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Contents
Introduction 3
Figure 1 - Proven oil reserves / Figure 2 - Oil production / Figure 3 - Refinning Capacity 4
Financial partners10
Figure 5 - PDVSA: production costs Figure 6 - Investment plan 2013/2019 /Figure 7 - Joint ventures of the orinoco oil belt
10 13
Conclusion16
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Introduction
Venezuela has the largest oil reserves in the world. With 297.6 billion barrels of crude oil, by the end of 2012 the country controlled 17.8% of all proven global reserves. Although recently the country has managed to significantly increase its oil reserves through new technologies that make the exploitation of heavy and extra-heavy crude oil feasible, oil production levels have fallen steadily since 1999, when former president Hugo Chvez began his first term. The state-owned oil company Petrleos de Venezuela (PDVSA) is the protagonist of this decline. PDVSA holds a monopoly on hydrocarbons in the country, forming partnerships with private partners but always retaining control of the projects. The key reason that PDVSA has not been able to transform its enormous potential into concrete resources is that the company is used as a central element in the Venezuelan economy, contributing nearly 60% of government revenues, says Asdrbal Oliveros, managing partner of the consulting firm Ecoanaltica, in Caracas. While the increasing support the company gives to social programs was one of the main factors in the decline in Venezuelas poverty levels from 49.4% in 1999 to 23.9% in 2012, according to figures from the Economic Commission for Latin America and the Caribbean (ECLAC), the tax burden on PDVSA was also used in the last fifteen years to finance items ranging from government operating costs to purely political objectives, such as the election campaigns of the ruling party. This ended up being too heavy a burden on PDVSA, especially considering that oil is also used as the enforcement arm of the so-called oil diplomacy, a strategy that began under President Chvez and consists of bartering oil for money or goods at very favorable conditions for importing countries. This drain on resources is compounded by heavy losses in the local market due to the very low prices at which gasoline is sold. Topping off the mix is a legal and policy framework that is far from encouraging private investment in the hydrocarbon sector. The result is a stateowned oil company that is overburdened with work and has a negative cash flow that prevents it from increasing its production levels, plus a financial debt that was around US$40 billion at the end of 2012, up 150% from 2007.
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But even in this bleak picture there is hope. The highest expectations lie in the Orinoco Belt, a still underdeveloped area containing the worlds largest deposits of heavy and extra-heavy oil. Here there are 1.36 billion barrels of original oil in place, located, among other areas, in Junn 4 and Junn 10, two of the biggest onshore exploration and production projects in Latin America. New trends in the global oil industry make prospects look even better. Historically, oil companies have not prioritized heavy and extra-heavy oil because its extraction, transportation, and refinement costs much more than light crude oil, but this has been changing. In addition to technological advances, the high oil prices forecast for the coming years and the shortage of light hydrocarbons are factors spurring a resurgence of interest in heavy oil around the world. Capitalizing on these opportunities depends on the course PDVSA takes in the short and medium term. While President Nicols Maduros administration has continued with the policies of the late Hugo Chvez, there are many in the oil industry who believe that the severe fiscal, exchange, and energy restrictions that Venezuela is subject to will end up forcing change earlier rather than later. This report will offer a description of PDVSAs current situation, its main challenges, and where opportunities lie. It will also list the main changes that the Venezuelan government could implement in the coming months and the impact these changes would have on the oil company in the short and medium term.
