VENEZUELAN OIL PRODUCTION AND OUTLOOK

C O N F I D E N T I A L SECTION 01 OF 05 CARACAS 000905

SIPDIS

SIPDIS

ENERGY FOR CDAY, DPUMPHREY, AND ALOCKWOOD

E.O. 12958: DECL: 11/25/2015
TAGS: EPET ENRG EINV VE
SUBJECT: VENEZUELAN OIL PRODUCTION AND OUTLOOK

REF: A. 2005 CARACAS 02934

B. CARACAS 784

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


1. (C) SUMMARY: A number of private sector contacts
believe that Venezuelan crude production has dropped to 2.3
million barrels per day. Conventional wisdom had placed
production at 2.4 to 2.6 million barrels per day. PVDVSA
has substantially increased its number of rigs but it does
not appear to be using the rigs in an efficient manner. As
noted in Reftel A, we believe that production will continue
to decline due to inadequate maintenance and a degradation
of PDVSA's and the private sector's operational abilities
due to the inexperienced personnel, poor management, labor
issues, and new social obligations. As a result, we do not
believe the additional rigs will be able to reverse the
overall downward trend in production. END SUMMARY

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OVERALL PRODUCTION TRENDS
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2. (C) Conventional wisdom among our private sector
contacts in the past has been that Venezuelan oil
production has hovered between 2.4 and 2.6 million barrels
per day. During a recent visit by a Washington energy
analyst, both the analyst and Petroleum Attache (Petatt)
were struck by the number of contacts, particularly in
western Venezuela, who believe that production has fallen
to 2.3 million barrels per day. A senior executive with
Inelectra, an engineering and construction firm with oil
and gas interests, told Petatt and analyst that his company
had carried out a major study on Venezuelan production.
The study, which assumed that PDVSA rigs were running at
pre-strike effeciency, concluded that current production
was approximately 2.3 million barrels. Jim Maruzuola
(strictly protect),owner of a service company operating in
western Venezuela, came to the same conclusion after
studying recent trends in production.

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LACK OF MAINTENANCE STILL PLAGUES PDVSA
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3. (C) As noted in Reftel A, Venezuelan production
capacity falls by 20 to 25 percent per year due to the
heavy nature of Venezuelan crude as well as the advanced
age of many of its wells. In order to counteract these
two factors, producers must use gas or steam injection to
bring the crude to the surface. This requires constant
maintenance on the part of operators. It is clear that
PDVSA has not been carrying out this maintenance,
particularly in western Venezuela.


4. (C) According to a former senior PDVSA engineer, PDVSA
used gas to lift crude or to fire boilers for steam in Lake
Maracaibo. Production of heavy crude has fallen from
300,000 to 25 to 30,000 barrels per day due to a lack of
gas for the boilers. Heavy oil is stuck in the lines and
the engineer said a number of heavy oil fields in western
Venezuela are "frozen". He estimated it would take two to
three years of injection in order to produce significant
amounts of oil in the affected fields.


5. (C) The engineer also told Petatt and analyst that oil
being produced in western Venezuela has a lower gas to oil
ratio than before. As a result there is more pipe with
less gas. Eventually, there will only be enough gas to
keep the injection plants operating and not enough gas to
actually lift the oil to the surface. The engineer
estimates that it used to take the energy equivalent of one
barrel of oil to produce 20 barrels of oil. It now takes
the energy equivalent of one barrel to produce three
barrels of oil. The engineer also believes that production
could drop rapidly in the West since PDVSA is currently
producing from deep wells without any restraints. As a

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result, pressure in the wells could drop quickly. The
engineer said he heard that the rate of decline in
production capacity had increased to 25 to 30 percent.
Maruzuola also estimates that Venezuela has a decline rate
of 25%.


6. (C) A senior executive at a Venezuelan service company
told Petatt and energy analyst on March 20 that PDVSA is
not applying cathodic protection to its pipes in eastern
Venezuela. (NOTE: Cathodic protection is an
anti-corrosion technique for metal. Given the high sulfur
and metal content of some Venezuelan crude, it is necessary
to apply the protection to pipes in order to keep them from
corroding. END NOTE) ExxonMobil executives also told
Petatt and energy analyst that they were also concerned
about the state of some of PDVSA's pipelines. If PDVSA
does not carry out routine maintenance to its pipelines, it
is possible that we could see a situation where PDVSA has
maintained or even increased protection but is unable to
distribute it due to failures in its pipeline networks.

