VENEZUELA: PLAN PETROLEUM SOVEREIGNTY ADVANCES

C O N F I D E N T I A L SECTION 01 OF 02 CARACAS 001139

SIPDIS

NSC FOR CBARTON
ENERGY FOR DPUMPHREY AND ALOCKWOOD
TOKYO FOR SFLATT

E.O. 12958: DECL: 04/17/2015
TAGS: EPET EINV PGOV VE
SUBJECT: VENEZUELA: PLAN PETROLEUM SOVEREIGNTY ADVANCES


Classified By: Acting DCM Abelardo Arias; for reasons 1.4 (b) and (d)

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SUMMARY
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1, (C) With announcements about the proposed forced
migration of contracts to vehicles under Venezuela's 2001
Hydrocarbons Law as well as changes in oil sector income
taxes, the GOV has launched another strong attack against the
legal basis of current international oil company operations
in Venezuela. Energy attorneys are skeptical that the GOV
has the wherewithall to negotiate the migration of the 32
Operating Service Agreement (OSA) contracts within the next
eight months. One attorney believes the tax announcement was
intended to be a further spur for companies to line up to
migrate their contracts. With the exception of ExxonMobil,
we believe the companies will cave. Current oil prices as
well as Venezuela's large reserves give them incentive to
hold their tongues and negotiate. End Summary.

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ALL OUT ATTACK
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2. (U) In an all out attack on what the PDVSA publicity
machine has dubbed "the pernicious" Oil Opening of the
1990's, Energy Minister/PDVSA President Rafael Ramirez
announced April 14 that the GOV will force the migration of
the 32 Operating Service Agreements (OSAs) to mixed companies
under the Hydrocarbons Law by the end of 2005. Ramirez also
alleged that many of the companies have not been paying the
appropriate income tax. Thus, he said, the Ministry had
instructed PDVSA to cap its payments to the operators at
66.67 percent of the value of the crude produced. Following
Ramirez's statements, on April 15, President Chavez announced
in a televized cabinet meeting that the taxes on the four
projects that process the extra heavy crude of Venezuela's
Orinoco heavy oil belt would be increased from 34 to 50
percent. Ramirez subsequently said that the 50 percent tax
rate will now apply to all operators.

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BACKGROUND
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3. (U) In the 1990's, as an important part of its "Oil
Opening" (Apertura Petrolera),PDVSA offered three bidding
"rounds" of marginal oil fields to international bidders.
The international oil companies (IOCs) that bid on these
fields took over field operations under operating service
contracts. The companies did not receive equity in the
fields. The contract provisions for the three rounds vary.
The first and second round contracts, for instance,
stipulated specific royalty provisions (16.67 percent) while
the third round contracts contained only a general reference
to the royalty applicable under Venezuelan law. The income
tax levied on the projects was 34 percent, or the tax on the
oil sector prior to the 2001 Hydrocarbons Law. The GOV's
refusal to grandfather these contracts was one of the
controversies surrounding passage of the Hydrocarbons Law.
At that time, the GOV argued that the contracts would be
protected by non-retroactivity provisions of Venezuela law.
Now, however, the GOV is arguing that the contracts were
illegal because they were never approved by the National
Assembly and that they were not true "service" contracts.

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WHAT IS A MIXED COMPANY?
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4. (C) Local energy attornies are skeptical that the GOV has
the staff or the wherewithall to negotiate the migration of
the 32 OSA contracts in the next eight months. For one
thing, there still is no model for what a "mixed company"
might look like and how it might operate. Attorneys in the
local offices of Steel,Hector & Davis have worked for over a
year with PDVSA to develop a draft but Vice Minister Bernard
Mommer has now reportedly rejected it. The list of other
outstanding issues is long: how would company sunk costs be
valued for migration to a mixed company? How would PDVSA pay
for its 51 percent share in each mixed company? What would
be the tax implications of a transfer of company assets from
an OSA to a mixed company? How much control would the
companies have over field operations? What arbitration
provisions would apply? And so on. It does appear, however,
that the GOV realizes it will have to grant more acreage or a
longer contract as compensation to the companies that agree
to migrate their contracts.


5. (C) Gabriela Rachadell, a partner in the energy division
of Canadian law firm MacLeod Dixon, noted to econoff that it
will be interesting to see on what legal basis the GOV plans
to implement the tax increase on the extra heavy oil projects
particularly. Two of the four projects, she said, have
provisions in their contracts that stipulate a 34 percent tax
rate while the other two have non-discrimination clauses.
Rachadell believes this decision could be fought, although it
would have to be handled through quiet negotiations. The tax
increase for the OSAs would be more difficult to fight, she
said, but not impossible. Rachadell, however, believes the
April 15 GOV announcements about tax changes were intended to
put more pressure on the companies to line up to migrate
their contracts.

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COMPANY OPTICS
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6. (C) In April 18 calls to a number of the IOCs, we were
informed that they are "considering their options." However,
with the exception of ExxonMobil, which is now consulting its
corporate headquarters following an unsatisfactory meeting
with Mommer, we believe the companies will cave. A recent
meeting between the Ambassador and Harvest International CEO
Peter Hill provides interesting insight. The Ambassador
asked Hill how low oil prices would have to drop before it
became uneconomical for the company to operate its South
Monagas Unit, a first round asset acquired in 1992. Although
Harvest was particularly hard hit by the GOV's decision in
late 2004 to cap its 2005 capital investment program, Hill
acknowledged that the company had just had its best quarter
ever. Oil prices would have to drop as low as $12-14 per
barrel, he said, before it would become uneconomical for the
company to continue to operate its three South Monagas
fields. In sum, current oil prices as well as the
attractiveness of Venezuela's large reserves will give the
companies the incentive to hold their tongues and negotiate.


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COMMENT
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7. (C) Since its inception in 1998, the Chavez administration
has made no bones about its dislike of the contracts
associated with the "apertura" of the 1990's. In May 2003,
at the Houston Offshore Technology Conference, then Vice
Minister of Energy Luis Vierma first said publicly that the
GOV would seek to re-negotiate the OSA contracts. Two years
later, with Bernard Mommer, the intellectual author of
Venezuela's oil policy firmly in place as Vice Minister, the
GOV is now ready to play hard ball.
Brownfield