A report on Venezuela’s hydrocarbon upstream opportunities

Jan 04, 2004 01:00 AM

by Adriana Lescano

The present political climate in Venezuela is not perhaps for the faint-hearted investor, but life nevertheless goes on in this oil patch. Governments come and go, and the farsighted, knowledgeable and careful companies will likely see a very healthy return on their money down the line, despite the upheavals that affect Venezuelans at this time.
We would like here to talk first of all about a series of new hydrocarbons projects that have recently been presented to potential investors by the Government, and then give our readers an overview of certain aspects of untested legislation that might not be as deterring as it appears at first sight.

So, first the projects. After the promulgation of the new Organic Hydrocarbons Law (OHL) two years back, the Ministry of Energy and Mines and PdVSA's Board of Directors have been offering investors new projects for oil exploration and production. Many believe that these fields in fact constitute a fourth round of Venezuela's oil opening, and experts consider them to be among the best development prospects in Venezuela.
They offer attractive returns, despite the financial and operational constraints imposed by the OHL, but they have to be developed under the framework of joint ventures with PdVSA, and this undoubtedly gave rise to serious misgivings among potential investors, over and above their concerns regarding the OHL. These misgivings and our thoughts regarding the legislation will be analysed later.

Up-and-coming projects
At a symposium held in Washington DC, on July 22nd and 23rd in 2003, Luis Vierma, Hydrocarbons Vice-Minister, revealed the official description of the facts surrounding these fields. Since this information comes from the most knowledgeable source available to us, we will quote him.
There are six fields: Ceuta Tomoporo, Horcon, Franquera 1-X, Domo Norte, Domo Sur, and Guaraní.

Field name -- Estimated resources

Franquera -- 738 mm barrels / 0.4 tcf

Domo Norte -- 96 mm barrels / 0.1 tcf

Domo Sur 173 -- mm barrels / 0.2 tcf

Horcon 115 -- mm barrels / 0.1 tcf

Guarani 149 -- mm barrels / 0.1 tcf

(i) Ceuta-Tomoporo
This field is known as the "jewel of Venezuela" and Ail Rodriguez, ex-President of PdVSA, once said about this project: "PdVSA can manage this project on its own." On November 19, 2003, PdVSA's current Vice President, Aires Barreto echoed Rodriguez, stating "We are going to do it alone". Time will tell if the State Company can manage, technically and financially, to develop the field.
According to Vierma in Washington, Ceuta-Tomoporo was discovered in March 1998. The field, located on the southeast side of Lake Maracaibo, has a total area of 15,467 acres and an average depth of 16,500 feet. The MEM estimates 4,585 mm bbl of oil in place. With a recovery factor of 22 %, this places the field's recoverable reserves at 1,008.7 mm bbl.
In Tomoporo 64 wells have been perforated, of which 58 are actively producing 120 mm bpd. Production is expected to reach 250 mm bpd at the height of the project, from both on and off-shore wells.

(ii) Franquera 1-X
Franquera 1-X is a larger field, expected to hold 738 mm bbl of oil and 378 mm cf of natural gas. The depth of this field is 19,550 feet. The type of crude is expected to be medium with condensates.

(iii) Horcon 1
The MEM believes that Horcon 1 may hold approximately 115 mm bbl of petroleum and 30 mm cf. The depth here is 15,150 feet. The crude is a medium 20-24 degrees API.

(iv) Domo Sur
Domo Norte and Domo Sur are located south of Franquera and Tomoporo. Domo Sur is expected to hold 173 mm bbl of crude and 233 mm cf of natural gas. The type of crude is medium to light (20-40 degrees API). Preliminary 3D seismic is currently being interpreted.

(v) Domo Norte
Domo Norte comes in at an expected 96 mm bbl and 58 mm cf of natural gas.

(vi) Guarani
Up along the Colombian border, north east of Lake Maracaibo lies the Guarani field which holds proven reserves of 31 mm bbl of crude and 43.8 mm cfof natural gas. Possible crude reserves are estimated at 117 mm bbl. The field may hold up to 104.34 mm cf of natural gas.
In addition to these most recent opportunities, we should also bear in mind that Venezuela's Orinoco Belt has recoverable reserves estimated at over 100 bn barrels of extra-heavy crude. Opportunities have also been offered for more upstream vertically-integrated projects to develop these reserves and convert the extra heavy crude from approximately 9 degrees API crude to 16-32 degrees API.

Investment alternatives
As we mentioned at the beginning of this article, the faint-hearted might balk at the challenges presented to them by the investment and legal climate currently prevalent here in Venezuela. Seen from a negative standpoint, we have an unstable political climate; a hydrocarbons law (OHL-2001) that generally grants the state more control than it had before; and in the case of the projects mentioned above, the necessity of entering into an incorporated joint-venture with PdVSA, where the latter will hold more than 50 % of the capital stock.
Evidently, this 50 %+ stake and consequent control over decision-making, equal more red tape and, thanks to a new Anti-Corruption Law, even possible criminal liabilities for the Operators' officers. Nevertheless, Venezuela's enviable geological wealth and geographical location, on the Caribbean, south of the Gulf of Mexico, mean that it possesses tactical advantages not to be had in other more distant and volatile places.