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ADMINISTRATIVE AND OPERATIONAL DIFFICULTIES
--------------

7. (C) PDVSA has clearly taken a number of steps recently
to increase production. According to Baker Hughes, the
number of oil rigs operating in Venezuela has increased
from 55 to 70 rigs between February 2005 and February

2006. The number of rigs increased by four between
January and February 2006. According to Maruzuola,
Venezuela needs 60 drilling rigs in order to maintain
production at 2.3 million barrels per day. Baker Hughes
executives told Petatt and energy analyst on March 15 that
81 rigs were operating in Venezuela and that an additional
six were stacked. Activity began rising at a brisk pace
starting in the third quarter of last year. There has been
more activity in western Venezuela than eastern Venezuela
and PDVSA is opening up some land prospects in the west.
Baker Hughes has seen bit sales increase 20 percent and the
majority of sales have been to PDVSA. The number of rigs
controlled by the private sector companies with OSA fields
has declined and PDVSA has assumed control of the rigs
(Reftel B). Baker Hughes executives stated six or seven
private sector firms are no longer drilling.


8. (C) Luis Prado (strictly protect),Shell Venezuela
Vice President for Exploration and Production, succinctly
summed up the private sector's position: "Why drill if you
are not sure that you will get your money back?" Prado
told Petatt and energy analyst on March 14 that Shell no
longer has a rig in Venezuela. As a result of
uncertainties arising from the OSA migration and budget
problems with the BRV, Shell decided to pause for six
months on drilling activities. It transferred the rig it
was using in its OSA field to PDVSA and hopes the rig will
be transferred back to its joint venture once it is
established. Prado said Shell needs nine months to a year
for advanced approval for drilling activities. He said
PDVSA officials did not understand this or did not care.


9. (C) Although PDVSA is drilling more wells, it is not
clear how great an impact this increased activity will have
in terms of overall production. Contacts repeatedly told us
that PDVSA was drilling in an inefficient manner. The
inefficiency stems in large part from inexperienced
drilling personnel and poor management practices. Senior
management turnover is also a problem. Western Venezuela
has had five PDVSA district managers in two years.


10. (C) Baker Hughes executives complained that PDVSA has
more people with less experience involved in drilling.
Once drilling begins, two to six PDVSA personnel make
drilling decisions as opposed to one person in the past.
Problems with a rig can take weeks to resolve. The
executives also complained that inexperienced junior

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engineers frequently tell Baker Hughes what to do. The
executives estimated that 60 percent of PDVSA employees
have three years experience or less. As a result, no cost
benefit analysis is done on operational issues such as
fishing. The executives stated that PDVSA employees
carried out fishing activities at one rig for an entire
month. (NOTE: Fishing refers to the process of retrieving
material that has fallen into a well. At a certain point,
it makes more sense to cement the well and drill a new one
rather than continue fishing. END NOTE)


11. (C) Service companies also complain that PDVSA
personnel exhibit a "penny wise, pound foolish" attitude.
PDVSA personnel tend to focus on the price of a product or
service rather than its overall value. Pride International
General Manager Al Vielma (strictly protect) told Petatt
and energy analyst on March 15 that his company offered to
drill a well for PDVSA in 45 days but at a premium. PDVSA
officials replied that a competitor offered to drill the
well in 120 days but at a cheaper price. They wanted Pride
to drill the well at the same price as the competitor but
in 45 days. Pride refused. Vielma repeatedly told the
PDVSA officials that they could pay his premium four or
five times over with the additional 75 days production they
would have but they did not appear to grasp the concept.


12. (C) Baker Hughes executives stated the use of Chinese
drilling rigs is another example of PDVSA penny-pinching
gone awry. Although the Chinese offer their services at a
much lower price, the four Chinese rigs operating in
eastern Venezuela have a downtime of 70 percent. The
Chinese do not have any repair facilities in Venezuela and
the operators of the rigs are Chinese.


13. (C) Finally, although PDVSA appears to be more open to
working with service companies in general, the PDVSA and
BRV bureaucracies make life difficult for service companies
that are in a position to boost PDVSA's production.
Marzuola stated his company was a member of a consortium
that was awarded a contract to repair, service, and put
on-stream 300 shut-in PDVSA wells. It is not clear what
condition the wells are in. The consortium will supply
rigs and basic production equipment. Despite the fact that
the situation appears to be win-win for both parties, PDVSA
in-fighting has delayed implementation of the contract.
Marzuola estimates that Venezuela has 2,800 to 3,000
shut-in wells.


14. (C) Payment and budget issues continue to plague
companies. Vielma complained that his company has not been
paid in over a year. When he complained to PDVSA that his
company was forced to take out an operating loan with a
high rate of interest, they were indifferent. Pride will
not be reimbursed for the interest that it paid on the
loan. The conversion of OSAs to joint ventures has raised
concerns among service companies that they will face the
same payment issues for work that they performed on OSA
fields. A manager for Hanover Venezuela, which is carrying
out an important upgrade at an OSA field, stated his
company would be paid on March 28. The payment was
structured so that Hanover would not have to deal with
PDVSA. In addition, Chevron was quoted by Dow Jones as
telling suppliers that they should deliver invoices by
March 31 since the OSA conversion to joint ventures could
slow payments. Baker Hughes executives stated they were
concerned that the OSA conversion would create a number of
"mini PDVSAs" that would produce all of the administrative
headaches of its parent.


