VENEZUELA: RECENT EXPROPRIATIONS' IMPACT ON THE

C O N F I D E N T I A L SECTION 01 OF 05 CARACAS 000817 SIPDIS ENERGY FOR CDAY AND ALOCKWOOD, DOE/EIA FOR MCLINE HQ SOUTHCOM ALSO FOR POLAD TREASURY FOR RJARPE COMMERCE FOR 4332/MAC/WH/JLAO NSC FOR RKING E.O. 12958: DECL: 06/30/2019 TAGS: EPET EINV ENRG ECON VE SUBJECT: VENEZUELA: RECENT EXPROPRIATIONS' IMPACT ON THE OIL SECTOR Classified By: Economic Counselor Darnall Steuarat, for reasons 1.4 (b) and (d). ¶1. (C) SUMMARY: Recent oil service sector expropriations in Venezuela targeted two diverse groups: (1) water injection and natural gas compression operations related to crude oil production; and (2) launch operators on Lake Maracaibo that had organized and threatened to strike over PDVSA's arrears. Both types of expropriation will affect negatively Venezuela's oil production levels. ¶2. (C) The expropriation of the Lake Maracaibo launch operators will however have a broader economic impact on the communities on the Eastern side of the lake where most of these firms operated. The economic ripples of the seizures are already being felt at nearly all levels of the regional economy: from casual workers who used to work for the launch operators to the catering companies that used to provide subsidized meals to launch company workers to the food vendors that supported the catering companies. The central government will now have greater economic control in Zulia state, a state that has steadfastly been in opposition to Chavez. Since the recent expropriations, locally owned companies have stopped complaining publicly about lack of payments. All involved know that PDVSA is the source of the payments problems, but no one is willing to protest against the state-run petroleum company. Some protests continue, but instead target the next rung down on the ladder, i.e., the large private service companies that are also behind on payments to many of their providers due to PDVSA's lack of payments. In the meantime, PDVSA has successfully deferred the arrears it owed to the expropriate companies to the future. END SUMMARY. Why These Expropriations -------------- ¶3. (C) The recent oil service sector expropriations targeted three market segments: (1) water, natural gas, and steam injection services, (2) water and natural gas compression services, and (3) launch operations on Lake Maracaibo. While most interlocutors speculate that the GBRV's initial target was the launch operators, the passage of the National Assembly's oil services expropriation law on May 7 followed by the immediate seizure of Williams' Wilpro subsidiary seems to indicate the GBRV was responding to a default notice by Williams which would have taken effect on the same date. In fact, the new law appears to target both (1) the Lake Maracaibo launch operators, and (2) Williams' Wilpro and Wood Group's Simco injection operations. Wood Group filed a ninety-day default notice with PDVSA first on December 1, 2008 (expired February 28, 2009) and its operations were quietly seized by PDVSA on March 4. On April 29, Williams announced publicly that it had taken a $241 million non-cash charge to net income on its operations in Venezuela. Its default notice was set to go into effect on May 7. The National Assembly introduced on May 5 and passed on May 7 the oil services sector expropriation law, effectively giving the GBRV the right to seize the Wilpro operations prior to it going into default. PDVSA officials, accompanied by a Venezuelan judge and the National Guard, began the expropriation of Wilpro assets at midnight the night of May 7-8, hours after Chavez promulgated the new law. ¶4. (C) On Saturday, January 24, many of the now expropriated launch operators on Lake Maracaibo met with PDVSA to discuss the outstanding payments. At that time, PDVSA officials pushed the launch operators (the majority of which were domestic companies who claimed they were ready to strike),to bring in offshore dollars to maintain operations. PDVSA also CARACAS 00000817 002 OF 005 asked for a detailed personnel list with the offer that it might consider paying the laborers directly. On January 27, PDVSA seized the ENSCO 69 drill rig in PetroSucre, an action that might have caused the launch operators to reconsider taking any coordinated action against PDVSA. It is highly likely, however, that PDVSA began drawing up plans to deal with them at that time. One Embassy source posits that the threat of concerted action by the launch operators caused the GBRV to believe the private sector would seek to shut down oil operations in the West. According to his theory, this raised memories of the oil strike (which was more successful in the west than in the east),and caused Chavez to seek to strike out against the private sector. Thus, while the new oil services sector law was likely timed to the Williams default, it provided the perfect vehicle for the GBRV to go after the western launch operators as well. ¶5. (C) Another U.S. firm, Exterran, has been affected by this wave of expropriations. As of June 6, PDVSA had completed the