Oil production problems in Venezuela

I have been very busy these days so no posting time. However I could not pass on a couple of choice items.

There is the rather dismal failure of the Margarita pseudo summit, reported here by Miguel. And I will pass on the video where Uribe and Lula are laughing at the silliness of Chavez.

And there is a little gem from Maria Anastasia O'Grady, ever sharp on Venezuela matters. I have observed that lately the pro Chavez lobby in Venezuela is making a frontal attack on any guy form the foreign press that does not like Chavez. I have even received reports from faithful readers of similar activities on this corner of the blogosphere from the pro Chavez cheer leading squad. So I am sure that it will be soon enough the turn of Ms. O'Grady to be crucified, as in character assassination since her arguments as those of the other "victims" of this campaign, are nearly unobjectionable. By the way, crucification of critics seems an appropriate activity I suppose for a Chavez posing under crucifixes these days.

Since the Wall Street Journal is for subscriber only, I give a hat tip to A. who sent me the article posted below, after the "click"

A Crude Power Grab
By MARY ANASTASIA O'GRADY
April 16, 2007, the WSJ

In two weeks' time, Exxon Mobil will complete the transfer of operations at its Cerro Negro facilities in Venezuela to the state-owned oil company Petroleos de Venezuela, known by its Spanish initials as PdVSA (pronounced pay-day-vey-sah).

The Dallas-based company isn't voluntarily relinquishing control, nor is it alone in doing so. President Hugo Chávez has decreed that all six U.S. and European oil companies running exploration and upgrading facilities in the country must turn over operations to PdVSA by May 1, and that they must surrender majority ownership of their projects as well. As to the compensation that Venezuela will pay for these expropriations, negotiations are still under way.

Mr. Chávez has been brimming with bravado as he has shredded these oil contracts and told foreigners to step aside because he's in charge now. But he'd better relish the thrill while it lasts. The move is not good for Venezuela and it will probably end up hitting the commandante of the revolution in the pocketbook. Corruption, incompetence and mismanagement have already taken a big bite out of PdVSA's productivity since Mr. Chávez began politicizing the company in 2001. High oil prices have mitigated the damage to his balance sheet up to now but they won't protect him forever. Meanwhile, this latest assault on property rights threatens to accelerate the steady deterioration of the Venezuelan oil sector and the broader economy, which remains heavily dependent on oil income.

Venezuela nationalized its oil industry in 1976. But in the 1990s, the government decided to sign 25-year contracts with foreign oil companies to form "strategic associations" with PdVSA, for the purpose of exploiting the rich reserves of tar-like heavy crude in the Orinoco Belt.

In the past decade, Exxon Mobil, BP, Conoco Phillips, Norway's Statoil, France's Total and Chevron all have set up shop in the oil-rich region, extracting the thick, black gold, sending it by pipeline to the Caribbean coast and "upgrading" it to make it lighter and therefore useful. U.S. companies send their upgraded Orinoco crude to Gulf Coast refineries specially designed to transform it into gasoline.

The foreign oil companies sank some $17 billion into the strategic associations with mutually beneficial results. The four projects together produce roughly 600,000 barrels a day from a region that, while rich in reserves, offered Venezuela little income potential before upgrading processes were mastered with sophisticated financing expertise and foreign technology.

The Chávez government says that it doesn't anticipate any production problems stemming from the change in operatorship or ownership. From a strictly technical point of view, that forecast may be defensible. It is certainly true that both oil extraction and the upgrading processes could be run by any oil company. Still, given the performance of PdVSA under Mr. Chávez, it is highly unlikely that productivity, investment and income won't suffer.

One problem already looming is labor. Last month Dow Jones Newswires' Peter Millard reported that, though PdVSA has said that it will retain the 4,000 employees who staff the strategic associations for the foreign companies, union leaders are warning that many of the chemical engineers and processing managers are unhappy about proposed pay cuts and are launching job searches.

A shortage of human capital is already pinching PdVSA. In 2002 Mr. Chávez fired 20,000 workers -- many of them skilled -- because he didn't like their politics. Those employees were replaced with politically compliant candidates and production never recovered. OPEC says that Venezuela now produces 2.5 million barrels a day, one million barrels less than in the pre-Chávez era. According to Mr. Millard, this year Nigeria replaced Venezuela as the fourth-largest oil supplier to the U.S.

Declining production at PdVSA may also be tied to a politicized management environment that takes it cues from the state. The Chávez government is notorious for graft and low standards and it would not be surprising to find that similar business practices had crept -- or rushed -- into the state-owned oil company. Nor would it be surprising to see those practices migrate to the strategic associations that will now be run by PdVSA.

The expropriation also threatens to destroy a business model that provides more than the pumping, processing and refining of oil. The marketing divisions of these companies play a crucial role in placing product and keeping transaction costs low. The loss of these networks will also harm Venezuelan competitiveness.

Finally, and perhaps most important, there is the damage to Venezuela's investment profile. PdVSA is already hurting for cash because profits that would otherwise be plowed back into exploration and development are being siphoned off by the government to advance political and social causes. In a robust investment climate, this misallocation of capital might be compensated for by the private sector. But so far investors have had a predictably bad reaction to their loss of property at the hands of Mr. Chávez. Mr. Millard reports that output has fallen an estimated 60,000 barrels a day to 440,000 at the 32 fields "as the companies affected by PdVSA's takeover halted new investments."

Mr. Chávez seems to think he can solve this by inviting China National Petroleum Corp. into Venezuela. But, as Mr. Millard reported from Caracas last week, CNPC has a dismal track record in the Venezuelan oil fields. In 1997 it committed to two oil-field blocks with a plan to raise production to 50,000 barrels a day in each field. By March 2006, one field was yielding 16,500 barrels a day while the other was still running at its 1997 production rate of 4,400 barrels daily, even though CNPC had doubled the number of active wells to 84. One former PdVSA project manager said that in 2001 CNPC drilled six dry wells at Caracoles, a field with 218 million barrels of proven reserves.

Exxon Mobil CEO Rex Tillerson said last month that if the terms of compensation offered by Venezuela are not acceptable to the company, it would leave Cerro Negro entirely. That would mean eating a loss, but with Mr. Chávez pulling stunts like he did in January, when he slashed production quotas for the foreign companies so that he could meet OPEC cuts without hampering PdVSA sales, the risks of walking away may be lower than perceived. In the end, an Exxon exit would probably end up costing Venezuela even more.


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