PDVSA: DIVERSIFICATION, CORRUPTION, AND

C O N F I D E N T I A L SECTION 01 OF 05 CARACAS 001238 SIPDIS SIPDIS ENERGY FOR CDAY, DPUMPHREY, AND ALOCKWOOD E.O. 12958: DECL: 05/05/2016 TAGS: EPET ENRG EINV VE SUBJECT: PDVSA: DIVERSIFICATION, CORRUPTION, AND INCOMPETENCE REF: A. CARACAS 00905 ¶B. 2005 CARACAS 02934 ¶C. CARACAS 910 Classified By: Economic Counselor Andrew N. Bowen for Reason 1.4 (D) ¶1. (C) SUMMARY: The politicization of PDVSA appears to have an increasingly negative impact on how it carries out its operations and conducts long term planning. As a result of Bolivarian ideology, PDVSA appears to be making a concerted effort to shed itself of long-term supply contracts as well as Citgo's refinery network despite the strong commerical justification for the refineries. The rationales for the campaign are increasing difficulty in meeting the contracts as well as the BRV's desire to diversify away from the U.S. market. Corruption appears to be prevalent in trading and drilling programs. Trading is confined to four to five traders and one major U.S. company will no longer allow its traders to deal directly with PDVSA. PDVSA continues to increase its rig count but is acting in a non-transparent manner that hints at widespread corruption. Chinese companies reportedly have a lock on new rig contracts. PDVSA refineries continue to be plagued with safety problems and the chance of a major accident occurring is significant. Venezuela is importing gasoline due to refinery problems. END SUMMARY -------------- PDVSA MOVES TO SHED REFINERIES AND CONTRACTS -------------- ¶2. (C) Petroleum Attache (Petatt) and Economic Specialist met with a marketing executive and a consultant on May 5 to discuss Citgo's recent announcement to sell its 41.25% stake in the Lyondell refinery and as well as press reports that it plans to sell two asphalt plants, Paulsboro and Savannah. According to the executive and the consultant, Energy Vice Minister Mommer plans on selling all of Citgo's refineries except for the Lake Charles and Corpus Christi refineries. Citgo can't sell these two refineries because they are collateral for a 1.8 billion dollar loan. (NOTE: The experts did not comment on whether they thought Citgo would sell the two refineries once the loan was paid off. END NOTE) The experts also stated the BRV wants to unload the Lyondell refinery in order to raise cash and free itself of its supply contract. ¶3. (C) According to the consultant, the BRV tried in the past to break Citgo's long-term supply contracts but was unable to do so due to IRS regulations. Since the breaking of the contracts would not be the result of an aQs-length transaction, it would create unfavorable tax consequences for Citgo. Covenants in Citgo's bonds also created problems for the sale of Lyondell as well as the breaking of its supply contract. The consultant said Citgo's recent purchase of its outstanding bonds cleared the way to sell Lyondell and made it easier for PDVSA to back out of its long term contracts with Citgo. (COMMENT: Many commentators believed the purchase of the outstanding bonds was merely an attempt by PDVSA to avoid SEC reporting requirements. END COMMENT) ¶4. (C) When Petatt pointed out that it did not make any sense for PDVSA to sell its interest in the Chalmette refinery since it was tied to the Cerro Negro upgrader in the Faja via a long term supply contract, both experts agreed. They noted that ExxonMobil specifically designed the Cerro Negro upgrader to supply the Chalmette refinery and that it would be extremely difficult otherwise to place its production. On the other hand, the Chalmette refinery could easily handle heavy crudes from a variety of sources. When pressed, both the executive and the consultant said they were convinced PDVSA would sell its interest in Chalmette. The executive opined that Cerro Negro's production could be CARACAS 00001238 002 OF 005 converted to and sold as fuel oil but that it would result in a significant loss of revenue. ¶5. (C) The consultant stated he did not believe Citgo would sell its Lemont, Illinois refinery in the near future. According to the consultant, the Lemont refinery generated approximately 50% of Citgo's 2005 net profit. The refinery has a long term contract for relatively cheap Canadian crude and produces products with high premiums. Despite its tremendous revenue stream and excellent location, the consultant said the refinery will eventually be sold. ¶6. (C) The executive and consultant also noted the proposed sales of the asphalt refineries