expropriation of its Venezuela assets, which provided natural gas compression and injection and electric power generation services for many oil field projects throughout Venezuela. Exterran was a minority partner with Wood Group in Simco and a minority partner with Williams in Wilpro. In addition, Exterran had 214 electric power and other units spread throughout Venezuela's oil sector (including in Maracaibo, Apure, Anaco, El Tigre, Maturin, and Corocoro). To date, the Ministry for Energy and Petroleum has not named Exterran in a published expropriation resolution. The seizure of these assets, however, may yet have an even more negative impact on Venezuelan oil production. Economic Impact of Expropriations: In Zulia -------------- ¶6. (C) The GBRV expropriations of oil service companies on Lake Maracaibo is already hurting local economies dependent on providing services to the expropriated private companies and will eventually impact oil production negatively. Several businesspeople whose launch companies were seized told PetAtt and visiting Washington energy analyst the week of June 2 that PDVSA was operating their boats and some had already broken down. Since the seized companies all had spare vessels prior to expropriation, these initial breakdowns will have little impact because PDVSA now has spare boat capacity. The businessmen pointed out, however, that while PDVSA has spare capacity now, it is only a matter of time before it runs out of functional vessels and will have no one to call on to provide transport services on the lake. PDVSA will then face significant challenges moving crews and supplies out onto Lake Maracaibo to operate and maintain the thousands of wells and other oil facilities. ¶7. (C) On June 1-2, casual workers formerly employed as needed by the expropriated launch companies, protested PDVSA,s failure to hire them in Ciudad Ojeda (eastern side of Lake Maracaibo and the base for many of the launch companies. Rafael Ramirez, Minister of Energy and Petroleum, PDVSA President, and Zulia state head of Chavez,s PSUV political party, reportedly distributed 300 PDVSA identification cards effectively employing the lucky recipients. He also sponsored a food distribution for displaced workers. One Chavista protester held a sign that read, "Chavez ) We are with you, but we are hungry." Press reports indicate PDVSA claims it will process a thousand new workers per week from the expropriated firms until all are hired. ¶8. (C) A member of the Ciudad Ojeda Chamber of Commerce told PetAtt and visiting Washington energy analyst that the CARACAS 00000817 003 OF 005 expropriations would affect nearly 75% of the population of the oil-dependent region. He broke the economic impacts down into three levels. In the first level, those directly expropriated, he included 60-70 companies and 9,600 workers. The second level of the economic pyramid includes 800 micro, small, and medium-sized companies that provided goods and services directly to the first level expropriated companies and employ some 20,000 workers. The third level and base of the pyramid includes a further 5,000 micro, small and medium-sized companies and cooperativas (coops) that are indirectly related to the expropriated companies, and employ some 80,000 workers. This image of an economic pyramid depicts the general impact on the local economy of the expropriations. The economic ripples of the seizures are already being felt at nearly all levels of the regional economy: from casual workers who used to work for the launch operators to the catering companies that used to provide subsidized meals to launch company workers (PDVSA does not provide such benefits) to the food vendors that supported the catering companies. In fact, the central government will now have greater economic control in Zulia state, a state that has steadfastly been in opposition to Chavez. Impact of Expropriations on Other Service Companies -------------- -------------- ¶9. (C) The expropriations have helped PDVSA postpone some of its outstanding debt, but it still owes billions more to other service companies. PDVSA continues to trickle payments out in an apparently haphazard manner; one firm reported that it believes PDVSA has set up a committee to oversee payments and there is likely a strategy in play to keep companies on life support and working. The impact of PDVSA not paying is hurting not only the service company but also its subcontractors. Companies such as Halliburton are limiting payments to their own suppliers and service providers, as they are not receiving any significant payment streams from PDVSA. Halliburton (and others) is downsizing its staff, limiting operations, and cutting costs. We believe that the majority of international service companies have been told by their home offices that they will no longer receive external financial support. Most firms have prioritized maintaining worker wages. With whatever funds are leftover, they parcel out some money to their service providers and supply chain by prioritizing who they think needs a