15. (C) Other BRV entities also make life difficult for
service companies. For example, the Hanover executive
stated his company is required to ship parts that need
servicing out of Venezuela in official Cadivi (the foreign
exchange commission) boxes. The boxes are simple pine
boxes with a Cadivi seal burned into them. The executive

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stated his company has to pay 250 USD for each box. In
addition, Hanover has to contact Cadivi days in advance in
order to have each box built to the part's specifications.

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LOOMING LABOR ISSUES
--------------

16. (C) Labor issues could also produce major production
declines in Venezuela. As reported in Reftel A, PDVSA
inaugurated a new employment system, the Democratization of
Work System (SISDEM),on July 1 that has created tremendous
problems for operators. SISDEM requires contractors and
service companies to hire new employees for union jobs from
a PDVSA employment pool. An executive from Maersk stated
it takes three days to process a selected employee. The
employee must undergo a physical and have his credentials
reviewed. If Maersk rejects the employee because he does
not have the requisite skills, it must start the process
all over again. If Maersk found a qualified employee, it
lost him as soon as the particular job was finished. The
employee's name went to the bottom of the SISDEM list.
Maersk finally made an agreement with SISDEM officials that
allowed it to have its own restricted pool of SISDEM
employees. It is not clear how many other companies have
made similar arrangements.


17. (C) In addition to having a negative impact on
operations, SISDEM has also played a role in increasing
tensions with labor unions and local communities. Prior to
SISDEM, labor unions played an active role in assigning
jobs to their members. SISDEM has eliminated key source of
patronage. The Venezuelan press reported on March 31 that
labor disturbances in the Jose Industrial Complex were due
in part to workers' concerns over SISDEM. ExxonMobil
executives told Petatt and energy analyst on March 23 that
the BRV and PDVSA are pressuring the strategic associations
to adopt SISDEM. They noted the move is extremely
unpopular among local communities since SISDEM draws from a
nation-wide pool of workers rather than from local
communities.


18. (C) (COMMENT: Apart from its direct impact on
operations, SISDEM in conjunction with recent PDVSA moves
to weaken labor unions' power in the petroleum sector could
eventually lead to a strike. A Venezuelan service company
executive told us that PDVSA plans to fire groups of
workers and replace them with workers who receive fewer
benefits. It is our understanding that a PDVSA labor
agreement covering benefits is set to expire in April. END
COMMENT)

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SOCIAL AND POLITICAL ISSUES
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19. (C) Social policies and political campaigning will
also take a toll on increased production. Under the BRV's
social production company (EPS) policy, companies in the
petroleum sector must devote one to two percent of gross
revenues to social development projects. Service companies
must also submit bids that contain proposals for social
development projects. A number of contacts have told us
that companies will merely pad their bids in order to
ensure that they have a reasonable profit margin.
(COMMENT: In addition to inflating costs for PDVSA, the
social project requirements should have an impact on
operational efficiency. Companies will not be devoting
their full energies to production. It is not clear how
much of an impact these changes will have on production
levels. END COMMENT)


20. (C) The increased emphasis on social development
projects will also have an impact on PDVSA's operations.
In addition to siphoning off needed financial resources,
social development projects are tying up significant
numbers of PDVSA employees. Baker Hughes executives stated

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that 70 percent of the PDVSA employees in Anaco were
working on social projects. They claimed the local manager
was not sure where many of his employees were.


21. (C) Finally, the coming elections in December could
have a significant impact on PDVSA operations if the Chavez
administration decides to use PDVSA resources for the
campaign. Possible uses could range from using PDVSA
vehicles for the campaign to using PDVSA staff for
campaigning and rallies. The Baker Hughes executives noted
28 busloads of Maturin workers were sent to Caracas at one
point to attend a large rally. As a result, production in
Maturin was down for three days. If the Chavez
administration decides to use PDVSA resources for the
election, we would expect to see a decline in production
beginning in the third quarter of this year.

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COMMENT
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22. (C) Given the myriad of issues and practices that are
currently weighing down Venezuelan production, we do not
believe that additional drilling activity will lead to an
increase in overall production. We believe the application
of SISDEM, poor administration, and lack of maintenance
will continue to push overall production down in the near
term. We base this in part on the fact that the BRV, via
the OSA migration, is taking some of the most efficient
operations and making them far less efficient. If the BRV
introduces SISDEM to the strategic associations and then
converts them to joint ventures as it says it will, the
last vestiges of efficiency in the Venezuelan petroleum
sector will be washed away. We believe production will
eventually reach a plateau but it is not clear at what
point this will happen. Obviously, this view assumes that
PDVSA will be able to reach some sort of arrangement with
its labor regarding benefits, SISDEM, and the role of
unions. If a strike does occur, all bets are off regarding
Venezuelan production.

BROWNFIELD
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