STRATEGIC ASSOCIATION MIGRATION: THE GAME'S AFOOT

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 002667

SIPDIS

SIPDIS

ENERGY FOR CDAY, DPUMPHREY, AND ALOCKWOOD
NSC FOR DTOMLINSON

E.O. 12958: DECL: 07/07/2016
TAGS: ECON ENRG EPET EINV VE
SUBJECT: STRATEGIC ASSOCIATION MIGRATION: THE GAME'S AFOOT

REF: A. CARACAS 910

B. CARACAS 2297

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


1. (C) SUMMARY: After months of speculation, the BRV has
contacted international oil companies (IOCs) with stakes in
the Faja strategic associations to begin negotiations on
migrating the associations to joint ventures in which PDVSA
holds a majority stake. Although the BRV has spoken with
individual companies, the IOCs are still waiting for written
proposals. It is not clear to what extent financing
covenants will protect the IOCs. We expect the BRV to push
for some sort of agreement before the December presidential
elections. END SUMMARY

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THE GAME'S AFOOT
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2. (U) The four Faja strategic associations (Sincor (Total
47%, PDVSA 38%, Statoil 15%); Petrozuata (ConocoPhillips
50.1%, PDVSA 49.9%); Ameriven (ConocoPhillips 40%, Chevron
30%, PDVSA 30%); and Cerro Negro (ExxonMobil 41.67%, PDVSA
41.67%, BP 16.67%)) produce roughly 620,000 barrels of extra
heavy crude per day. Private sector estimates of total
Venezuelan crude production range from 2.4 to 2.6 million
barrels per day. The extra heavy crude is sent to four
dedicated upgraders which in turn convert it into syncrude
with APIs of between 15.5 (Cerro Negro) and 30.9 (Sincor).


3. (C) Senior executives at ExxonMobil (strictly protect)
told Petroleum Attache (Petatt) that Energy Vice Minister
Bernard Mommer met with them in late August and stated the
BRV was formally beginning negotiations on the migration of
the strategic associations to joint ventures in which PDVSA
holds a majority stake. A ConocoPhillips executive (strictly
protect) also confirmed that his company has begun
discussions regarding the migration of their two strategic
associations.


4. (C) An ExxonMobil executive told Petatt on September 5
that Vice Minister Mommer promised the BRV would provide
ExxonMobil with a "terms sheet" that would set out specific
proposals for the migration within a week of their meeting.
Almost three weeks have passed and ExxonMobil is still
waiting for the terms sheet. The executive also stated the
BRV first approached ConocoPhillips and asked it to provide
the BRV with its list of proposals for the migration.
ConocoPhillips decided that it was in its best interests not
to provide the BRV with its proposals. The ExxonMobil
executive likened the BRV's request to asking someone to
provide the rope that will be used to hang him. After
ConocoPhillips failed to provide the proposals, the BRV
decided to begin negotiations with its own list of proposals.


5. (C) According to ExxonMobil executives, the new joint
ventures will be formed roughly along the lines of the joint
ventures formed from the operating service agreements (OSA)
earlier this year (Reftel A). Although BRV officials
originally stated publicly that PDVSA wanted a 60% stake in
the new joint ventures, it now appears that it is willing to
accept a 51% stake. The royalty and tax structures of the
new joint ventures will also be similar to the former OSA
joint ventures. A tax bill that raises the income tax rate
for the strategic associations from 34 to 50% is currently
winding its way through the (all-Chavista) National Assembly.
The BRV stated it will compensate the association partners
for their lost value stemming from the migration by allowing
the new joint ventures to significantly increase their
production. (COMMENT: Any significant increase in production
would require IOCs to invest substantial sums in the new
joint ventures. The BRV is clearly calculating that the IOCs

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are still willing to invest billions in Venezuela in exchange
for increased production and future investment opportunities
in the Faja region. However, given the lack of legal
certainty in Venezuela, it is not clear that many of the IOCs
are willing to significantly increase their exposure. END
COMMENT)


