According to the oil executive who formerly worked 
for PDVSA, officials at the Ministry and PDVSA realized at 
the last minute that the firms would have an inherent 
conflict of interest.  In order to bolster their bargaining 
position when it came time to form joint ventures to exploit 
the blocks, it is in the firms' interest to come up with a 
low number for reserves.  In order to reduce the risk of the 
firms low balling their reserve figures, the GOV placed 
language in the MOUs at the last minute that stated the firms 
may not receive the blocks where they carried out the studies 
to certify the reserves. 
Whitaker