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By James L. Williams

Venezuela

Hugo Chavez has recently announced a policy reversal. He is now welcoming the major oil companies to bid on projects in Venezuela. While this is about Hugo Chavez and his latest policy reversal it also may the harbinger of a trend in other OPEC member countries.

History

Oil was first discovered in Maracaibo in 1922 and dominated by the influence of American oil companies for many years. Venezuela began to exert more control over its own petroleum destiny in 1943 with the advent of the 50-50 agreement with Standard Oil of New Jersey. Juan Pablo Pérez Alfonso, who studied the Texas Railroad Commission's control of oil prices, was a major contributor and probably the designer of what in 1960 became OPEC. By 1960 Venezuela's production had reached 2.85 million barrels per day and accounted for a third of OPEC production and 13.6 percent of total world production. In 1960 it's share of OPEC and world production was roughly comparable to Saudi Arabia today.

By 1970 Venezuelan production reached 3.71 million barrels per day, but fell to third place in OPEC because of rapid growth in output from Iran and Saudi Arabia. The EIA's Energy Chronology notes that July 31, 1971, "Venezuela's Hydrocarbons Reversion Law mandates gradual transfer to government ownership of all 'unexploited concession areas' by 1974 and 'all their residual assets' by 1983." In 1973 Venezuela voted to nationalize the industry effective at the beginning of 1976. From that point annual production dropped to about 2.2 million barrels per day before reaching an annual low of 1.68 million b/d in 1985.

The decline can be assigned to lower investment and loss of the expertise of the major oil companies. Part of the lower rate of investment can be put to declining oil prices which peaked at $38 in 1981 before falling to $10 in 1986.

The downward trend was reversed in the 1990s with the new policy called Apertura Petrolera or the "oil opening." This once again allowed investment by international oil companies in Venezuelan oil production. The results were obvious with production rising to average 3.17 million barrels per day in 1995 as a consequence of the higher investment in exploration and production as illustrated by oil rig count in pink below. Since exploration is both labor and equipment intensive the higher level of drilling due to investment by the international oil companies contributed directly and indirectly to more Venezuelan jobs.

We now switch to another graph on the right. It shows Venezuelan oil production (black) and Venezuela's OPEC quota (red). With the Apertura and the resulting increase in production by 1998 Venezuela was producing far beyond its 2.4 million barrel per day capacity. At the same time OPEC faced a future of lower prices. As has often happened in the past OPEC adjusted its member country quotas to the reality of changes in capacity. Following the upward adjustment, Venezuela was more or less in compliance with the quota system as OPEC proceeded to cut production to support falling prices in 1998 and 1999. A member with sufficient spare capacity can usually increase its share of the OPEC quota by overproducing in a weak price environment as other members know they will not be as effective in controlling prices without that member's participation.

Hugo Chavez took office in 1999. In late 2002 the strike at PdVSA (Venezuela's national oil company) followed by the dismissal of over 40% of PdVSA's employees left the company without many of its most skilled employees. That loss combined with nationalization of over 51% of the interest of international companies investing in Venezuela and the failure of the government to allow sufficient investment by PdVSA left capacity stuck near 2.5 million barrels per day for the last five years. The 60-70 rigs drilling for oil over the last few years is only sufficient to maintain production levels

Current Situation in Venezuela

News started filtering out a week ago that Chavez was putting out feelers to major oil companies including Chevron, Royal Dutch/Shell and Total about investing in Venezuelan oil production. This is obviously a policy reversal brought on by low oil revenues which are down over 60% since August.

Chavez canceled his program to subsidized heating oil to the Northeast. and then faced with bad press reversed a decision not to provide The cycle on this story was about 48 hours. It underlines the difficulties Chavez faces with his foreign policy of largess directed at Caribbean and South American nations.

Apparently the government has extended the breath and depth pf price controls on food, which will certainly lead to longer lines and shortages. This may lead to closure or nationalization of many agribusinesses.

The EIA expects OPEC export revenues to drop 54% in this year based upon a forecast of $43.25 per barrel for WTI in 2009. Applied to Venezuela that means oil revenues will fall from $59 billion dollars to about $27 billion and per capita oil export revenue from $2,251 to a little over $1,000. Chavez will use Venezuelan reserves to fund part of the the difference but the primary source of funds for his massive social spending has just been cut in half.

Chavez is once again pushing a referendum that will allow him to run for reelection after his term expires in 2012. It did not pass the last time when the economy was in better shape. Protesters of the referendum were recently greeted with plastic bullets and water cannon.

He has often benefited in elections from some votes garnered from those he can convince the Venezuelans need his protection from that Great Satan George Bush.

Conclusions for Venezuela

Some of the majors may try to take another bite at the Venezuelan apple. Given the recent experience with nationalization they will want lower royalties, lower taxes and a higher percentage of ownership. Because of uncertainty under Chavez of Venezuela keeping its side of the bargain, they will have a strong preference for projects with an immediate return rather than super heavy oil projects with the costly upgraders. Offshore projects might present some protection from repatriation but not much. >>>

On the other hand, with the very long term planning horizons of major oil companies it is possible that some will take on the politically risker projects with the hope that by the time they are ready to start producing in 3-5 years Chavez will be out of power.

Unfortunately for Venezuela given Chavez' desire to maintain power a regime change may only come at the expense of massive civil unrest.

Larger Lessons from Venezuela

While some of these are simplistic its does well to keep them in mind.

With rare, if any, exceptions international oil companies outperform national oil companies in developing reserves and increasing production.
Many leaders of resource rich countries use current resource revenue to maintain power at the expense of reinvestment in productive capacity.
Unilateral changes in contract terms or outright nationalization is more likely in a high oil price environment.
International oil companies are more likely to be invited to enter new projects or expand capacity in a low price environment.
Terms (royalty, taxes) will be more favorable to international companies in a low price environment.
Some international companies may discount current country leadership in expectation of more favorable future rulers.
Greater country risk favors projects with greatest short term return.

James L . Williams is a well known energy analyst and President, WTRG Economics, a firm that provides analysis, planning, forecast and data services for energy producers and consumers. (jlwilliams@energyeconomist.com )
Petroleumworld does not necessarily share these views.

Editor's note: This commentary was originally published by WTRG Economics , on Jan 29, 2009, its Energy Economist Report. Petroleumworld reprint this article in the interest of our readers.

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