Figure 1
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Figure 2
Oil production
(Thousands of barrels per day)
2012 Saudi Arabia Russia United States China Canada Iran United Arab Emirates Kuwait Iraq Mexico Venezuela 11,530 10,643 8,905 4,155 3,741 3,680 3,380 3,127 3,115 2,911 2,725 % of world production 13.3 12.8 9.6 5.0 4.4 4.2 3.7 3.7 3.7 3.5 3.4
Figure 3
Refinning Capacity
(Thousands of barrels per day)
2012 United States China Russia Japan India South Korea Italy Saudi Arabia Germany Canada Brazil United Kingdom Mexico France Singapore Venezuela 17,388 11,547 5,754 4,254 4,099 2,887 2,200 2,127 2,097 2,063 2,000 1,631 1,606 1,478 1,395 1,303 % of world total 18.8 12.5 6.2 4.6 4.4 3.1 2.4 2.3 2.3 2.2 2.2 1.8 1.7 1.6 1.5 1.4
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even more evident considering that the portion of heavy and extra-heavy oil within total Venezuelan production is growing: it went from 31.3% in 1999 to 50.1% in 2008. This requires higher expenditures on upgraders (smaller scale than a refinery) to improve oil quality, given the natural decline in conventional oil fields in the Maracaibo-Falcn basin (western region) and El Furrial field (eastern region), which is where most of PDVSAs production has come from in recent years. The delay in constructing upgraders is not the only infrastructure issue pending. The lack of infrastructure development in the Orinoco Oil Belt is a serious constraint on increasing PDVSAs production, says Igor Hernndez, coordinator of the International Center on Energy and the Environment of the Institute of Management Studies (IESA) in Caracas. This is an area that has not traditionally focused on oil, and therefore it lacks development, such as pipelines to transport production to the ports, for instance. This is compounded by a lack of human capital. For example, Chinese drills have been bought, but there is no one trained to use them, says Hernndez. Lastly, another major reason that PDVSAs production levels remain low is the massive debt that the company has been accumulating with suppliers. In late 2012, its debt was US$16.5 billion dollars. According to PDVSA, this amount fell at the end of the first half of last year to US$12.5 billion, although this has not yet been audited. What is certain is that debt to suppliers ended up affecting PDVSAs productive dynamic, especially in mature and conventional fields, which account for nearly 100,000 Mb/d of reserves. While the large multinational companies are interested in the Orinoco Belt, service companies like Schlumberger and Halliburton are looking to develop mature fields, says Pin. But for this to happen, these companies have to be respected and their bills have to be paid.
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Figure 4
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English teachers sent from Jamaica. The value of these products and services is not determined by market prices, since the agreement states that Venezuela can offer special prices as a mechanism of solidarity with the recipient countries. Also, there is the impact of the payment of a revolving credit for around US$40 billion that Venezuela has with the China Development Bank for investments in different economic areas, including housing and agriculture, transportation and industry, roads, electricity, mining, health, science, and technology. In this agreement, between 270,000 and 300,000 b/d, or about half of Venezuelas shipments to China, go just to pay the loan, says Oliveros. Since the agreement is managed by the Bank for Economic and Social Development of Venezuela (Bandes), PDVSA does not see these resources reflected in its cash flow, and this ends up having a strong financial impact on the company. The agreement is designed for the Venezuelan government to cover its extrabudgetary expenditures and not to benefit PDVSA. But international agreements are not the only reasons that the state-owned oil company has a reduced foreign exchange flow. Low gasoline prices in the domestic market and the growing use of gasoline and diesel in thermal power plants have caused an increase in domestic demand in recent years. The conclusion is that the export volumes that bring PDVSA actual cash are less than 1.7 Mb/d, well below the 2.4 Mb/d in 2007. This decline means there is between US$80 million and US$90 million per day that the company no longer receives. On the other side of the equation, imports are on the rise. The fall in production combined with a sharp rise in domestic demand and a precarious network of refineries has transformed Venezuela into a net importer of gasoline. The country bought 25,000 barrels per day of gasoline and 21,000 barrels per day of diesel from the United States alone between January and July of 2013. Between the two fuels, purchases abroad in seven months of 2013 totaled US$1.161 billion, 78% more than in the same period of 2012.
