UPDATE ON THE FAJA STRATEGIC ASSOCIATION MIGRATION

C O N F I D E N T I A L SECTION 01 OF 05 CARACAS 000967 SIPDIS SIPDIS ENERGY FOR CDAY AND ALOCKWOOD NSC FOR DTOMLINSON AND JSHRIER E.O. 12958: DECL: 01/12/2017 TAGS: EPET ENRG EINV ECON ELAB VE SUBJECT: UPDATE ON THE FAJA STRATEGIC ASSOCIATION MIGRATION REF: A. CARACAS 854 ¶B. CARACAS 825 ¶C. CARACAS 833 ¶D. CARACAS 526 Classified By: Economic Counselor Andrew N. Bowen for Reason 1.4 (D) ¶1. (C) SUMMARY: International oil companies (IOCs) believe PDVSA's assumption of operational control on May 1 went relatively smoothly. IOCs stated production numbers are holding stable, but the companies believe PDVSA will begin having problems operating the upgraders by the end of the year. A significant number of Cerro Negro employees have refused to migrate to the new entity. May 1 brought few changes for employees at Sincor, Petrozuata, and Hamaca, at least initially. Negotiations will now begin on the remaining terms for migration to PDVSA-controlled joint ventures. Key IOC issues are compensation for lost value and minority shareholder rights, particularly in the areas of governance and the use of dispute resolution mechanisms outside of Venezuela. END SUMMARY -------------- -------------- DETAILS ON THE MAY 1 TRANSFER OF OPERATIONAL CONTROL -------------- -------------- ¶2. (C) The Ambassador spoke with the local presidents of ExxonMobil (XM),ConocoPhillips (CP),and Chevron on April 30 to discuss PDVSA's assumption of operational control of the four strategic associations in the Faja as well as profit sharing agreements in the Gulf of Paria on May 1 (Reftel A). All of the executives stated they believed the handovers would occur relatively smoothly. In a follow-up meeting with the Ambassador on May 4, CP Latin America President Roy Lyons (strictly protect throughout) stated National Guard personnel arrived at CP's Corocoro project and its Puerto La Cruz facility on April 30 and took over the facilities. A brief incident occurred at La Guiria, home of a support facility for Corocoro, when a CP manager refused to sign a document that included terms that were well beyond the transfer of operational control. A PDVSA attorney began cursing and threatening the manager but a senior PCP official (PDVSA's security unit) intervened and the lawyer backed down. The PCP official stated his job was to ensure that the operations were transferred without any sort of incident. ¶3. (C) Lyons stated PDVSA assumed control of offshore drilling at the Corocoro project on May 1. CP's contractor agreed to continue drilling under PDVSA's supervision. Lyons added that as of May 4 PDVSA still had not assumed control of the construction site for a large processor in Puerto Ordaz or a floating production storage off-loading barge that supports Corocoro operations. Lyons believed PDVSA does not have the necessary expertise to operate the barge. He told the Ambassador that CP as of May 4 had not had any communications from these projects since PDVSA assumed control. ¶4. (C) Lyons stated operations continue at the Petrozuata and Hamaca (also known as Ameriven) strategic associations under existing contractors and association employees. He added CP is receiving daily reports from both associations. ¶5. (C) XM Venezuela President Tim Cutt (strictly protect throughout) told Petroleum Attache (Petatt) and a visiting USG analyst on May 10 that the transfer of operational control at Cerro Negro was somewhat uneven. The information technology and field operations transfers went very well. Cutt stated the Cerro Negro board still remains in place. Since XM did not sign a memorandum of understanding (MOU), but rather a document that merely transferred operational CARACAS 00000967 002 OF 005 control, Cerro Negro does not have a transition committee running operations. Cutt believes that XM still has all of its rights under the original Cerro Negro agreement. XM has received its first weekly report on Cerro Negro operations from PDSVA. ¶6. (C) Statoil Venezuela President Thore Kristiansen (strictly protect throughout) told Petatt and the analyst on May 11 that nothing has changed at the Sincor strategic association. According to Kristiansen, the president of Sincor, who is a PDVSA employee, has assumed the title of general manager. The general manager and assistant general managers, who are Total and Statoil employees, then assumed the titles of assistant general manager and special consultant. Apart from the changes in titles, no other operational changes have been made to date at Sincor. (COMMENT: We are assuming that a transition committee is now running Sincor rather than its former board of directors due to the fact that Total and Statoil signed MOUs establishing the committee (Reftels B & C) END COMMENT) -------------- PRODUCTION -------------- ¶7. (C) Energy Minister Rafael Ramirez stated in an interview on May 13 that the four strategic associations were producing 480,000 barrels per day the "first week of the nationalization." He claimed the associations were only producing 400,000 barrels per day prior to May 1. Lyons told the Ambassador on May 4 that both Petrozuata and Hamaca were still subject to OPEC cuts and that their production was 87,000 barrels per day at Petrozuata and 