Lagniappe

 

Oliver L Campbell: Petrobras loses
interest in Orinoco belt joint venture

 

It was no great surprise to learn last November that Petrobras was pulling out of the natural gas project, Mariscal Sucre. The gas production and liquefaction project has been on the drawing board for over 15 years, but PDVSA cannot make up its mind about the amount of gas that will be available for liquefaction and export. For any foreign investor, the viability depends on this since gas prices in the local market are purposely set at much below international prices.

However, it did come as a shock to read in December that Petrobras will reduce its investment in the Carabobo I block of the Orinoco Oil Belt from 40 percent to 10 percent, which is only a token participation in the joint venture with PDVSA. A spokesman for Petrobras said, “Despite the huge reserves--some 45 billion barrels of oil in place--production costs are very high because upgrading is required prior to refining, and Petrobras has other, more viable projects in its portfolio.”

If other oil companies are so anxious to invest in the Orinoco Oil Belt, why does Petrobras walk away from the opportunity? I don’t have exact figures, but I have used some estimates to calculate that Petrobras would earn in the order of $17.50 per barrel with a price of $75.00 a barrel for a crude upgraded to 16º API. It could even be more since the total production and upgrading cost, including depreciation, which I have assumed to be $15 a barrel, may be on the high side. If the price fell to $60 a barrel, Petrobras would still earn around $12.50 a barrel. My estimated figures are shown in the table below.

Price per barrel of a crude upgraded to 16º API	$75,00	$60,00
Less crude production cost	-5,00	-5,00
Less upgrading cost	-10,00	-10,00
Sub-total	60,00	45,00
Less royalty at 33%	-25,00	-20,00
Income before income tax	35,00	25,00
Income tax at 50%	-17,50	-12,50
Net income for Petrobras	$17,50	$12,50

Assuming Petrobras sends the oil for refining at its Pernambuco refinery, now being built, the added value, after deducting freight and refining costs, should be at least $10 a barrel. In other words, the integrated profitability from production, upgrading and refining looks most attractive, so why has Petrobras lost interest in investing the 40 percent?

Is there a rational explication? Indeed there is, and it has to do with what the economists call the “opportunity cost.” This is Petrobras’s best alternative to investing in the Orinoco Oil Belt. Apart from putting money into producing wells, Petrobras would have to invest in an upgrading plant. The latter could cost some $2.5 billions, for which Petrobras would have to contribute $1 billion. But this money could be put into another project with a better return. The one that stands out is development of the new oil discoveries in the pre-salt rocks offshore Brazil.

This development offshore in deep waters will require huge investment but--and this is the crucial point--all the royalty and income tax payments will remain in Brazil and not in Venezuela. In any State company, all the difference between income and costs accrues to the State. The crude found in the new province is a light one, so its current value is around $90 a barrel. Assuming the production cost is as high as $20 a barrel, because it is offshore in deep water, that still leaves a margin of $70 a barrel. It is not surprising Petrobras prefers to invest in Brazil rather than Venezuela.

If a State has oil, it makes commercial sense for its State company to produce the oil in that country before it does so in a foreign country. The royalty and the income tax paid abroad is money given away whereas, with indigenous production, both those items remain in the country as part of the government take. It is notable when PDVSA forms a joint venture in Bolivia and Ecuador to produce oil, the motivation can only be political since PDVSA will only take home its share of the net income. This is a fact and not a criticism since, if the government of Venezuelan wishes to be altruistic and help a neighbour, that is its decision. However, it is a decision that gives away a considerable sum when compared with alternative of investing in Venezuela.

In the same vein, PDVSA’S 40 percent investment in the Pernambuco refinery is a questionable one since the added value from refining will be subject to income tax in Brazil. It would have been much better to construct a refinery in Venezuela, with deep conversion capacity, to process the upgraded crude. The 2007 capital budget had a provision of $3.4 billions for refining projects, though it is to be seen how much of this was spent. Exceptionally and for strategic reasons, as in the case of CITGO, it is necessary to invest in refineries abroad. But why incur income tax on the refineries’ foreign earnings when there is no need?

Until a year ago, Brazil did not produce enough oil for its domestic consumption so it made sense to explore for and produce oil outside the country. Brazil is now self-sufficient, though it will doubtless continue with its many international operations. However, it is almost certain that Petrobras will now put more emphasis in increasing national production because it produces such a large government take. Venezuela’s situation is quite different since it has so much oil that it has no need to look for it elsewhere.

However, PDVSA’S and Petrobras’s situation is similar to the extent they both generate more funds for the government by producing and/or refining in their own countries rather than abroad. Petrobras is an international oil company and it will not cease to invest in producing oil abroad. However, it makes no commercial sense for PDVSA to produce oil abroad since it will pay both royalty and income tax on the earnings there.

If PDVSA is short of funds for investment, as many think is the case, it should look very carefully at any proposals to invest abroad when investments in production, upgrading and refining in Venezuela are obviously more profitable.

 

Oliver L Campbell, MBA, DipM, FCCA, ACMA, MCIM was born in El Callao in 1931 where his father worked in the gold mining industry. He spent the WWII years in
England, returning to Venezuela in 1953 to work with Shell de Venezuela (CSV), later as Finance Coordinator at Petroleos de Venezuela (PDVSA). In 1982 he returned to the UK with his family and retired early in 2002. Petroleumworld does not necessarily share these views.

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Petroleumworld News 01/08/08

Copyright© 2008 Oliver L Campbell. All rights reserved.

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