Identifier
Created
Classification
Origin
07CARACAS1466
2007-07-23 21:32:00
CONFIDENTIAL
Embassy Caracas
Cable title:  

PDVSA'S "IMPORTANT OPERATIONAL EMERGENCY"

Tags:  EPET ENRG EINV ECON VE 
pdf how-to read a cable
VZCZCXRO0284
RR RUEHDE
DE RUEHCV #1466/01 2042132
ZNY CCCCC ZZH
R 232132Z JUL 07
FM AMEMBASSY CARACAS
TO RUEHC/SECSTATE WASHDC 9342
INFO RUEHHH/OPEC COLLECTIVE
RUEHAC/AMEMBASSY ASUNCION 0849
RUEHBO/AMEMBASSY BOGOTA 7433
RUEHBR/AMEMBASSY BRASILIA 5959
RUEHBU/AMEMBASSY BUENOS AIRES 1644
RUEHLP/AMEMBASSY LA PAZ 2554
RUEHPE/AMEMBASSY LIMA 0824
RUEHME/AMEMBASSY MEXICO 4034
RUEHSP/AMEMBASSY PORT OF SPAIN 3450
RUEHQT/AMEMBASSY QUITO 2645
RUEHSG/AMEMBASSY SANTIAGO 3971
RUEHDG/AMEMBASSY SANTO DOMINGO 0480
RUMIAAA/HQ USSOUTHCOM MIAMI FL
RHEHAAA/WHITEHOUSE WASHDC
RHEBAAA/DEPT OF ENERGY
RUCNDT/USMISSION USUN NEW YORK 0890
RUCPDOC/DEPT OF COMMERCE
RUEATRS/DEPT OF TREASURY
RHEHNSC/NSC WASHDC
C O N F I D E N T I A L SECTION 01 OF 04 CARACAS 001466 

SIPDIS

SIPDIS

ENERGY FOR CDAY AND ALOCKWOOD
NSC FOR JCARDENAS AND JSHRIER

E.O. 12958: DECL: 07/23/2017
TAGS: EPET ENRG EINV ECON VE
SUBJECT: PDVSA'S "IMPORTANT OPERATIONAL EMERGENCY"


Classified By: Acting Economic Counselor Shawn E. Flatt for Reason 1.4
(D)

C O N F I D E N T I A L SECTION 01 OF 04 CARACAS 001466

SIPDIS

SIPDIS

ENERGY FOR CDAY AND ALOCKWOOD
NSC FOR JCARDENAS AND JSHRIER

E.O. 12958: DECL: 07/23/2017
TAGS: EPET ENRG EINV ECON VE
SUBJECT: PDVSA'S "IMPORTANT OPERATIONAL EMERGENCY"


Classified By: Acting Economic Counselor Shawn E. Flatt for Reason 1.4
(D)


1. (C) SUMMARY: Luis Vierma, PDVSA's Vice President for
Exploration and Production, testified before the Comptroller
Committee of the National Assembly on July 18 that PDVSA was
facing an "important operational emergency" due to the
failure of two bid rounds for drilling rigs. PDVSA's rig
count of 112 differs significantly from service company Baker
Hughes' count of 82. Local analysts do not believe that
PDVSA is producing more than 3.0 million barrels per day as
it claims due to the rig count and a lack of investment in
recent years. It appears that PDVSA plans to deal with its
operational problems via Citgo investment in upstream
projects in Venezuela, a greater reliance on service
companies, and a drilling program that focuses on quick,
short-term results. Citgo would finance the upstream
investments via bank financing. The assets of a highly
leveraged Citgo may not be as attractive to the holders of
arbitration awards against PDVSA if they were used as
collateral for bank loans. END SUMMARY

--------------
PDVSA'S EMERGENCY
--------------

2. (SBU) PDVSA's Vice President for Exploration and
Production Luis Vierma testified before the Comptroller
Committee of the National Assembly on July 18 that PDVSA was
facing an "important operational emergency" due to the
failure of two bid rounds for drilling rigs. Vierma was
testifying before the committee due to allegations of
improprieties in a 145 billion Bolivar drilling rig contract.
The Reporte newspaper has repeatedly charged Vierma with
corrupt practices over the past several months. The charges
have been quite detailed and rumor has it that a PDVSA or
Energy Ministry insider has been leaking information to the
paper.