did not make sense from a commercial point of view. The Paulsboro, New Jersey refinery has a 70,000 barrel per day refining capacity during the April to October asphalt season and its feedstock consists of Boscan and Bachaquero heavy crudes from western Venezuela. Its Unit 1 is specifically designed for Boscan and has a 30,000 barrel per day capacity during the asphalt season. The Savannah, Georgia refinery has a 30,000 barrel per day capacity during the asphalt season and Boscan is its only feedstock. Paulsboro's crude supply agreement with PDVSA expires in 2010 and Savannah's in 2013. According to the consultant, the refineries were worth very little without their long term supply contracts. (NOTE: The asphalt business is seasonal in nature. Road repairs and construction occur primarily in the spring and summer months. As a result, asphalt refining for the North American market surges during the period of April to October. END NOTE) ¶7. (C) Both the executive and the consultant argued that the proposed sale of the asphalt refineries was clear evidence that the PDVSA management did not know what they were doing. The same week that the press reported PDVSA was shopping the asphalt refineries, PDVSA Director Eulogio Del Pino announced that PDVSA would invest 220 million USD to increase production in the Boscan field from 100,000 to 113,000 barrels per day. The executive noted Del Pino's comments were absurd for two reasons. First, Boscan production is already close to 113,000 barrels per day. The 220 million USD is merely a routine investment to maintain Boscan production at current levels rather than an investment in increased production. Second, the executive noted that it is odd to trumpet that you are significantly increasing asphalt production at the same time other executives in your company are clearly indicating that you want out of the asphalt business. -------------- DIVERSIFICATION -------------- ¶8. (C) The PDVSA's plans for selling the refineries stem from a desire to diversify out of the U.S. market, the BRV's firm belief that the "apertura" (the opening and internationalization of the Venezuelan petroleum sector) must be completely erased, and difficulties in meeting the contracts. The executive and consultant noted PDVSA used to place 800,000 barrels per day via third parties in the U.S. market. It is now placing less than 300,000 barrels of a Merey and Mesa 30 blend. In addition, until recently, ExxonMobil was sending approximately 150,000 barrels of Mesa 30 to the Lake Charles refinery. It is now taking in less than 90,000 barrels of Mesa and Santa Barbera crudes at Lake Charles. The consultant and executive also pointed out that PDVSA invested significant sums of money in a 100,000 barrel per day expansion at the Lake Charles refinery that was supposed to increase the refinery's take of Venezuelan heavy crude. The refinery now purchases heavy crude from other suppliers in order to utilize this additional capacity. ¶9. (C) The consultant stated that crude that was placed on CARACAS 00001238 003 OF 005 the U.S. spot market is now being diverted to China and India. India has a contract for 66,000 barrels of crude per day. The consultant said PDVSA was meeting the contract by blending an 8 API oil with lighter crude. The blending did not make commercial sense due to the fact that PDVSA would make more money if it sold the blend's components separately. ¶10. (C) China has a contract for 100,000 barrels per day but appears to only be taking 30,000 barrels of Boscan crude. The crude destined for China is shipped from Lake Maracaibo, which does not have the facilities for supertankers, to Bonaire or Curacao where multiple shipments are combined or blended and combined and loaded on to VLCCs (Very Large Crude Carriers). The executive noted that shipments to China suffer from two problems. As in the case of the shipments to India, blending crude results in a product that produces lower profits than the separate sales of its components. In addition, the transportation of the crude to Bonaire and Curacao and the combination of smaller loads raises transportation costs. ¶11. (C) Both the executive and the consultant stated it is not clear what the Chinese are doing with the Boscan shipments. Rumor has it that the shipments are not reaching China but are sold in route. If the Boscan shipments are being sold for coke feed, the Chinese would earn substantial profits. There does appear to be one case in which PDVSA rerouted a shipment of Boscan crude from an established