THE TRANSITION TO JOINT VENTURES: BAD TO WORSE

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 003000

SIPDIS

ENERGY FOR CDAY, DPUMPHREY, AND ALOCKWOOD

E.O. 12958: DECL: 10/05/2015
TAGS: EPET EINV ENRG VE
SUBJECT: THE TRANSITION TO JOINT VENTURES: BAD TO WORSE

REF: CARACAS 02387

Classified By: Economic Counselor Andrew Bowen for Reason 1.4 (D)

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SUMMARY
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1. (C) SUMMARY: Energy Minister Rafael Ramirez raised the
pressure last week on foreign oil companies holding Operating
Service Agreements (OSAs) to migrate their contracts to joint
ventures under the 2001 Hydrocarbons Law when he publicly
threatened to take over OSA fields if the companies did not
migrate their contracts to joint ventures by the end of the
year. Petrobras promptly signed a transition agreement, and
we fully expect additional companies to follow suit over the
next two weeks. It is not clear what form the various
transition agreements and the resulting joint venture
contracts will take. It is also not clear what the GOV plans
to do if joint venture contracts are not signed by the end of
the year or if oil companies invoke their rights to
international arbitration. END SUMMARY

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MERRY CHRISTMAS AND HAPPY NEW YEAR
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2. (C) Energy Minister Ramirez substantially raised the
pressure on foreign oil companies with OSAs on September 26
when he publicly threatened to take over fields operated
under OSAs if companies failed to migrate their contracts to
joint ventures controlled by PDVSA by the end of the year.
Ramirez also stated PDVSA must have at a minimum a 60 percent
and at a maximum 80 percent stake in the new joint venture
companies. On September 29, President Chavez and Petrobras
President Jose Eduardo announced that Petrobras would sign a
transition agreement to migrate its OSAs to joint venture
companies. They also announced a joint venture to build a
refinery in Pernambuco, Brazil, an agreement to develop four
gas blocks in the Mariscal Sucre offshore project, an
agreement for PDVSA to supply Petrobras with geological data
for the quantification of reserves of a block in the Faja as
well as joint exploration of the block, and information on
four mature fields. A prominent energy attorney
sarcastically told Petroleum Attache (PetAtt) that the
decision to sign the transitory agreement made sense for
Petrobras since they "received half the country" in exchange.


3. (C) As reported in Reftel A, four international operators
(Harvest, Repsol, Hocoil, and Teikoku) and four local firms
(Inemaca, Open, Suelopetrol, and Vincclair) signed transition
agreements on August 4. A prominent local analyst, as well
as an energy attorney at Macleod Dixon, (strictly protect)
told PetAtt that additional companies will be signing
transition agreements over the next two weeks. The analyst
and attorney were not at liberty to reveal the firms'
identities, but we were told that no U.S. companies were in
the group. The analyst and attorney differed on the number
of firms and fields that were involved.


4. (C) It is also not clear what form the various transition
agreements and the resulting joint venture contracts will
take. We were led to believe that the initial round of
transition agreements that the eight firms signed were
identical. The Macleod Dixon attorney told PetAtt that the
agreements were different. In addition, partners at the law
firm of Squire, Sanders & Dempsey (strictly protect) told
PetAtt the oil companies have been divided into three basic
groups: international oil companies (IOCs),national oil
companies (NOCs),and local companies. The Squire Sanders
attorneys said local companies would be given special
treatment. The Macleod Dixon attorney also stated local
companies would be given some sort of reward for signing the
transition agreements. According to the Squire Sanders
attorneys, the IOCs would face the harshest terms during
negotiations. The Squire Sanders attorneys said the GOV
originally stated the joint venture contracts would be
standard for all of the companies. However, it appears the
GOV has changed its mind and is now accepting proposals for
language in the transition agreements and joint venture
contracts. (NOTE: Squire Sanders recently merged with Miami
firm Steel Hector & Davis. Steel Hector represented PDVSA
for a number of years and Squire Sanders continues to
represent them. The firm received a waiver from PDVSA that
allows them to represent oil companies in the transition
agreement and joint venture negotiations. END NOTE)


5. (C) Both the Squire Sanders attorneys and the local
analyst told PetAtt the GOV has said it will create
Operational Transitional Committees composed of PDVSA and GOV
officials that will be in charge of shepharding the
transition from OSAs to joint ventures. It appears the
transitional teams will be showing up at companies' offices
within the next few weeks. No one seems to know what powers
the committees will have. Given the fact that no one has
signed a joint venture contract, it is not clear what
"transition" the committees will be shepherding.

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COALS AND SWITCHES
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6. (C) Apart from PDVSA officials, we have yet to find
anyone in the industry that believes the GOV and the oil
companies will be able to reach an agreement on the myriad of
legal and operational issues that the migration from OSAs to
joint venture companies raise by year end. According to IOC
documents that were supplied to PetAtt, major negotiation
issues include operational issues such as employees and
termination payments as well as labor unions; lack of
definition regarding minority shareholder rights,
commercialization, and property value assement; and any
potential incentives for companies to migrate such as longer
term contracts, payments in kind, and new additional areas if
development plans show poor economies at the end of the joint
venture contract.


7. (C) Some companies apparently were holding out hope that
signing a transition agreement would give them extra time to
negotiate the joint venture contracts. A Petrobras executive
told PetAtt on September 27 that his company believed that to
be true. We do not believe this is a reasonable hope. PDVSA
Vice President Luis Vierma told the Economic Counselor and
PetAtt on September 28 that all of the OSAs must migrate to
joint ventures by the end of the year. Signing a transition
agreement will not give companies additional time for
negotiation. Squire Sanders attorneys confirmed that senior
PDVSA officials have told them the same thing.


8. (C) The obvious question is what happens when December 31
arrives and a company has not signed a contract to migrate
its OSA to a joint venture. The general opinion among
private sector players is that companies that have signed a
transition agreement will be treated better than those who
have not signed. However, no one knows what types of
sanctions will be applied to either group. The Macleod Dixon
attorney believes that one or more companies will not sign
either document and will elect to take the GOV to
arbitration. The attorney was not sure what would happen if
a company elected to pursue arbitration.


9. (C) Failure to sign a joint venture agreement by year end
also raises a number of operational issues. If the OSAs do
not migrate by year end, who will be operating the fields on
January 1? The local analyst hypothesized that PDVSA may
create some sort of transitional mixed companies to carry out
operations until the permanent joint venture is formed. The
analyst believes the Operational Transitional Committees may
have a some sort of governing role in the transitional joint
venture. The Macleod Dixon attorney also thought this may be
a possibility and stated the GOV would have to come up with
some sort of transitional mechanism. The attorney raised
another possibility: the GOV may let the oil companies
continue operating the fields but refuse to pay them. By
witholding payment, the GOV could "bleed" the companies into
submission. The attorney pointed out the GOV has repeatedly
said there will be no funds for the OSAs in the 2006 PDVSA
budget.

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CONCLUSION: WHERE IS RUDOLPH WHEN YOU NEED HIM
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10. (C) The rumor mill is presently operating full blast in
the oil sector. Between Ramirez's September 26 comments and
the fact the oil companies will be receiving tax bills based
on GOV audits in the next few weeks, the only thing that is
certain is more uncertainty between now and year end. Post
will continue to monitor the situation.
Brownfield