cash infusion the most. This situation continues down through the oil sector hierarchy. Both of Halliburton's bases in Maracaibo and Maturin were shutdown for several days in June due to protests outside their gates by second and third level companies in its supply chain. Companies and workers know PDVSA is the source of payments issues, but no one is willing to protest against PDVSA; instead, they have targeted the next rung on the ladder. Continuing Payments Issues? -------------- ¶10. (C) Since the initial May oil sector expropriations, public complaints from oil service companies and media stories focusing on PDVSA's daunting arrears have largely disappeared. The private sector seems to have learned a hard lesson about the GBRV,s likely reaction to such complaints from this round of expropriations. Companies continue to struggle with payments from PDVSA trickling out at levels less than 10% of total owed. ¶11. (C) PDVSA's financial report for 2008, released in February 2009, indicated it carries nearly $14 billion in debt to service companies. There is no other public figure available on the debt owed to the expropriated service CARACAS 00000817 004 OF 005 companies. Roughly, we believe the outstanding debt owed to expropriated international firms was Williams $100 million, Wood Group $130 million, Exterran $130 million, and Tidewater $35 million. These might represent the largest debts owed to expropriated companies. According to a Petroleum Chamber director, PDVSA owed Chamber member companies $300 million. Thus, the expropriations of these companies might suggest that PDVSA has not eliminated or postponed a majority of its outstanding arrears. It has only postponed payment until a future point when the parties involved agree to a negotiated settlement for seized assets. Instead, PDVSA may have significantly increased its liabilities through the expropriations by assuming the private companies' liabilities and the need to pay compensation for the assets. ¶12. (C). According to the May oil services sector law, companies will be compensated for seized assets at book value. According to local energy lawyers, this law contradicts the Venezuelan constitution and other laws that indicate compensation for expropriated assets should be fair market value. The new law also provides that labor and environmental liabilities will be discounted from the amount of the compensation to be paid to the affected parties. Owners of expropriated assets indicated to PetAtt and visiting Washington energy analyst that they believe they will be fortunate &to walk away with the shirts on their backs8 once the government has subtracted labor and environmental costs from the book value of their assets. Some speculated that, with the new law,s pricing formula, they might have to pay the GBRV just to settle the expropriations. ¶13. (C) COMMENT: Regardless of the political or economic background to the latest oil service sector expropriations, the common denominator is that the action conforms with the GBRV's playbook ) push current financial troubles into the future, regardless of the actual mid to long-term costs of this strategy. Western firms claim that by the Fall of 2009 they will shut down unless they receive substantial payments of current arrears and they believe that if they shut down the apocalypse will occur in Venezuela. For its part, the GBRV believes firms will flock to Venezuela just because of the country's huge oil reserves. There is likely too much crude oil in Venezuela to believe that this industry will implode, but if it continues, its current trajectory it will resemble Cuba's decimated sugar industry. If Western firms decide they cannot continue in Venezuela, we should expect to see the GBRV turn more towards China and other "like-minded" countries to develop the Venezuelan oil industry. The problem the GBRV will have is that these "alternative" companies are looking for economic and not political opportunities. CNPC and Petropars both operate out of a profit motive, just like ConocoPhillips and Exxon Mobil. In the meantime, companies are continuing to work to develop these reserves, albeit at a lower level of efficiency brought about by partnering with PDVSA and with smaller profit margins. But for how long? Private sector cries that this situation is unsustainable make sense from an entrepreneurial standpoint, but do not reflect the political agenda of Chavez's 21st Century Socialism. END COMMENT ¶14. (SBU) For more background on topics mentioned above, please see the following cables: payments to service companies - CARACAS 136, CARACAS 214, CARACAS 239, CARACAS 288, CARACAS 362, CARACAS 428, CARACAS 440, CARACAS 541, CARACAS 545, CARACAS 548; mission creep in PDVSA ) 2008 CARACAS 473; PDVSA's financial situation ) CARACAS 564, CARACAS 282, 2008 CARACAS 276, 2007 CARACAS 2346; nationalizations inside and outside the oil sector - 2007 CARACAS 00000817 005 OF 005 CARACAS 1281, 2007 CARACAS 2013, 2008 CARACAS 1690, CARACAS 581, CARACAS 592, CARACAS 644, CARACAS 707, CARACAS 725. CAULFIELD