145,000 barrels per day at Hamaca. CP has offered to assist PDVSA with associations' operations, but PDVSA must sign a technical services agreement and compensate CP for its services. As reported in Reftel C, Chevron expects production at Hamaca to eventually decline by 30%. Kristiansen stated Sincor was producing 700,000 barrels per month less than normal, about a 15% barrel per day reduction. Kristiansen added PDVSA has indicated that it wants to increase production at Sincor. Due to a 45 day planning window, he thought Sincor would only be able to produce an additional half cargo in May. ¶8. (C) Cutt stated production capacity at Cerro Negro was 112,000 barrels per day, but, that it should increase to 120,000 barrels in one months time due to the addition of a workover rig. BP Venezuela President Joe Perez (strictly protect throughout) told Petatt and the analyst on May 9 that Cerro Negro was producing 85,000 barrels per day in the field and 78,000 barrels per day of syncrude. He placed the upgraders capacity at 120,000 barrels per day. He stated the upgrader had the ability to produce 145,000 barrels per day but that Cerro Negro had not carried out any well repair operations since the beginning of the year. As a result, field production capacity had declined. Perez also opined that PDVSA would not need to drill any new wells at Cerro Negro in order to maintain operations. ¶9. (C) Cutt opined that PDVSA could maintain operations at Cerro Negro for six months to one year before there was a major deterioration in operations. XM has offered a consultancy contract to PDVSA but PDVSA has not signed any agreements or paid XM anything. Cutt stated he would no longer answer PDVSA's operational questions after noon on May 11 if they did not sign a consultancy agreement. According to Perez, the breaking point for the Cerro Negro upgrader is 75,000 barrels per day. (NOTE: Upgraders must operate at a certain level. If they fall below this level, continued operation would result in significant damage to equipment. END NOTE). Cutt stated he believes that PDVSA could not deal with a major fire at the upgrader. He described a emergency CARACAS 00000967 003 OF 005 response drill that XM carried out with PDVSA prior to the transfer as a "disaster." -------------- LABOR ISSUES -------------- ¶10. (C) Lyons stated CP pulled out all of its expat employees prior to the May 1 turnover. Of the 88 expat employees in Venezuela, CP has already found jobs for 65 employees; they would depart by June. Lyons stated the CP expats would not return to Venezuela under any scenario. CP will not subject its employees (expat or local) to PDVSA control. As noted in Reftel C, Chevron has stated it will not withdraw its expat employees under any circumstances. It is not clear at this point where local Petrozuata and Hamaca strategic association employees stand in terms of converting to joint venture employees. Kristiansen stated Sincor employees have not been offered a compensation package to date. He seemed somewhat optimistic that the employees would not suffer a significant decline in their total compensation packages but did not elaborate on what he based his optimism. ¶11. (C) Cutt told Pettatt and the analyst that acceptance rates at Cerro Negro varied widely. The acceptance rate among local employees in the field was 70% and the rate at the upgrader was 60% for those who submitted their names to migrate. However, Cutt added that the rate was lower for processing and engineering personnel. In addition, the acceptance rate for office personnel was only 38%. Perez stated 20 Cerro Negro employees did not wish to migrate and did not submit their names. In addition, another 20 employees were rejected by PDVSA. ¶12. (C) Cutt said the biggest risk for PDVSA was in the area of business services. He expressed concern that PDVSA would fall behind in payments to contractors. He also complained that PDVSA recently changed out the logistics team and replaced the team with junior employees. XM had spent a great deal of time orienting the team to Cerro Negro operations and it did not make any sense to transfer the personnel. Cutt described logistics as the hardest job at Cerro Negro. Cutt also made a point of noting that most of the better employees were the ones who decided to leave. XM has a rating system that divides employees into A, B, and C groups. According to Cutt, all of the A group employees and most of the Bs decided not to stay at Cerro Negro. ¶13. (C) Cutt stated XM had 500 employees in Venezuela prior to May 1. It now has 97 and it plans to place 65 Venezuelan employees in its worldwide system. In addition, XM will transfer out 12 expat employees. XM will retain a small group of employees to provide support services and expects to have 20 to 25 employees in Venezuela by July 1. Most of the management team will have departed by that date. Cutt said XM plans to have four to five employees in Venezuela by year-end, provided it decides to stay. ¶14. (C) According to Perez, PDVSA sent approximately 50 refinery employees to Cerro Negro. He described the employees as "somewhat competent." Cutt described the PDVSA accounting manager and the new upgrader manager as quite competent. However, he stated the upstream manager was "clearly