Caracas Chronicles

Last time, I discussed how hard it will be to realize Venezuela’s oil potential. Even producing 40% of our reserves (i.e. 3.7 million barrels per day flat until year 2100, just to pick some numbers) is far from easy.  Maintaining the status quo will not deliver this, so urgent structural changes must occur to make it happen.

Today, the Venezuelan State (including PDVSA) is practically broke. PDVSA does not have the financial muscle to maintain oil production, and certainly no capital to increase it. The first structural reform is to allow for private participation in the oil sector and to make State participation optional rather than mandatory.

The constitution states that the Republic owns all hydrocarbon resources, whatever their nature, (article 12) and the State reserves “petroleum activities” to itself (article 302).  I’m no lawyer, but in my view this does not mean that the government must actually extract the oil.  They can decide to assign extraction rights or contract the private sector to make it happen – especially given that the State is broke.

Maybe my energy lawyer friend Carlos Bellorin can comment and enlighten us…

The hydrocarbon law (a.k.a., the oil law) is less ambiguous and plainly incompatible with the reform proposed here.  Article 22 of the oil law mandates that the State, either directly or through PDVSA, or joint ventures (aka Empresas Mixtas) with more than 50% ownership of the State, must execute extraction activities. This is an area where reform is necessary.  It could be simply resolved allowing the private sector (without State participation) or joint ventures with minority State participation, to extract and commercialize the oil.

In principle, this should not be a big deal.  Firstly, the Venezuelan gaseous hydrocarbon law (aka gas law) created by Chavismo, which I personally think is fairly decent, is a valid precedent as it allows for private participation in gas production without mandatory State participation – so why should it be different for oil?  It is a hydrocarbon after all.

Reduced state participation is also a regional trend in traditionally big oil countries that cannot be ignored.  In Mexico and Brazil for example, the government realized that forcing their national oil company to be the sole operator and investor in the oil industry over stretches know-how and capital.  The result: underinvestment, suboptimal development of oil resources and ultimately decline in production and revenue.

Mexico broke the historical Pemex monopoly by opening the oil industry and Brazil is preparing to revert the 2010 pre-salt law to to relieve Petrobras of its position as sole operator of Brazil’s pre-salt (the Brazilian version of our Faja, just smaller, underwater and with much higher quality oil).

Exploration and development opportunities are plentiful around the globe, especially with governments making way for the private sector, and investment appetite is limited. So what can we do to be attractive?

Reforming fiscal policy is the other fundamental change we need.  Taxes for oil & gas companies, including PDVSA, need to be competitive depending on the type of hydrocarbon (so investing in Venezuela is more attractive than investing elsewhere), they need to be predictable and stable (so firms can make long term investments) and they need to be simple (complexity is costly and confusing).  It’s not rocket science, all it takes is some excel modeling to come up with fiscal terms (say tax and royalty) that deliver a fair return to private investors in current market conditions AND that are attractive relative to our competitors.  These fiscal terms will also need to take into consideration other factors such as country risk (very high for Venezuela) and exploration risk (very low for the Faja for example).

Some people will react to this proposal by saying that if implemented we would be giving away our resources.  My response to that is simple.  In the context of a broke State like ours and natural resources with an expiry date, it is better to have some of something than all of nothing.

We urgently need to implement legislative reform and adjust energy policy to maximize oil production and fast. Participation of the private sector will be fundamental, and that can only be achieved through competitive and stable fiscal terms that not only provide fair compensation but also help offset our high country risk. This approach assumes direct participation of the private sector (with all the side benefits of employment, investment, etc.) and at least indirect participation of the State through taxation (for redistribution back to society later on) – by the way the government take under the current gas law is circa 60% of profits and more than 80% under the current oil law, quite a chunky slice in my view.  This approach is also compatible with the constitutional principle of the Republic owning the barrels and having a national oil company like PDVSA running its legacy hydrocarbon activities.

I do still believe that the direction in the short term is to realize The Shocking Potential of Natural Gas and Condensate as a first step and in parallel implement the structural reforms needed to reach 3.7 million barrels per day of production, or pretty much whatever production level we wish, in the medium to long term.  Clearly the constraints to unlock this path are not oil reserves but the lack of political will to create the right terms and conditions that will attract the very needed financial resources to make it happen.  It is in our power to change that.