3. (SBU) El Universal newspaper in separate articles quoted
Energy Minister and PDVSA President Rafael Ramirez and Vierma
as stating the first bid was declared void because its terms

did not include a "social responsibility component", was
organized separately by operational area, and was for a
period of only two years. El Universal quoted Ramirez as
stating that operating districts must have unified equipment
requests, contracts must be for five years, and all contracts
must contain an obligatory social component equal to 10% of
the gross amount of the contract.


4. (SBU) Following the failure of the first bid round, PDVSA
invoked a section of the Public Bidding Law that allowed it
to proceed with direct assignment. According to El
Universal's account of Vierma's testimony, Vierma stated 63
companies began the bidding process but only 22 actually
completed it. Of these 22companies, 12 received contracts
for 27 rigs. Verma then admitted that only five of the 12
compnies actually completed the contract. One of the
companies that did not complete the contract was Constructora
Interbolivariana Multinacional Andina, a Colombian firm that
is suspected of being a shell company due to its low level of
capitalization. (NOTE: Septel will discuss the Venezuelan
Public Bidding Law and its impact on the oil sector. END
NOTE)


5. (C) A shipping executive and marketing executive told
Petroleum Attache (Petatt) and Econ Specialist on June 28
that a number of companies that were awarded bids for
drilling rigs were shell companies. The marketing executive
claimed that the companies tried to sell their contracts but
were unable to do so under Venezuelan law. The owners then

CARACAS 00001466 002 OF 004


tried to sell the companies to international service
companies in order to unload the contracts. The marketing
executive stated none of the international companies wanted
anything to do with the proposals.

--------------
FIGURES LIE AND LIARS FIGURE
--------------

6. (SBU) According to Vierma's testimony and PDVSA's website,
there are currently 112 drilling rigs operating in Venezuela.
PDVSA's goals for 2007 were to have 190 rigs operating by
the end of the year and to drill 1,700 wells. Vierma stated
PDVSA's 2007 budget for rigs was over 3.5 billion USD.


7. (C) PDVSA's claim of 112 drilling rigs varies widely with
service company Baker Hughes' rig count for Venezuela.
According to Baker Hughes, Venezuela had 82 drilling rigs
operating in June 2007. Of these 82 rigs, 71 were drilling
for oil and 11 for gas.


8. (C) Vierma's rig figures and comment about an operational
emergency raise real questions about PDVSA's production
claims of over 3 million barrels of oil per day. Local
analysts have pointed out that PDVSA invested nearly 6
billion USD in the oil sector and had 120 operational
drilling rigs in 1997, the year PDVSA hit a maximum crude
production level of 3.5 million barrels of oil per day. The
1997 production level was also the result of seven years of
increasing investment in the sector. Local analysts estimate
that PDVSA invested less than 3.5 billion USD in 2006 and
that this amount is hardly enough to support 120 drilling
rigs given the sharp increase in operating costs over the
last two years. Both Ramirez and Vierma have publicly
admitted that rig costs have skyrocketed. Given the 2002-3
strike, the firing of thousands of PDVSA employees, and
relatively low levels of investment in recent years, it is
very difficult to believe PDVSA's claims that it is producing
over 3 million barrels of oil per day.

--------------
WHERE DOES PDVSA GO FROM HERE?
--------------

9. (C) Based on Vierma's comments and information from a
Citgo executive, it appears that PDVSA plans to deal with its
operational problems via Citgo investment in upstream
projects in Venezuela, a greater reliance on service
companies, and a drilling program that focuses on quick,
short-term results. Despite Vierma's positive spin during
the National Assembly hearing, PDVSA's three-prong plan
raises more questions than it answers.


10. (C) A senior Citgo executive told Petatt and Econ
Specialist on July 20 that he has been assigned to draft a
proposal for Citgo investment in upstream projects in
Venezuela. According to the executive, only three senior
executives in Citgo have knowledge of the project. The plan
is to be completed and submitted to Citgo President Alejandro
Granado the week of July 23. Granado will then present the
plan directly to Energy Minister Rafael Ramirez. The
executive stated Faja projects are one of the options being
considered. He also indicated that the projects will be
financed via bank loans. Based on the executive's comments,
it appears that the size of Citgo's investment will be based
on the amount of money that it can raise in the financial
markets. The executive stated Citgo's studies show that the
company would make a healthy rate of return from investments
in Venezuelan upstream projects.


