Venezuela Squeezes Energy Companies; Will Others Follow?

Venezuela Squeezes Energy Companies; Will Others Follow? - Yahoo! News

Monica Showalter
Wed Aug 17, 7:00 PM ET



Despite record oil prices and profits, it's not exactly the best of times for energy companies in Venezuela. President Hugo Chavez accuses foreign oil companies of "robbing" the nation and is trying to extract more cash.

Thirty-two publicly traded oil companies -- including Shell (NYSE:RD - News), Exxon Mobil (NYSE:XOM - News), Repsol YPF (NYSE:REP - News), Chevron (NYSE:CVX - News), BP (NYSE:BP - News) and Total (NYSE:TOT - News) -- are accused of owing $4 billion in back taxes for overproduction, something they deny.

That follows Venezuela's hikes on production royalties from 1% to 16.7% in October, hikes on taxes on operating agreements from 32% to 50% in April, and declared end to contracted dollar payments to foreign oil field operators in May.

While the royalty hike was costly, it didn't breach contracts. But oil companies say the tax hikes do. Some are trying to fight back. Many are just frustrated.

"The desire to operate in Venezuela is fading fast," said Kyle Cooper, energy analyst for Citigroup Global Markets.

Still, there is no exodus of existing investment. With oil prices well over $60 a barrel, profits remain high for oil firms invested there. Global spare production capacity is at its lowest level in three decades, according to the Energy Department, so there aren't many other places to go.

Saudi Arabia is the only country with spare production capacity. Venezuela has drawn no new foreign oil investment in the past six years, and nobody's leaving.

"My feeling is that the companies here that already made investments will do what the government says," said Miguel Octavio, managing director of BBO Financial in Caracas.

So if Venezuela can get away with it, will other oil-producing countries seek more?

Industry watchers say they probably won't.

Venezuela is unusual due to the size of its resources, says Komal Sri-Kumar, chief global strategist at Trust Co. of the West.

Venezuela is the world's sixth largest oil producer, with 77 billion barrels in provable conventional reserves, and as much as 200 billion barrels including unconventional reserves (like oil sands), a figure that approaches Saudi Arabia.

Venezuela also is geographically near the huge U.S. market. Venezuela sells 60% of its oil exports to the U.S., and the two nations have long had cooperative ventures.

Oil-producing countries with less foreign investment are unlikely to follow Venezuela's lead because they don't have the same advantages, said Sri-Kumar.

"It's not the sentiment in other oil-producing nations, and I don't think it will spread," he said.

Smaller producers such as Algeria, Angola and Oman must work harder to attract and retain foreign investment. "They know that prices have gone up substantially and there could be pressure to put them down," said Sri-Kumar. If prices go down, smaller producers will suffer first. These countries compensate by offering optimal treatment of their foreign investors, he said. "It's not out of goodwill, but out of their knowledge, that good treatment brings investment."

Cooper said newer energy-producing nations can see foreign investment reverse fast. Amid threats of nationalization, natural gas-rich Bolivia lost a lot of foreign investment in the first half of 2005 due to a punitive hydrocarbon tax hike that disrupted contracts. Exploration investment plunged by 83%. Most of it headed for Peru -- a smaller player in natural gas, but investment-friendly.

Sri-Kumar said Venezuela historically has "aggressively" sought more of the profits from foreign investors when oil prices rise. In 1974, Venezuela joined Kuwait and Saudi Arabia in nationalizing its oil industry amid soaring prices triggered by the Arab oil embargo.

That approach has overlapped into the politics of Chavez, said Sri-Kumar. "It stems from an anti-U.S. attitude that extends to foreign oil companies. Other countries do not share the anti-U.S., pro-Cuba attitude that is so important in characterizing Venezuela," said Sri-Kumar.

Iran Bears Watching

An exception is Iran, the No. 3 oil producer, said Anne Korin, director of policy and strategic planning at the Institute for the Analysis of Global Security. "Watch them carefully -- there is reason to think they might flex their muscles a bit," she said, citing its nuclear confrontation with the West. Amid the lack of spare capacity, "if someone is playing games with production, it is a big problem."

China, Japan and India are more likely to be hit than the U.S. if Iran knocks around European oil companies invested there. (U.S. sanctions block American investment there). But any resulting price rise would affect the global market, Korin said.

Tight energy supply is a factor and an effect of nationalization, according to Dale Nesbitt at Altos Management. He said state takeovers of oil companies in the '70s are responsible for the world supply squeeze that's given leaders like Chavez leverage to seek more. There are too many underproductive state oil companies without access to investment capital to meet global energy needs.

"National oil companies have no results to report, don't follow FASB (accounting standards), don't follow reserve write-downs or answer to shareholders," he said.

Those firms can't borrow for infrastructure maintenance and production in global markets as publicly traded companies can. Every nationalized oil firm is cash short. "Shell can invest twice as much as state oil companies because of its borrowing leverage," he said.

He added, "How much money are you going to loan Chavez? He doesn't do accounting, maintain ratios nor collateralize loans. If you want to repossess anything for nonpayment, you have to go in with a machine gun. That hurts Venezuela's ability to develop infrastructure."

Undercapitalization hurts production. "If you don't produce optimally, you can do permanent damage to your reservoirs," Nesbitt said.

Private companies can recover 40% of oil assets while state companies recover just half that, he said.

Sri-Kumar said the structure of Venezuela's economy, with its vast state oil company and a small consumer market, damps production. "Venezuelan oil production is not only large relative to exports, but oil exports are substantial compared to (Venezuela's 25 million) population," he said.

In contrast, Russia's large population and more diversified economy make it less likely to rupture relations with foreign investors.

"Russia has a bigger population, so their need to expand oil production is greater. If you have a small population and big production, it is not as urgent to further increase production of oil," Sri-Kumar said.