Generally speaking too, oil company executives are patient people who have to look far ahead, considering the decades-long production agreements to which they have to commit their companies. So, placing these prime concerns on one side of the scales, and the long-term tactical advantages on the other, we believe that Venezuela has a great deal still to offer. The fields mentioned above are proof, if necessary, of that.
The biggest headache for companies about to get involved in long term agreements is probably Article 22 of the OHL, which says "primary activities indicated in Article 9 (production, gathering, and initial transportation and storage of hydrocarbons) shall be carried out by the State, whether directly by the Executive branch (Ministry of Energy and Mines) or through entities of which the State is the sole owner. The State may also perform such activities through entities in which it has control over its decisions, by maintaining a participation greater than 50 % in the capital stock, which for purposes of this Decree-Law shall be referred to as Joint-Venture Entities. All entities dedicated to the performance of primary activities shall be deemed operating companies." The third alternative just mentioned is the one that would apply to the above-mentioned projects.

This question of "control" has always been the subject of contention. It used to be understood that this meant shareholder majority, but a 1991 decision of the Supreme Court ruled that "control" could be exercised through the use of a "golden share", a mechanism that guaranteed State control over association agreements.
Other control mechanisms, such as a list of "issues of national interest" that had to be decided by a Control Committee where the State had the deciding vote, and a State veto power over certain decisions specifically listed in Association Agreements, further reinforced the concept of State control. The OHL's Legislative History, although not explicitly restricting the use of veto power or a golden share, refers to "real control granting decision power over all the business and operations of the hydrocarbon entities" which one could interpret as excluding contractual control arrangements used in the past. In short, State intervention means real control and decision-making power.

Then an important question arises: Could a Joint-Venture Entity, where PdVSA holds 50 %+ of the shareholders' equity, enter into an operating services agreement (OSA) with a service company where the State has no participation or control? Obviously the Joint-Venture Entity would have to be a decision-maker, not just a "shell entity", but it would be theoretically possible to transfer part of the business to the service company without violating the OHL.
Under OSAs in the past, the service-company acted on behalf of PdVSA, but did not own the assets or the production. This set-up should still be strictly adhered to, and, just in case, the possibility of signing an agreement with a services company should be expressly included in the request for National Assembly approval of the Joint-Venture Entity.
Since the OHL does not clarify whether Article 22 excludes Joint-Venture Companies from the definition of "State-owned companies" provided in the OHL, it could be considered that such Joint-Venture Companies are indeed subject to government laws. Many laws would apply here -- the Laws on Financial Management of the State, Bidding, General Comptroller's Office, Public Administration, Supreme Court, Commercial Arbitration and last, but by no means least, the Anti-Corruption Law which we mentioned above. This all adds up to an awful lot of red tape.

So there are powerful reasons to structure the OSA in such a way that, without taking away PdVSA's all-important "control", one can establish a more mobile and less bureaucratic organization that would guarantee agility and more profitability. This is how we envisage such an organization: Joint-Venture Entity A, owner of the license, payer of royalties and approver of overall development plans, will enter into a fixed-term services agreement with Entity B, proponent and executor of development plans and financing entity, where the latter will perform all activities required to exploit the oil reserves owned by Entity A.
For its services, Entity B will receive a variable fee tied to an international price marker (e.g. WTI) and will assume all the risks associated with the production and reservoirs, as a consequence of agreeing to receive a variable fee. We would emphasize "assumption of risk" because this would allow Entity B to record reserves in its US accounting books.

The oil produced by Joint-Venture Entity A will be sold to a Venezuelan entity wholly owned by PdVSA, "PdVSA Marketing", at a fair market price established by international demand and quoted prices. The latter because under the OHL, crude commercialisation activities can only be carried out by wholly-owned State entities.
To conclude, Venezuela has its reserves, its 50-year-old democratic establishment, its geo-politically-advantageous location and a huge need to generate income for its people. There are, we know, disadvantages under the present tumultuous political situation, but the long view is overwhelmingly positive and that is what really should matter to serious investors.

Adriana Lezcano is a member of Macleod Dixon, Caracas office, Despacho de Abogados miembros de Macleod Dixon, SC and its practice is concentrated in commercial and civil law with experience in the area of oil and gas. She has been involved in major deals pertaining to production-sharing agreements and service contracts in Venezuela. She has also been involved in major downstream infrastructure projects.
Its views are not necessarily those of Petroleumworld.

Source: Petroleumworld.com
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