customer in Asia to China. The enraged customer later publicly berated a PDVSA official at an asphalt show for diverting his shipment. The executive also said PDVSA is trying to place an asphalt shipment in China this month. Although asphalt shipments to Asia are common in winter months, placing an asphalt shipment during the high season in North America is extremely unusual. Both the executive and the consultant stated the shipment made little commercial sense. PDVSA's attempts to move away from the North American asphalt market also makes little sense given the fact that its storage facilities for asphalt are frequently full, which in turn forces down production. According to the executive, asphalt storage facilities used to be filled during the winter months and then drawn down until August when they started to fill again. This cycle has been broken and now PDVSA storage facilities are frequently filled to the rim with asphalt. ¶12. (C) The executive also noted the VLCC shipments are a prime source of corruption. The VLCC contracts frequently do not mention back hauls (the cargo that is placed in the VLCCs on their return trips to Venezuela). The executive stated the VLCCs are not returning empty and that the back hauls are generating kickbacks for someone. -------------- TRADING -------------- ¶13. (C) According to the executive and consultant, PDVSA only deals with four or five traders. The consultant described the select companies as "enchufes" (electrical plugs). Companies that want to do business with PDVSA have to plug into the enchufes. The consultant stated Russian firm Lukoil is one of the enchufes and is currently purchasing large quantities of Venezuelan crude. The consultant said Lukoil pushes PDVSA for good prices so that it can turn a decent profit when it sells the crude to third parties. ¶14. (C) It is not clear to what degree PDVSA's reliance on a limited number of traders is due to corruption, an inability to find willing partners, or both. According to the consultant, U.S. energy firm Valero (strictly protect) prohibits its traders from dealing with PDVSA directly due to CARACAS 00001238 004 OF 005 concerns over corruption. Valero traders may conduct business with PDVSA via one of the enchufes. The consultant said PDVSA has been importing large quantities of MTBE, a fuel oxygenate that is used in gasoline to reduce pollution, and he knew that Valero had a large amount of it on hand. He contacted a friend at Valero and recommended they contact PDVSA. The friend stated it was against company policy. Valero eventually sold the MTBE to a third party, which in turn sold it to PDVSA. The consultant stated Valero upset PDVSA officials when it asked PDVSA for letters of credit in past deals. As a result, it is not clear PDVSA would deal directly with Valero even if Valero was interested in doing so. ¶15. (C) PDVSA also suffers at times from general incompetence among its traders. Approximately one year ago, PDVSA officials accidentally placed too high a floor on Santa Barbera and Mesa crude. As a result, PDVSA could not find any takers for these crudes and its storage facilities quickly filled up. It was then forced to dump its inventories on the markets. (COMMENT: Both the executive and consultant hinted broadly that PDVSA occasionally sets floors too high on purpose. They did not elaborate. END COMMENT) -------------- RIGS -------------- ¶16. (SBU) Senior BRV and PDVSA officials have repeatedly stated they wish to increase the number of rigs operating in Venezuela as well as overall production (Reftel A). According to the Baker Hughes rig count, there were 81 rigs in Venezuela in March 2006, up from 66 in March 2005. On May 5, the press reported that PDVSA would acquire 28 rigs from the China Petro Technology and Development Corporation, a subsidiary of China National Petroleum Corporation (CNPC). PDVSA's goal is to assemble the rigs in Venezuela in 2008 and develop the capacity to assemble the rigs on its own by 2010-11. ¶17. (C) According to the consultant, PDVSA has lost credibility with many service companies for a variety of reasons. When it has made public presentations for more rigs, companies have given it a tepid response. The key reasons for this are that "the business has become dirty (corrupted)", a clear lack of will to follow through on plans by PDVSA, and the diversion of investment funds to the BRV's social missions. The lack of continuity in PDVSA management is also a problem. The consultant also mentioned the fact that PDVSA does not have