OIL COMPANIES WITH OPERATING SERVICE AGREEMENTS

C O N F I D E N T I A L SECTION 01 OF 04 CARACAS 001721

SIPDIS

NSC FOR TSHANNON AND CBARTON
ENERGY FOR DPUMPHREY AND ALOCKWOOD

E.O. 12958: DECL: 06/05/2015
TAGS: EPET EINV VE
SUBJECT: OIL COMPANIES WITH OPERATING SERVICE AGREEMENTS
FACE ADDITIONAL PRESSURE

REF: CARACAS 1496

Classified By: ECONOMIC COUNSELOR RICHARD SANDERS, FOR REASONS 1.4 (B)
AND (D)

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SUMMARY
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1. (C) The foreign oil companies holding Operating Service
Agreements (OSAs) signed in three bid rounds in the
Venezuelan oil liberalization of the 1990's (the "apertura")
are now facing additional pressure from the GOV to migrate
these contracts to mixed companies/joint ventures under the
2001 Hydrocarbons Law. The companies have now received a
proposed "Transition Agreement" from the GOV which would
force them to recognize that their contracts are illegal and
would take away their rights to international arbitration.
In a June 6 luncheon with Codel Renzi, Royal Dutch Shell's
General Counsel confirmed that PDVSA had asked it to sign the
document by Friday, June 10. Tactics to pressure the
companies include announcements of tax increases (and bills
for alleged back taxes) and a requirement that companies take
in local currency money due for internal costs incurred. GOV
pressure also includes constant assertions of the unfairness
and illegality of the OSAs, which oil companies fear may lead
to a lasting negative impression of them among Venezuelans.
End Summary.

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A SERIES OF BLOWS
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2. (C) On April 14, Energy Minister/PDVSA President Rafael
Ramirez announced that the GOV would force the migration of
the 32 OSAs to mixed companies by the end of 2005. (Note:
Under the OSAs companies have received a per-barrel fee for
producing on PDVSA's behalf and relatively favorable royalty
and income tax treatment, including the ability to write off
development and operating expenses against their tax
liability. End note.) At that time, Ramirez said for the
first time that the OSA contracts were illegal because they
had never been approved by the National Assembly and that
they were not true "service" contracts. On April 15,
President Chavez announced an increase in the tax rate on oil
projects. On April 20, Minister Ramirez clarified that only
the OSAs (and not the four Orinoco heavy oil belt joint
ventures) would be subject to an increase in the tax rate
from 34 to 50 percent and that the tax increase would be
effective as of April 18. On May 10, a senior GOV tax
official stated that the OSA companies had cheated on their
taxes to the tune of some $2 billion over the past ten years
and that it would perform tax audits retroactive to 2001.
(Note: Local attorneys confirm that the audits will only be
retroactive to 2001 because of a statute of limitations
written into Venezuelan tax law. End note.)


3. (C) Most recently, on May 15, President Chavez announced
that PDVSA would no longer pay foreign oil company expenses
in dollars. And on May 25, Minister Ramirez addressed the
National Assembly and made additional allegations against
both the OSA and heavy oil projects. Company officials note
that Energy Vice Minister Bernard Mommer was at Ramirez's
side during his National Assembly appearance and that Mommer
is now participating in their meetings with PDVSA. They
credit Mommer with orchestrating the GOV strategy toward them
and point to his career as an academic in which he studied
how to maximize collection of oil rents on the part of the
state.

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EVEN CHEVRON TAKES A HIT
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4. (C) Although the noise level against all the foreign
companies in the OSAs has increased dramatically in the past
month, it is most notable that Chevron's Boscan oil field
contract has now been singled out by senior GOV officials.
Despite the fact that Chevron has seemed to have the inside
track with this government (most notably in being named,
together with Spain's Repsol, to develop one of the blocks of
the Deltana Platform natural gas project),in his May 25
address to the National Assembly Rafael Ramirez stated that
the Boscan field Operating Service Agreement had been a
non-competitive direct award for a field producing 86,000 b/d
) far from being a marginal field. Ramirez's comments on
the Boscan field have since been reiterated by Deputy Rodrigo
Cabezas, the head of the National Assembly committee
investigating the contracts between the international oil
companies and PDVSA. Cabezas has gone so far as to say that
the contract should be revoked which has raised significant
concern among Chevron managers in Venezuela.

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CONTRACT MIGRATION
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5. (C) Econoff met on May 23 with Eulogio del Pino, President
of the Corporacion Venezolana de Petroleo (CVP, the PDVSA
subsidiary which manages contractual relationships with
foreign oil companies) who explained that the GOV now
envisions a three-step process for the migration of the OSA
contracts. According to del Pino, the first step in the
process is the valuation of the existing contract assets.
The second step will be the valuation of the proposed joint
venture assets, while the third would be the negotiation of
the structure of the mixed company/joint venture. Del Pino
also informed econoff that during this negotiation period,
PDVSA would not pay any OSA contract holder more than 66.67
percent of the value of each barrel it produced, i.e., taking
for the government the 30 percent royalty and an
approximately three percent administrative fee.


