The destruction of the Venezuelan oil sector and the mismanagement of Joint Venture companies

Francisco Rojas, Economist

This is a english version of the post titled La Destrucción del Sector Petrolero Venezolano

1. Introduction

Nowadays, in Venezuela is very difficult to find an economic sector that is not moving backwards. Unfortunately the oil industry, which is the most important sector in the country, does not escape to this circumstance. In fact, in 2016 the oil production experienced one of the biggest slumps in the hundred-year-old history of this industry in Venezuela, -14% in a span of a year, from December 2015-2016, according to OPEC data.

The only time this South American Country had worse figures was more than forty years ago, the year previous to the oil industry nationalization. In that year the oil production shrunk -21%, although it is natural that a previously announced nationalization process generated such a decline. Therefore, the 2016 phenomenon has no comparison with any other in the country’s history. It is a shame given that Venezuela possesses the largest oil reserve in the world, and if this were to continue, this huge resource will stay undergrown forever.

Let’s detail some figures about this 2016 collapse:

• Fall in production of 337.000 barrels per day in twelve months (-14%)[1]. 
• This fall caused a lost of income of nearly 5.000 million dollars[2]. 
• Venezuela was the member of the OPEC with the poorest performance, even Iraq, which is now a war-torn state, increased its production 7,5%[3]

This is very painful to see in a country where 80% out of the population is losing weight because of scarcity of staple foods, that money could have been used to import at least half of the country’s food needs[4].



The Foundation of the Collapse

The Venezuelan government stated that the 2016 fall was just momentary, in the words of Eulogio del Pino, President of the state oil corporation, PDVSA:

“The fall of 220.000 barrels per day was temporary because of electrical problems and one situation that we had in one of the upgraders”[5].

Beyond the temporary elements which had an impact in the industry’s poor performance in 2016, there are deeper reasons that help to explain this collapse. Since 2003, Hugo Chávez began using PDVSA to build the so-called “Socialism of the 21st century”.

Every year PDVSA leverages more of its revenues to fund social programs, which has resulted in the careless investment, and the increasing of financial debt. Meanwhile, the labor force multiplied more than three times[6] and the private participation in the sector was reduced by force[7]

These elements have affected the oil production considerably in Venezuela. However, there is a more significant factor that is seldom mentioned by anybody (experts, managers, much less politicians): the mismanagement of the Joint Ventures in the Orinoco Oil Belt.

The Mismanagement of the Joint Ventures in the Orinoco Oil Belt

The Orinoco Oil Belt is a territory on the Orinoco River Basin in Venezuela that holds the world's largest oil deposits. Since the Chavez government, the business model is based on Joint Ventures where international investors always had the minor shareholding.

Many companies from all over the world decided to take part in this Joint Ventures, among these corporations are: Total (France), Statoil (Norway), Rosneft, Gazprom and Lukoil (Russia), Chevron (US), CNPC (China), Repsol (Spain), Petronas (Malaysia), ONGC and IndianOil (India), Mitsubishi (Japan), Petrovietnam (Vietnam) and ENI (Italy).

Every one of these corporations have been struggling with enormous problems that have been caused by the Venezuelan Government’s policies. Those difficulties, which have been present before the downfall of the petroleum price since 2015, headed stagnation in investment and the failure to meet the planned production. Actually, the production goal of the Orinoco Oil Belt in 2015 was 2 million barrels per day but the production achieved was just 1.3 million barrels per day, around 700 thousand barrels less[8].

Of course, the foreign investors have been very cautious regarding the business difficulties in the Orinoco Oil Belt. But by making a compilation of the statements made by members of some companies (ENI, Lukoil, ONGC, Petronas, PetroVietnam), we can get a sense of the problems they have faced. Let's see what they have said in the next table:

From the analysis made, we can identify the roots of the sector debacle, among these long-term errors in industry management we can mention:

1. Unfavorable macroeconomic environment for investments: High inflation, control and the exchange differential, makes it very expensive for foreign companies to invest in our country and even more facing the obligation to sell currencies at the official rate, which is well below the parallel market.

2. Dividend retention of joint venture partners: For some years the lack of foreign exchange has prevented the government from liquidating the foreign exchange corresponding to the profits of its joint venture partners. This puts a brake on the investment disbursements to which the PDVSA partners had committed themselves.

3. Low profitability of joint ventures: this is caused not only by the fall in oil prices but also by excessive taxes levied on joint ventures. This low profitability caused by taxes pushes investors to steer their efforts to more attractive markets like Canada. The “Law of Special Contribution to Extraordinary and Exorbitant Prices” is of special importance.

4. Majority shareholdings of joint ventures: Due to this, PDVSA has the right to most of the profits of joint ventures but also greater responsibility for the disbursement of investments, but the national company has not complied with the investment disbursements.

5. Slow incorporation of technology from China: The national government has relied on this technology but apparently the drilling machinery and services of the Venezuelan China Drilling Industry (ICVT) have not been able to reverse the paralysis of the operations of companies such as Schlumberger and Halliburton.

Conclusion

The mismanagement of joint venture companies in the Orinoco Oil Belt has not been the only cause of the fall in Venezuelan oil production. There are other factors that add to the demise of Venezuela’s oil industry such as the abandonment of traditional fields, PDVSA's financial management and even corruption (issues that can be addressed in the future). However, there is no doubt that a well executed business plan would have completely changed the oil outlook in Venezuela.

Only in 2016, if the collapse of the Orinoco Oil Belt hadn’t occurred, Venezuela would have obtained 5,000 million more dollars in income, an amount that would be sufficient to import or produce all the products that are missing in Venezuelans’ shelves

Now, since the 2015 fall of oil prices, many people think that the largest oil reserve in the world is going to remain underground forever. That is not necessarily true but the prospects from this point in 2017 are dim.

[1] Personal calculations from OPEC data
[2] Personal calculations from OPEC data
[3] Personal calculations from OPEC data
[4] Survey of Living Conditions 2016 (Encuesta de Condiciones de Vida 2016)
[5] http://www.petroguia.com/pub/article/eulogio-del-pino-fue-un-error-lo-que-se-hizo-con-empresas-del-lago-de-maracaibo (jun-16)
[6] The employees increased from 33.998 in 2003 to 150.032 in 2015, 341%, according to the official reports of PDVSA.
[7] Oil corporations with already-firmed concession, had to accepted the renegotiation of the contracts. They were made to chose weather participate as a minor partner in Joint Ventures or be expropriated. Exxon Mobil and ConocoPhillips didn’t agree but others did.
[8] Official reports of PDVSA.