11. (C) COMMENT: PDVSA may be able to kill two birds with
one stone if Citgo begins investing in upstream projects in

CARACAS 00001466 003 OF 004


Venezuela. First, use of Citgo's assets and access to
financial markets allows PDVSA to increase investment in the
oil sector without exacerbating its cash flow problems.
Second, it is not clear if Citgo would have to utilize a
PDVSA-controlled joint venture structure with PDVSA in order
to invest in Venezuelan upstream projects since it is a
wholly owned PDVSA subsidiary. If Citgo does not utilize a
joint venture, service and equipment providers may feel more
comfortable entering into contracts with Citgo directly for
sorely needed equipment and technology. Citgo could draft
the contracts with provisions granting arbitration rights and
a host of other protections PDVSA is loathe to grant. In
addition, if the services and equipment were contracted in
the United States, suppliers may be able to avoid the
Venezuelan Public Bidding Law. The assets of a highly
leveraged Citgo may not be as attractive to the holders of
arbitration awards against PDVSA if they were used as
collateral for bank loans.


12. (C) Given PDVSA's self-acknowledged operational
problems, it would seem logical that it would turn to service
companies to provide the equipment and technology that it so
desperately needs. However, it appears that PDVSA is sending
mixed signals regarding service companies. Vierma is quoted
on the PDVSA website as stating that PDVSA due to "national
security and strategic reasons" must field its own fleet of
drilling rigs in order to reduce its vulnerability that it
has to third party contracts. He also said PDVSA was equally
vulnerable to third party contracts for well services. It is
hard to believe that PDVSA will be able to build up a fleet
of drilling rigs given high market prices and its current
cash flow problems. Even if it could purchase the rigs, it
is not clear that it could find a sufficient number of
capable crews to run them given the dearth of human capital
in the Venezuelan hydrocarbon sector. END COMMENT.


13. (C) The media reported the week of July 16 that French
service company Schlumberger had signed an operating contract
with PDVSA to manage rigs and provide engineering services to
PDVSA for the Cerro Negro and Petrozuata strategic
association fields. We have been unable to confirm the
reports. If true, the move makes a great deal of sense due
to the fact that no one believes PDVSA has the wherewithal to
adequately run the fields on their own. A local analyst told
Petatt on July 19 that he believes Venezuela is moving toward
the Mexico model, whereby the state oil company depends
heavily on the service companies for a wide variety of
activities. The analyst noted that Schlumberger has done
very well in Mexico and thrives in closed, state-dominated
markets. He also noted that although service companies can
"get the job done", they lack all of the assets and skill
sets that first-tier, international oil companies possess.
The analyst noted that this lack of skills has caused real
problems in Mexico. (COMMENT: We believe that PDVSA, despite
Vierma's nationalist rhetoric to the contrary, will
eventually have to rely to some extent on the service
companies due to its lack of management expertise, human
resources, and technology. We concur with the analyst that
the service companies will not solve all of PDVSA's problems.
Service companies in many ways act as sub-contractors in the
construction sector. They are excellent at what they do but
they need someone to provide them with overall direction. We
do not believe that PDVSA is capable of providing the
necessary project management that the service companies need
to fully utilize their capabilities. END COMMENT)


14. (C) Vierma is also quoted as telling the Comptroller
Committee that PDVSA may have to orient its drilling program
to increase drilling in the Faja region. Vierma stated that
it only takes four days to drill a well in the Faja as

CARACAS 00001466 004 OF 004


opposed to 200 days in other parts of Venezuela. As a
result, he stated PDVSA may focus on drilling more wells in
the Faja in order to keep up the volume of production.
(COMMENT: Although this sounds good on the surface, the
problem is that the Faja produces extra heavy crudes, which
must be upgraded or blended before marketing. At this point,
it does not appear that the four upgraders currently
operating in the Faja are capable of handing a substantial
increase in production. Based on conversations with multiple
contacts, it also does not appear that PDVSA has sufficient
blending facilities or a sufficient supply of lighter crude
to mix with extra heavy crudes. As a result, it is difficult
to believe that a substantial increase in the flow of extra
heavy crudes will alleviate PDVSA's production problems. END
COMMENT)

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WE ARE NOT MAKING THIS UP
--------------

15. (C) Ironically, on July 19, the same date that the press
reported on Vierma's "operational emergency" testimony, the
media reported that PDVSA planned to form seven new
affiliates: PDVSA Industrial (the production of equipment for
the oil sector); PDVSA Agricola (agriculture); PDVSA
Servicios (oil services); PDVSA Ingeieria y Construccion
(engineering and construction); PDVSA Desarollo Urbano (urban
development and infrastructure); PDVSA Naval (docks and
shipbuilding); and PDVSA Gas Popular (gas distribution). We
have little doubt that PDVSA's new affiliates will be just as
well-run and efficient as their parent.
FRENCH