HARVEST PUSHES BACK ON THE WINDFALL PROFITS TAX

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 000610 SIPDIS ENERGY FOR CDAY AND ALOCKWOOD NSC FOR JSHRIER E.O. 12958: DECL: 01/28/2018 TAGS: EPET ENRG EINV ECON VE SUBJECT: HARVEST PUSHES BACK ON THE WINDFALL PROFITS TAX REF: A. CARACAS 00565 ¶B. CARACAS 00581 ¶C. CARACAS 00494 ¶D. CARACAS 00532 Classified By: Acting Economic Counselor Shawn E. Flatt for Reason 1.4 (D) ¶1. (C) SUMMARY: U.S. oil company Harvest Natural Resources has begun to directly and indirectly lobby the BRV to define the terms of the new windfall profits tax. Harvest would like to see the BRV discount the 33.33% royalty when calculating the new tax. In addition, it also wants the BRV to provide a discount based on the quality of the crude individual joint ventures produce. END SUMMARY -------------- HARVEST'S LOBBYING CAMPAIGN -------------- ¶2. (C) Mauricio di Girolamo (strictly protect throughout), HarvestVinccler Vice President and General Manager, told Petroleum Attache (Petatt) on April 30 that his company has begun to lobby senior BRV officials directly and indirectly to apply a liberal interpretation to key provisions of the new windfall profits tax (Reftel A). Di Girolamo expressed frustration that his colleagues in other international oil companies have expressed little or no interest in the windfall profits tax. He added a colleague in Shell still seems convinced that the tax will not apply to joint ventures. Due to other companies' lack of interest, Harvest has begun a lobbying campaign via the Venezuelan Association of Hydrocarbons (AHVI),the association of international oil companies operating in Venezuela. Despite its members' current lack of interest, AHVI President Luis Xavier Grisanti agreed to lobby BRV officials for a liberal interpretation of the tax law's provisions. ¶3. (C) Di Girolamo stated he has contacted Energy Vice Minister Bernard Mommer and CVP President Eulogio Del Pino directly via telephone and e-mail to raise Harvest's concerns. Di Girolamo added Grisanti had breakfast with Ambassadors Ali Rodriguez and Bernardo Alvarez the weekend of April 26 to discuss the tax's provisions. (NOTE: Rodriguez and Alvarez were in Caracas to meet with New Mexico Governor Bill Richardson (Reftel B) END NOTE). -------------- KEY AREAS OF CONCERN -------------- ¶4. (C) Di Girolamo said Harvest would like to see five clarifications in the implementation of the tax. First and most importantly, Harvest would like the BRV to discount the 33.33% royalty companies must pay when it computes the windfall profits tax. Second, Harvest would like to see a discount in the windfall profits tax based on the quality of oil that is produced by the individual joint ventures. Third, Harvest is also hoping that there will be a discount applied to oil that is consumed in the domestic market. Fourth, Harvest believes companies should be allowed to deduct the science and technology tax, social investments, and the anti-drug tax when calculating the windfall profits tax. Finally, Harvest is requesting that the windfall profits tax be considered when calculating the provision that guarantees 50% of gross revenues to the BRV (the so-called shadow tax). According to di Girolamo, the first two points are key for Harvest. -------------- WHAT DO THE NUMBERS SAY? -------------- ¶5. (C) As part of its lobbying campaign, Harvest created a CARACAS 00000610 002 OF 003 model showing the impact of the tax with and without discounts for royalty payments and differences in crude quality. It then provided the results to AHVI for use with BRV officials. In addition, di Girolamo sent the results directly to Mommer and Del Pino. He said BRV officials were well aware of the fact that Harvest was the source of the model. Di Girolamo stated Mommer, whom he described as the "father of the tax" was surprised by the results and said he wanted to see di Girolamo the next time Mommer was in Caracas. Mommer divides his time between Caracas and his consulting business in Vienna. Di Girolamo said Mommer also confirmed in their conversation that the windfall profits tax would be applied to all of the joint ventures. ¶6. (C) Harvest's model assumed that a generic joint venture was producing a crude that received 70% of the Brent crude price. According to Harvest's figures, the average price Petrodelta, its Venezuelan joint venture, received in the first quarter of 2008 was USD 79.2 or approximately 81% of West Texas Intermediate (WTI). According to PDVSA, the average price of WTI in the first quarter of 2008 was USD 100.57 and the average price of Brent was USD 99.10. ¶7. (C) Under the terms of the windfall profits tax, a 50% rate is applied when Brent prices are between USD 70 and 100. A 60% rate is applied on the amount above USD 100 (See Reftel A for details). According to Harvest's model, if the price of Brent is USD 70, a joint venture that receives 70% of the Brent price for its crude (USD 49 in this case) would generate profits of USD 3.5 per barrel for the private sector partner and 5.3 USD for PDVSA. The figures are reached via the following calculation: 49 (price per barrel) - 16.3 (33.33% royalty)- 15 (the cost of operations and development) -8.8 (50% income tax) = 8.8 USD per barrel in net profits (60% for PDVSA and 40% for the private sector partner Under this calculation, the Venezuelan state would receive 30.5 USD in royalties, taxes, and PDVSA's share of net profits. As a result, the total BRV take would be 90%, based on the sales price minus cost of production. ¶8. (C) If the price of Brent was USD 120 with no discounts for royalties or price differences, the joint venture would end up losing 4.8 USD per barrel, assuming operational costs rise to 21 USD per barrel in a higher price environment. The private sector partner in the hypothetical joint venture would receive only 1.6 USD per barrel and PDVSA would receive 2.4 USD in net profits per barrel. The overall state take would climb to 66.2 USD per barrel and the state's take would climb to 97%. ¶9. (C) According to Harvest's model, if the same figures are used but with a discount for the hypothetical joint venture's lower crude quality, the joint venture loses 70 cents per barrel and the private sector partner receives 3.2 USD per barrel. The overall state take is 59.8 USD per barrel and the state's take as a percentage would be 95%. ¶10. (C) If discounts are given for royalties and crude quality, the joint venture's net profit would increase to USD 11.2 per barrel when Brent reached USD 120 per barrel. The private sector partner would receive 4.5 USD per barrel. The overall state take would be USD 58.5 per barrel and its take would be 93%. Di Girolamo noted that the state's take as a percentage matched Energy Minister Rafael Ramirez' previous comments on the windfall profits tax. -------------- VERY ANGRY SHAREHOLDERS CARACAS 00000610 003 OF 003 -------------- ¶11. (C) The stock market views Harvest as a pure Venezuela play. Di Girolamo complained that Harvest's stock price has fallen approximately 20% since the windfall profits tax announcement and the recent nationalization of cement and steel companies (Reftels C & D). Harvest's stock closed at a 52 week low on May 1 following the company's first quarter results. Di Girolamo told Petatt he was concerned that he and his superiors could lose their jobs if the investment environment in Venezuela did not improve soon. -------------- COMMENT -------------- ¶12. (C) According to di Girolamo, BRV officials were shocked at the model's results. The fact that joint venture partners would be much worse off if prices increased never seems to have occurred to them. The question at this point is whether the BRV will attempt to lighten the burden on the joint ventures by allowing discounts for royalty payments and the quality of crude. In our opinion, the BRV has the legal ability to provide the discounts without amending the windfall profits tax law. Under Article 2 of the law, the National Executive may grant total or partial exoneration for exports made under the "framework of economic policies" (Reftel A). We believe this language is broad enough to institute the discounts on the grounds that it is BRV policy to increase the joint ventures' crude production. DUDDY