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Figure 5
* The production cost per barrel is calculated by dividing the sum of direct and indirect production costs (excluding depreciation and depletion) by total volumes Source: PDVSA
Financial partners
After taking office in March 2013, President Nicols Maduro has stayed the course outlined by Chvez for PDVSA. However, analysts believe that due to the plight of the oil company and of the Venezuelan economy in general, a number of changes are looming. Since the electoral landscape cleared at the end of 2013, the Venezuelan government has made some indications that there will be adjustments, says Hernndez. These changes will pave the way for PDVSA to at least begin approaching medium term production goals. The company has repeatedly failed to reach its targets. For instance, in 2005 Chvez launched his Oil Sowing plan, which was set a production goal of 5.8 Mb/d in 2012. The company, from achieving what would have been a 76% increase in production levels, experienced a decline of 8.5% in this period, according to official PDVSA reports. Authorities set a new target of 4 Mb/d of crude oil production in 2014 although this was reduced to 3.3 Mb/d in December last year and 6 Mb/d in 2019. The great hope lies in the Orinoco Belt, which has 4 blocks Junn, Boyac, Ayacucho, and Carabobo, plus neighboring fields like Morichal that have been appended. In 2010 the Venezuelan government tendered a large number of areas, which allowed two consortia led by PDVSA, in alliance with the Spanish company Repsol and the US company Chevron, to participate in the Carabobo block in the Belt. It also directly allocated several areas in the Junn block to the Italian company Eni, Vietnams PetroVietnam, Chinas CNPC, and Russias Rosneft and Lukoil, among other companies. In every
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case, PDVSA has more than 60% of the shareholding. These projects add to the joint ventures that emerged after the nationalization of hydrocarbons in the Orinoco Belt was decreed in February 2007. According to PDVSAs audited financial statements, production in the Belt was 1.17 Mb/d in 2012, and the Venezuelan government wants to raise this number to 4 Mb/d by 2019. It is an ambitious plan, but PDVSA has not yet begun to bridge the gap between its current levels of production and target levels. An example: in early 2012 the goal was set that new business in the Orinoco (the joint ventures Petromacareo, Petrojunn, Petromiranda, Petrourica, Petrocarabobo, and Petroindependencia came into being in 2010) would reach between 160,000 and 180,000 b/d of early crude oil production, in which the heavy crude is mixed with a diluent in order to generate exports before the launch of the upgrader. In September of the same year this target was reduced to 100,000 b/d, but with the promise that 2013 production would reach 400,000 b/d. However, these projects plus the Junn 10 block currently produce less than 30,000 b/d. Not only have the partners not guaranteed new investment for the upgraders, there are also significant problems with transporting early production, says Hernndez. There are no pipelines to move it: only 6,000 b/d can be transported. The failure of new businesses in the Belt to meet the early production targets is very problematic, because without these expected contributions, cash flow is insufficient to further the development of the joint ventures. Thus much of the current production still stems from the first projects (Petropiar, Petrosivensa, Petrocedeo, and Petromonagas), created via agreements signed in the 1990s. To help production, last October PDVSA announced an ambitious investment program of US$257 billion by 2019. Besides disbursements to increase production, there are upgrader projects in the Belt to convert heavy crude of 8 API to 42 API with a total processing capacity of 1 Mb/d, and two new refineries (one in Cabruta and the other in the Jose Antonio Anzotegui Industrial Complex) with a total processing capacity of 720,000 b/d. The big question in the oil industry is where these investments will come from, given PDVSAs serious problems generating cash flow. Analysts agree that since the oil company is looking for less burdensome debt mechanisms than debt issuances, a large part of the capital could come from a new scheme that the company agreed upon with some of its minority partners in the Orinoco Belt. These companies use loans to finance joint ventures, with the aim of increasing production levels. The proceeds from oil sales go to trusts, from which private companies withdraw their part based on their shareholding without PDVSAs intervention. This is a secure way to recover their investments.
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Loans provided by partners can be good, because they go directly to increasing production and not to financing the expansion of the Venezuelan state, as is the case with other agreements, says Pin. For instance, in the agreement signed with Chevron in May 2013 to increase production in Petroboscn, the U.S. oil company will grant financing of US$2 billion, which will be deposited in a trust in installments. PDVSA agreed to pay the loan with a Libor interest rate plus 4.5% tied to increased production (expected to grow from 107,000 to 127,000 b/d). In other words, to repay the loan, production has to increase. Under similar schemes, PDVSA reached agreements for more than US$9 billion with CNPC, Rosfnet, Repsol, the Russian financial institution Gazprombank, and the transnational company Schlumberger. So far, PDVSA has been responsible for everything from hiring services to commercializing the products of these projects. But the declared aim with these agreements is to involve partners in the task of increasing production levels. Last October, Rafael Ramrez, vice economy minister, oil minister, and president of PDVSA, said that this scheme would work within the framework of the projects approved by the National Assembly, with the agility and flexibility necessary for these projects to be in the scheduling stage (for production). It is in all our interests to increase production in order to finance the joint ventures. Funding in exchange for greater management control and more responsibility in commercialization are repeated claims by PDVSAs partners. The oil companies demands are to make sure that the past experience of suppliers, who developed a financing scheme with PDVSA and ended up accumulating unpaid loans, is not repeated. While until now PDVSA had not taken the complaints of international companies into account, for some analysts the gravity of the situation is already forcing change. It seems that PDVSA has to give private companies more participation, and even encourage this type of agreement, says Hernndez.
