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.

21 COMMENTS

  1. I suspect the biggest impediment to increased production will be predictable and stable terms for foreign participation. In the 1990s, when oil prices were low, PSVSA made some production partnerships with foreign oil companies. When the price of oil increased in the next century, the terns of these production partnerships were termed “vendepatria.” Chavez tore up the production partnerships. As the price of oil will go up, and as Chavismo will remain a force of sorts in Venezuela, foreign oil companies will be extremely skeptical about any terms with PDVSA being predictable and stable.

    • Thank you. That is exactly my sentiment. No company is going to trust VZ to honor their word.

      Perhaps this is why VZ is so adamant about paying bond holders. They are trying to cling to the last promise that hasn’t been broken yet.

      • They are trying to cling to the last promise that hasn’t been broken yet.
        That is one of the better explanations I have heard for not defaulting.

    • I agree with you and Ron, this will be a massive challenge. Having said that there are some contractual mechanisms such as allowing again for international binding arbitration in the contracts that could help mitigate this risk.

      Because of this issue you highlight I suspect that the oil industry will not be a short term contributor during an eventual political transition, it will take time for the industry to trust Venezuela and invest again…

  2. Quicker cash will come by paying Halliburton and Schlumberger and get them back to work on increasing existing production and supporting new well programs. That’s where the fast money is.

    Otherwise oil and gas projects requiring changes of laws, agreements and partnering with IOCs often take years to develop and put in production. No matter how “urgent” the requirement, these things just take time.

    • Absolutely. Stimulating and re-working existing wells or those recently taken off-line due to increasing production costs and falling production totals would have a much more immediate positive impact than starting from scratch looking for foreign investment. Both Halliburton and Schulumberger have the technology.

  3. Could one of the many knowledgeable folk here comment on the new Rystad Energy report making the rounds? Among other things like saying the US has the most reserves in the world, it sharply downgrades Vzla’s reserves. I realize it is a methodology thing vs BPSR, but does it really mean that the “largest reserves in the world” thing is massively overstated? tia.

    • Proven reserves have to be profitable to extract, that’s why they increase as price goes up, but should also shrink as prices decline.
      If oil was to sink to $10 then Venezuela’s reserves would be tiny, but at $100 or $200 they are massive

  4. Venezuela has neither the capital nor the know-how to increase production, especially since 2002 when they chased off the experts in PDVSA and replaced them with crooks and idiots who only knew how to kiss Chavez’s butt. What the Maduro government, like the Chavez government, was/is best at is making inflated, ridiculous promises that will never be kept. Remember, these are the people who sit in front of TV cameras and say there is no food crisis, there is no lack of medicine, there is no such thing as inflation, etc. This government simply doesn’t know what to do but cling viciously to power any way it can, blame the usual culprits, keep the upper level lucrative corruption going and keep trying to spread this 21st Century Socialism insanity to other countries.

  5. We have to also consider that there is a global warming aspect to this discussion. We have to realize that in about 30 years, the world is likely to have used up most of its “carbon budget” (the amount of carbon that the atmosphere can absorb while keeping temperatures below 2 degrees C). After that, there will (hopefully) be immense political and moral pressure to leave most of all the oil that is left in the ground and never extract it. So it’s like a giant game if musical chairs: once the world gets serious about global warming, the music will stop and whatever oil we did not extract, will simply stay there for good.

      • Having a big’ol carbon tax imposed on our main export (making its explotation barely profitable) is something that will happen to us and is completely out of our control. The oil consuming countries will impose this and we need to start to face that fact. I give it 30 years before it happens.

  6. A Carbon Tax will make electricity very expensive so that manufactures that require the use of massive amounts of electricity will have an incentive to set up business in a place where the power costs arent so high …………, the greatest threat to fossil fuels ( and they are not all the same, coal being much more a pollutant than natural gas for example) is technology that reduces its use and which allows for the development of cheap alternative forms of energy………., readapting to the production and use of massive alternative sources of energy and the replacement of old ones has a big big price tag , the economy has to be able to afford it and the old days of great unlimited growth seem to be a thing of the past , I fear it will be long drawn out process, ……!!

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