LUKOIL DEEPLY PESSIMISTIC

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 002104 SIPDIS SIPDIS ENERGY FOR CDAY AND ALOCKWOOD NSC FOR JCARDENAS AND JSHRIER E.O. 12958: DECL: 10/02/2017 TAGS: EPET ENRG EINV ECON VE SUBJECT: LUKOIL DEEPLY PESSIMISTIC REF: A. CARACAS 2050 ¶B. CARACAS 1466 ¶C. CARACAS 1467 ¶D. CARACAS 1314 ¶E. CARACAS 1577 ¶F. CARACAS 1822 Classified By: Economic Counselor Andrew N. Bowen for Reason 1.4 (D) ¶1. (C) SUMMARY: According to a senior Lukoil executive, Lukoil is highly pessimistic about investment opportunities in Venezuela. The Russian company is particularly concerned about constitutional reforms such as the definition of private property and the six hour workday. In addition, the company expressed frustration over public procurement regulations, the lack of independence for joint ventures, and PDVSA's increasing inflexibility. Lukoil did not sign a deal to rehabilitate wells due to concerns over public procurement rules. A senior executive opined that Chavez was willing to do whatever it takes to secure passage of his reforms and that Venezuela would soon resemble the former Soviet Union. END SUMMARY -------------- NEGATIVE VIEW OF THE INVESTMENT CLIMATE -------------- ¶2. (C) Petroleum Attache (Petatt) and Economic Specialist met with Xenia Baumgarten, Lukoil's Director of Business Development for Latin America, (strictly protect throughout) for almost two hours on October 29 to discuss Lukoil's views on Venezuela. Petatt began the conversation by asking Baumgarten if Lukoil was concerned about recent proposals to amend the Venezuelan constitution (Reftel A). Baumgarten replied Lukoil was particularly concerned about the definition of private property in the proposals but admitted that it was difficult to analyze the proposals since the BRV was constantly proposing new changes. Later in the conversation, she stated Lukoil was also concerned about the proposed six hour workday. She stated the proposal would result in a 30 to 40% increase in the cost of drilling operations. ¶3. (C) Baumgarten stated repeatedly that public procurement was a major impediment to investment for Lukoil. Although the press reported that Lukoil was close to signing a major agreement to rehabilitate oil wells in Venezuela, Baumgarten said Lukoil has refused to sign the agreement due to its concerns over public procurement. She added that Lukoil was worried the BRV would penalize it for failing to sign the 
agreement. (COMMENT: As reported in Reftels B and C, Venezuela's public procurement laws are byzantine. If a company in a joint venture was forced to follow them, the joint venture's operating efficiency would decline markedly and its costs would greatly increase. END COMMENT) ¶4. (C) Baumgarten stated she requested a copy of PDVSA's operating policies and procedures to assuage Lukoil's concerns. She was shocked when the resulting package did not contain a single reference to procurement. She requested additional information on procurement but PDVSA has not responded. Lukoil is hoping that public procurement regulations do not apply to affiliates. If this were true, Lukoil could form an affiliate that would do business with Lukoil's Venezuelan joint ventures and earn significant amounts of revenue. -------------- A JAUNDICED VIEW OF JOINT VENTURES -------------- ¶5. (C) Despite the fact that BRV-controlled joint ventures CARACAS 00002104 002 OF 003 are independent entities under Venezuelan law, Baumgarten stated she does not believe the companies are truly independent. For example, the joint ventures' budgets were subject to a central budgeting commission. When Petatt noted that joint venture partners feel pressured to inject additional capital into joint ventures despite their independent status, Baumgarten agreed. ¶6. (C) Baumgarten stated Lukoil was concerned over what terms required approval by a qualified vote of the board as opposed to a simple majority. She stated Lukoil was carefully studying the terms of the migration of the strategic associations to joint ventures. She said Lukoil was particularly interested in the private sector partners' ability to name their employees to management positions as well as control marketing. She noted that at least two of the joint ventures that were formed from the strategic associations appeared to have favorable terms regarding qualified majority voting, the assignment of senior positions to the private sector partners, and control of marketing by the private sector. However, she later noted that the terms may no longer be relevant given recent constitutional proposals that further limited private sector participation in the hydrocarbon sector. (COMMENT: As reported in Reftels D-F, both Chevron and Statoil told us that they received highly favorable terms in their migrations. END COMMENT). -------------- HIGH LEVEL INTERGOVERNMENTAL COMMISSION -------------- ¶7. (C) Baumgarten stated she was a member of the Russian delegation to the high level intergovernmental commission that met on October 27. The meeting, which President Chavez addressed, resulted in the signature of six agreements, including the assignment of the Ayacucho block 2 in the Faja to the Anglo-Russian company TNK-BP Management for the purposes of reserve certification. Baumgarten stated the Russians had hoped to sign a bilateral investment treaty (BIT) at the event but the two sides could not agree on the arbitration provisions. Baumgarten stated Lukoil currently operates in Venezuela under the Dutch BIT. She stated Lukoil was going to begin running all of its investment projections using a project's stated timeline as well as a 15 year timeline. If Venezuela pulled out of the Dutch BIT, investors would still be subject to its terms for 15 years. -------------- PERCEPTIONS OF PDVSA -------------- ¶8. (C) Baumgarten stated Lukoil's certification study of the Junin 3 block in the Faja block was behind schedule due to PDVSA's general inefficiency. She complained that Lukoil had had difficulties securing drilling rigs for the project and stated it had only drilled six wells instead of the 11 or 12 that were needed. ¶9. (C) Later in the conversation, Baumgarten stated a number of PDVSA officials were commercially savvy and opined that PDVSA would not enter into agreement with private sector companies if they were not commercially advantageous to PDVSA. PDVSA's commercial savvy did not translate into operational acumen. Baumgarten complained that PDVSA managers were afraid to make decisions and it was paralyzing the company. She also complained that CVP President Eulogio Del Pino was no longer accessible to companies. In the past, Baumgarten said she sent Del Pino e-mails, which he quickly answered. She stated she is now required to contact him via letters and that the letters are never answered. -------------- CARACAS 00002104 003 OF 003 BACK IN THE USSR -------------- ¶10. (C) Baumgarten ended the meeting by offering a bleak prophecy of Venezuela's future under Chavez. She said she felt as if she were living in the Russia of 1917. She harbored no illusions that Venezuela would soon be copying key elements of the Soviet system. She stated Chavez said during the intergovernmental commission meeting that elements of society were trying to derail his constitutional reforms but that they could not do it. He added that elements of the government were opposed to the reforms but that he would deal with them. Based on Chavez' demeanor, Baumgarten said she thought Chavez was capable of doing whatever it took to secure his reforms, including "killing his opponents". DUDDY