Oil firms study legal options after royalty increase in Venezuela

Oct 14, 2004 02:00 AM

Foreign oil companies in Venezuela's extra-heavy crude projects in the Orinoco belt are studying their legal options after President Hugo Chavez announced they will now have to pay 16.7 % royalties compared to the 1 % they had been paying, analysts and industry sources say.
"The first reaction was surprise, the second was OK we're obviously going to respect the law and the executive's decision, the next reaction is let's get a legal opinion and then go from there," an analyst at IPD Latin America, David Voght, told.

Venezuela's 1943 hydrocarbons law gives the government the sovereign right to increase royalties whenever it wants, but the extra-heavy crude contracts, signed in the mid-1990s, take advantage of a clause in the law that allows for lower royalties. Although the move to increase royalties may be legal, the government has ignored the contract conditions, which could alienate companies and have repercussions on future investments, industry sources say.
"The nuts and bolts issue here is the relationship between partners. I don't think the Venezuela government is treating the private sector like its partner," Voght said.

Chavez announced the royalty increase in a radio broadcast on October 10, taking industry analysts and companies by surprise. The royalty increase will boost the state's share of syncrude production to $ 3.33 a barrel from $ 0.20, which implies extra revenues of $ 766 mm annually for social projects such as schools and hospitals, government officials said.
Although investor interest in Venezuela's oil sector will likely remain strong, "the way the government handled this announcement is going to need to be included in future risk analysis," Voght said. Increasing royalties without giving companies a chance to react sends a signal of disrespect for private partners in joint venture projects with PdVSA, he added.

US oil company ChevronTexaco has a 30 % stake in the Hamaca extra-heavy crude project and it has proposed to build another $ 6 bn project. The company's partners in Hamaca are fellow US oil producer ConocoPhillips with 30 % and Venezuela's state oil company PdVSA with 40 %. However, ChevronTexaco is now re-evaluating its investments in Venezuela in the wake of Chavez’s announcement, the regional manager for Latin America at ChevronTexaco's Global Gas group, Chris Smith, told.
"If you have any big sea change in economic terms then you take a look at everything you're doing, but I certainly wouldn't say we're putting anything on hold or stopping anything," Smith said. "We're in the process of seeing how signals like this will affect some of our plans in the region," he said. "Anything that gives you a signal of instability is something you take into account when you're making future investment decisions," Smith said, adding: "We've had a long and successful history in Venezuela."

Given current high oil prices, analysts say the royalty increase is unlikely to make extra-heavy crude projects unprofitable, but it "certainly pulls down your rate ofreturn," according to Smith.
"We haven't pulled the plug on anything based on this, but we have to see what the longevity of the royalty change is and how it affects our long-term plans," Smith said. "Anytime you go from 1 % to 16 % in royalties, that comes right off your bottom line."

Apart from ChevronTexaco, multinational partners in Venezuela's four extra-heavy crude projects -- Petrozuata, Cerro Negro, Sincor and Hamaca -- are France's Total, Norway's Statoil, the UK's BP, ConocoPhillips and another US company, ExxonMobil. Contracts for these projects were signed in the mid-1990s when the risk of syncrude not being accepted by the market led the government to offer a 1 % royalty to attract investment.
However, refining concerns have since been surmounted, the market has welcomed syncrude and the partners in these projects are making handsome profits with oil at $ 53 a barrel. It makes sense that the government should want a larger piece of the pie, some experts say.
"The government has explained that [the royalty increase] is due to the unreasonableness of the royalty burden given the current market prices for oil," a partner at Houston-based law firm King and Spalding, José Valera, told.

However, analysts and companies alike are questioning the manner in which the government increased royalties unilaterally, without giving companies a chance to negotiate. In addition, while it is not unheard of for governments to introduce windfall taxes on commodities when prices are high, they are usually temporary whereas Venezuela's royalty increase is permanent, which begs the question what happens when oil prices drop, Valera said.
The royalty "has been approved without necessarily saying when it is going to come back down to 1 % -- the danger is in it staying at that level," he said.

Venezuela is the world's fifth largest oil exporter.

Source: BNamericas
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