clueless" and that his own subordinates did not pay any attention to him during meetings. -------------- NEGOTIATING POSITIONS -------------- ¶15. (C) Lyons told the Ambassador that CP has no intention of signing a MOU along the lines of the one signed by Chevron. The question for CP at this time is what is its CARACAS 00000967 004 OF 005 future in Venezuela. Lyons explained that there were two types of documents that were signed prior to May 1. The first, which XM signed, merely stated that the IOC was turning over operations to PDVSA. However, the MOU that Chevron signed contained a provision that gave control of the associations to a committee that PDVSA controlled (Reftel C). CP was willing to sign the same document as XM but was unwilling to sign the MOU for Petrozuata and Hamaca. CP believes the MOU goes beyond the scope of the nationalization decree. In CP's view, there is no reason to change the governance structure of the associations at this time. Lyons explained that CP was afraid the acceptance of a transition committee would damage its rights under the original agreements and would allow PDVSA to upgrade oil at Petrozuata and Hamaca from outside sources, particularly Cuba (Reftel D). ¶16. (C) Lyons told the Ambassador that CP would stay in Venezuela if it could come to terms with the BRV on three key issues. First, CP must have a governance structure that respects minority rights and gives it influence in investments. Second, CP must have adequate compensation for lost value in the projects. Book value is not an acceptable measure for compensation. Finally, CP must have access to dispute resolution measures outside of Venezuela. Lyons stated there was a large gap between the BRV and PDVSA on each of the issues and that the BRV has to give in on all three issues. He later added that the BRV and PDVSA have hardened their positions since May 1. For example, the BRV has publicly taken cash compensation off of the table. ¶17. (C) Cutt told Petatt and the visiting analyst that he believes XM and CP's negotiating positions are close. He stated the BRV and PDVSA have offered XM book value minus a discount factor for its lost value. They have also stated Cerro Negro's acreage will be reduced but have not given any specifics. Cutt believes the BRV will seek one contract for all four strategic associations. He also believes the BRV will force a short negotiating period and will not relax the June 26 deadline for reaching agreement on outstanding issues. He stressed that XM wished to stay in Venezuela and that arbitration would be a lose/lose situation. Statoil's Kristiansen also told Petatt and the analyst that the deadlines were hard. He stated that everyone will know by the August 26 deadline for National Assembly approval who will still be operating in Venezuela and who Venezuela's future partners will be. ¶18. (C) Cutt also said XM was looking at the Chalmette refinery as a possible negotiating point. There are currently six supply contracts with Chalmette. XM could force PDVSA out of one of the supply contracts, which would force them to sell on the open market. As a result, PDVSA would lose three to five USD per barrel. He also added the XM has a blocking vote on the sale of PDVSA's stake in Chalmette. Cutt stated XM was looking at a crude supply contract and a related technical services agreement as one possible solution. (NOTE: A retired PDVSA senior executive told Petatt that XM received a series of supply contracts as part of the settlement for the 1975-6 nationalization and earned more money under the supply contracts than it had operating in Venezuela. END NOTE) ¶19. (C) Cutt also believes ENI will pull out of Venezuela. When Petatt pointed out that Reuters had reported that ENI signed a MOU for the Corocoro field, Cutt replied that it was the same agreement that XM signed. In separate meetings on May 9 and 10, Perez and Kristiansen strongly implied that Statoil and BP would stay in Venezuela do to the large amount of reserves at stake. -------------- CARACAS 00000967 005 OF 005 CREDITORS -------------- ¶20. (C) Lyons stated Petrozuata and Hamaca together have 1.5 billion USD in outstanding loans. Petrozuata's financing is in the form of bonds and Hamaca's is bank loans. When asked if lenders had shown any sign of taking a hard line with the BRV or PDVSA, Lyons replied no. It is possible that lenders have begun to take notice, PDVSA issued a press release on May 12 stating that PDVSA Cerro Negro received a notification from Deutsche Bank Trust Company America on April 26 regarding potential problems with bonds issued by the Cerro Negro Finance Ltd. PDVSA Cerro Negro issued a reply stating that it was meeting all of the bonds' conditions. -------------- COMMENT -------------- ¶21. (C) At this point, it appears that Chevron, BP, and Statoil have decided to stay come what may. Both XM and CP have made it clear that they want to avoid arbitration but have also been just as clear that they will not compromise on their core beliefs. XM has shown that it can be very creative in offering the BRV alternatives. The question is whether the BRV can show some flexibility. Up until now, it has shown little inclination to do so, despite the fact that it needs the IOCs to run the upgraders. WHITAKER