6. (C) The ExxonMobil executives also stated the BRV has
suggested that the four upgraders be separated from the
fields that supply them. The new tax bill reinforces this
proposal by preserving the 34% tax rate for entities that
exclusively upgrade or refine crude oil. (COMMENT: It is
not clear exactly why the BRV is differentiating between the
fields and upgraders. We suspect the policy stems from two
factors. First, PDVSA desperately needs the IOCs' expertise
in running upgraders and refineries. As recent accidents
have shown, PDVSA does not have the human capital to run its
current refineries, much less the strategic association
upgraders or new refineries (Reftel B). Second, reclaiming
oil fields fits perfectly with the Chavez administration's
past political rhetoric of reclaiming Venezuela's patrimony
and sovereignty and eliminating the "opening" of the
hydrocarbon sector. As a result, the migration of the
strategic association's fields is the perfect fodder for a
campaign speech. Assuming majority control of upgraders and
refineries does not provide the same political "bang for the
buck" and only creates additional operating problems for
PDVSA. END COMMENT)

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POTENTIAL ROADBLOCKS FOR THE BRV
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7. (C) The ExxonMobil executive said Vice Minister Mommer
stated he believes the strategic association migration will
be easier than the OSA migration because the agreements
creating the strategic associations are legal. When
Petroleum Attache stated he did not understand Mommer's
logic, the ExxonMobil executive admitted that he did not
either. Given the fact that the BRV acknowledges that the
strategic associations are legal, it is readily admitting
that it does not have a legal basis for forcing the companies
to migrate.


8. (C) Although the BRV may not have a legal basis for
forcing the migration, it can encourage the IOCs to migrate
just by making life difficult for them. The ExxonMobil
executive stated his company recently requested a production
increase at Cerro Negro in order to make up for a scheduled
maintenance shutdown. The production increase would allow
Cerro Negro to reach its average yearly production figure.
The BRV agreed to the production increase but only if
ExxonMobil and BP agreed to waive their arbitration rights.
ExxonMobil rejected the production increase and BP sent a
letter to ExxonMobil and PDVSA stating ExxonMobil's position
had rendered its decision moot. (NOTE: Under the terms of
the strategic association, all of the partners have to agree
to production changes. END NOTE)


9. (C) The BRV also faces a significant obstacle in the
form of financing covenants. At least two of the strategic
associations, Ameriven and Petrozuata, have loans or bonds
that contain covenants governing changes in equity. Under
the covenants, the strategic association partners cannot
change the equity structure of the associations without the
creditors' permission. A senior Chevron executive (strictly
protect) told the Economic Counselor and Petatt in July that
he believes the financing covenants will prevent the BRV from
migrating the strategic associations to joint ventures.
According to the executive, the IOCs can say they would like
to cooperate but the creditors will not let them do so.
(COMMENT: The obvious weakness in this theory is that the BRV
and PDVSA can always repay the loans and purchase the bonds.

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Although this would be quite expensive, the BRV and/or PDVSA
could always refinance the projects using loans from banks.
END COMMENT)

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COMMENT
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10. (C) We believe that the BRV wants to have some sort of
agreement on the migration before the elections. The
agreement could be anything from a non-binding memorandum of
understanding to a transition agreement along the lines of
the transition agreements used in the OSA migrations (Reftel
A). An agreement would give President Chavez the perfect
opportunity to claim that he has reestablished Venezuelan
sovereignty and completely dismantled the "opening" of the
Venezuelan hydrocarbon sector. Although the Chevron
executive thought the BRV would be satisfied with a
non-binding MOU, we do not share his optimism. The BRV may
be temporarily satisfied with some form of weak agreement
before the elections, but we firmly believe that the BRV will
eventually, by hook or by crook, force the migration of the
strategic associations to joint ventures. In our view, the
question is not "if" but rather "how" and "when".
WHITAKER