6. (C) Del Pino also informed econoff that the GOV would
shortly ask the OSA companies to sign a Transition Agreement
("Convenio Transitorio"). Copies of this draft agreement
were subsequently received by the companies on June 2-3. The
agreement cites that PDVSA will only pay a maximum 66.67
percent fee, and requires the "contractor" to pay all taxes
owed to Venezuela's tax authorities. Signature would also
require the signing companies to recognize that their
contracts are illegal and would take away their rights to
international arbitration. In a June 6 luncheon with Codel
Renzi offered by the Venezuelan Hydrocarbons Association,
Royal Dutch Shell's General Counsel confirmed that PDVSA had
asked it to sign the document by Friday, June 10. (Note:
The GOV is asking companies to sign this document before they
have received from the government the draft text of the
proposed mixed company/joint venture agreement. End note.)


7. (C) In meetings with a number of the OSA companies in the
week of May 30, econoffs were told that despite the fact that
the GOV has been saying publicly that several companies are
well advanced in this process, it is doubtful that any
company has yet completed the initial valuation of its OSA
assets, although Spain's Repsol is rumored to be the farthest
along in this process. (Note: ExxonMobil, a minority
partner in the Quiamare-La Ceiba OSA operated by Repsol, told
econoffs May 31 that Repsol has not yet approached it about
its proposed negotiating posture. End note.) Despite the
fact that the GOV appears to be starting this negotiating
process with companies such as Repsol from its favored
country partners, it is unlikely that it will allow any one
company to get too far ahead of the pack. One international
oil company president commented to econoffs that the GOV will
probably advance the negotiations at the same pace in order
to extract maximum concessions from all the companies.

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DOLLAR PAYMENTS
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8. (C) Econoffs were told by several companies that they have
yet to receive their first quarter or April monthly payments
from PDVSA (some companies receive their "service" fee on a
quarterly basis and others on a monthly basis). It is likely
that this delay is linked to Chavez's May 15 announcement
about dollar payments although it may also be linked to
on-going tax threats. However, a representative of Harvest
Vinccler (80 pct owned by U.S. independent Harvest
International) attending the Codel Renzi lunch on June 6 said
that he had been informed that PDVSA would soon make a
payment. A member of the local trade press also informed
econoff June 6 that he believes PDVSA will shortly make
payments to the companies that will include 70-80 percent
dollars and 20-30 percent bolivars. He noted that PDVSA does
not yet know how to handle Chavez's May 15 announcement.


9. (C) A local attorney informed econoffs that the Venezuelan
Central Bank law says that all obligations contracted in
foreign currencies are payable in local currency unless the
parties expressly provide otherwise. Although some of the
OSA contracts have provisions stipulating dollar payments,
they do not use the word "exclusively," which, according to
this attorney, could allow the GOV to get away with payments
in bolivars.

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TAXES
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10. (C) As noted above and reported in reftel, as of April
18, the GOV increased the income tax levied on the OSA
operators from 34 percent to 50 percent. On May 10, the GOV
declared that the companies had cheated on their taxes to the
tune of some $2 billion and that it would perform tax audits
retroactive to 2001. It now appears that SENIAT, Venezuela's
IRS equivalent, will seek to assess a retroactive 50 percent
income tax on the companies for the years 2002-2004 and that
2001 taxes will be retroactively assessed at 67.67 percent,
the tax rate in effect in 2001. (Note: the 2001
Hydrocarbons Law, which became effective on January 1, 2002,
increased royalties from 16.67 to 30 percent. At the same
time, the income tax was reduced from 67.67 percent to 50
percent. The GOV had previously applied a 34 percent income
tax rate to the OSA companies because, at that time, they
were considered to be simply supplying a service to PDVSA.
End Note.)


11. (C) Despite numerous press reports since early May that
SENIAT has reached agreement on back taxes with multiple
companies, econoffs have not been able to confirm this and
believe that the GOV has leaked these reports in order to put
additional pressure on companies to break ranks. In
conversations with a number of the OSA companies the week of
May 30, company spokesmen underlined that they do not believe
any company has yet come to an agreement with the Seniat.
The companies also informed econoffs that SENIAT audit teams
have been lodged full time in their offices for months.


12. (C) SENIAT authorities have made comments to the press to
the effect that as much as $744 million is being retained
while companies make good on back taxes owed. A local
consulting firm notes that these monies may correspond to VAT
reimbursements owed to the 32 operating agreement projects.
Most recently, the press reports that Seniat will bill three
companies whose audits have been completed. The three
include Royal Dutch Shell, Italy's ENI, and Harvest Vinccler.


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COMMENT
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13. (C) The GOV continues its pressure on companies operating
in Venezuela's oil sector in a move to extract as much
revenue as it can. The fallout from this is growing
uncertainty on the part of the companies that complain that
their reputations are being unfairly tainted and that they do
not understand the ultimate intentions of the GOV. They are
worried that they will be perceived negatively by the
Venezuelan people and that the vitriolic rhetoric that is
accompanying this campaign could well demonize the companies
to such an extent that it could put company personnel at
risk.


13. (C) If taken to its logical conclusion, the claims by the
GOV against the OSA companies, and particularly the claim
that the contracts are illegal, could also mean that the GOV
could refuse to pay the OSA operators again until their
assets have been migrated to mixed companies/joint ventures
or they sign the Transition Agreement. Any such action by
the GOV would only serve to underline the seriousness of what
some in the community are now calling "creeping
confiscation." It does not appear that the companies will
make the hurried decisions to sign the "Transition Agreement"
that the GOV wants. This may well open them up to escalating
attacks by other Venezuelan Government entities that impact
on their operations such as the Labor and Environment
Ministries.
Brownfield