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Figure 6
Figure 7
Source: PDVSA 13
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Analysts believe that with the ability to sell dollars at the Sicad auctions rate, operating costs and liabilities in bolivars of oil companies in Venezuela can be reduced by approximately 80%. For PDVSA, the change also means a substantial improvement in cash flow: it can get a larger amount of bolivars each time it sells dollars from crude oil sales to the BCV. Nevertheless, without a more fundamental change in company management, analysts believe that the benefits of devaluation will be limited in time. Despite the fact that past devaluations have resulted in short-term profit, PDVSAs operating expenses in dollars have almost doubled in the last two years, says Lucas Aristizbal, director of Fitch Ratings in Chicago.
Figure 8
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The gasoline subsidy has not only generated losses in terms of production costs. Increased domestic consumption has also meant a high opportunity cost in shipments abroad, says Hernndez. For example, 95 octane gasoline could be sold abroad at a value 51 times higher than that of the domestic market. Faced with this scenario, in recent months Maduros administration has indicated that it is considering a gasoline price adjustment of between 700% and 3,000%. This measure would give PDVSA some oxygen, although analysts believe that the companys benefits will be marginal. An adjustment of gasoline prices in the domestic market would not improve PDVSAs financial situation in any way; the deficits and debts of the company are too big, says Diego Gonzlez Cruz, Senior Associate E&P and Natural Gas at GBC Global Business Consultants in Caracas.
Figure 9
(*) Thousands of barrels per day (**) Thousands of barrels of oil equivalent Source: PDVSA
Conclusion
PDVSA is at critical point. Production levels continue to fall, debt is rising, and Orinoco Oil Belt projects are not taking off. Paradoxically, this gloomy outlook could open the door for change. The new credit schemes with partners in the Belt projects, announcements of a likely reduction in the tax burden, the devaluation of the bolivar for the oil sector, and the possible increase in prices in the domestic market are all reasons to be optimistic, and more so considering that politically there is room to implement these measures, since there will be no elections until the last quarter of 2015, says Oliveros. But we have to wait. Different forces are at work in the government and we dont know whether these measures will ultimately materialize. This uncertainty also extends to the big global oil companies. While companies such as Chevron, ENI, and Repsol remain in Venezuela, waiting for conditions to change in order to profit from the countrys enormous hydrocarbon potential,
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others have decided to retreat. Last October, Lukoil, the second largest oil producer in Russia, announced that it wants out of the consortium developing the Junn-6 project in the Orinoco belt, which is led by Rosneft. The members of the Surgutneftegas and TNK-BP consortium also decided to abandon their project. And last September, the Malaysian oil company Petronas announced that it was leaving Petrocarabobo, one of the largest projects in the Belt. For now, signals remain mixed. The more flexible and open oil policy implemented by some sectors of the Venezuelan government exist alongside measures that go in the opposite direction, like the expropiation last November of two platforms from the U.S. provider Superior Energy Services, which had taken its units out of service after months of not being able to collect about US$9 million owed. These contradictory messages increase doubts about the path the Venezuelan government is going to take. What is certain is that the high tax burden, the use of PDVSA resources to finance not only social programs but also government operating costs, extremely low gas prices in the domestic market, and exports of crude oil to neighboring countries at disadvantageous terms are some of the factors that have made PDVSA the antithesis of successful state-owned companies like Petrobras or Ecopetrol. The direction the state-owned oil company will take in the coming years will depend on the result of infighting in the Venezuelan government between those who seek to improve PDVSAs conditions and those who prefer to stay the current course.
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