audited financial statements also raises concerns among companies. Since PDVSA is having difficulty finding contractors, it has been forced to purchase rigs. (COMMENT: As we reported in Reftel, PDVSA also does not have a great reputation for paying contractors in a timely manner. END COMMENT) ¶18. (C) The consultant also mentioned that PDVSA used to rely on small Venezuelan service companies to carry out workovers and provide rigs. PDVSA no longer appears to be relying on these companies. The consultant said he put together a deal for three rigs and took it to PDVSA. He was shocked when PDVSA failed to take him up on the proposal. When he approached friends that work in PDVSA, he was told that rig contracts required the approval of the top management. According to the consultant, two companies have been receiving all of the new business. Although the companies appear on paper to have no relationship, they are both controlled by CNPC. (COMMENT: The consultant's story about his rig deal does explain something that has long puzzled us. Hugo Hernandez Rafalli, an ex-PDVSA director who maintains good ties with Chavistas and owns a service company, told Petatt that he put together a five rig deal CARACAS 00001238 005 OF 005 that he took to PDVSA. He was shocked when the deal was turned down. Hernandez said he offered PDVSA a very good deal considering the current scarcity of rigs. END COMMENT) -------------- REFINING -------------- ¶19. (C) The Venezuelan press during the past year has repeatedly carried stories of accidents at refineries. The consultant, who has a refining background, stated that refining accidents can be thought of as a pyramid with fatal accidents (the most severe) at the point. Given the significant number of fatal accidents, he stated the Venezuelan refining system is currently at the point of the pyramid. When Petatt asked what were the chances of a major accident in the near future, the consultant replied "High". Both the executive and consultant stated PDVSA only carries out the minimum repairs necessary in order to resume operations. ¶20. (C) The consultant stated the HDS (hydrotreating) units at the Paraguana refining complex have been down for a month. PDVSA officials have actively been covering up the problem. (NOTE: Hydrotreating is the process in which a hydrocarbon is subjected to heat and pressure to remove sulfur and other contaminants. END NOTE) Since the HDS units are the core of the refinery, this has triggered a gasoline shortage of approximately 100,000 barrels per day. Domestic gasoline consumption is slightly more than 300,000 barrels per day. As a result, exports have dropped and Venezuela has been reduced to importing gasoline. According to the executive, PDVSA will import shipment of eurograde gasoline this month. Although PDVSA is willing to import gasoline from Europe, imports from the U.S. are prohibited. ¶21. (C) PDVSA is also a net importer of components for gasoline production. It imports roughly 1.23 million barrels worth of components per month. As noted earlier, PDVSA has imported significant amounts of MTBE since Venezuela phased out leaded gasoline. -------------- COMMENT -------------- ¶22. (C) As reported in Reftels A and B, PDVSA suffers from a myriad of administrative and operational shortcomings that will have a significant negative impact on its ability to increase or even maintain production levels. The problems in the refining sector are merely another example of shortcomings. The increased politicization of PDVSA and BRV hydrocarbon policy, as evidenced by the forced migration of the Operating Service Agreement (OSA) fields (Reftel C),the awarding of contracts to politically acceptable entities, and the recent demands by the BRV that the strategic assocations migrate to strategic associations, will only increase ineffeciencies in the sector. Assuming that the strategic assocations are migrated to joint ventures with the same terms as the OSA fields, we expect to see a decrease in their effeciency as the BRV burdens them with labor and social policies and removes technical staff who do not meet the Bolivarian litmus test for political correctness. In the end, President Chavez is betting that high oil prices will negate the effects of politicization, corruption, and commercial decisions that make little sense commercially. He is also betting that foreign oil companies will continue investing in Venezuela despite the legal uncertainties and operational headaches his hydrocarbon policies have generated for them. BROWNFIELD