Venezuelan Oil Politics at the Crossroads
Record Export Revenues
Hugo Chávez took over the Presidency of Venezuela on 2 February 1999. At that time world petroleum markets were in deep disarray. Since then the situation has changed radically, and favourably. And there is no doubt that the new Venezuelan government played an important role in the recovery. The last government of the ancien régime under pressure from the national oil company, Petróleos de Venezuela (PDV), came close to abandoning OPEC, and PDV’s publicly heralded policy to maximize volumes disregarding OPEC quotas and price objectives was a major cause of the 1998 oil price crisis. President Chávez and his oil minister, Alí Rodríguez Araque, reversed this situation completely. Together with the governments of Mexico and Saudi Arabia, Venezuela promoted successfully a new understanding on quotas and higher prices between OPEC members and other exporting countries. Moreover, the Venezuelan government promoted and hosted, in 2000, the second head-of-state meeting ever held in the history of OPEC. As a result the proceeds from hydrocarbon exports of the country peaked at US$ 27.3 billion in 2000, a significant increase over the previous peak of US$ 19.1 billion in 1981.
Falling Fiscal Revenues
There was, however, an important difference. In 1981 those US$ 19.1 billion of export sales generated US$ 13.9 billion in royalties and income taxes for the Venezuelan government, while in the year 2000, US$ 27.3 billion of export proceeds generated only US$ 11.3 billion in fiscal revenues. Royalties and income taxes amounted to 73 percent of export revenues in 1981, but only to 41 percent in 2000. As a matter of fact, between 1976, the year that saw the nationalization of the Venezuelan oil industry, and 1992, this percentage varied between 64 percent and 81 percent, averaging 71 percent. Since 1993 and until 2000, the proportion has varied between 28 percent and 50 percent, with an average of only 36 percent.
One of the reasons for falling fiscal revenues goes back to 1989 when the country came close to insolvency, and was forced to subscribe to IMF – and World Bank – inspired adjustment programmes and reforms. PDV adopted then the worldwide combined accounting method for reporting profits and losses, thus bringing down the ring fence around its activities in Venezuela. It then started to transfer to Venezuela, on a massive scale, costs incurred in its ventures abroad, thus increasing the profits deemed to have accrued outside the country. The benefits to the company were obvious, as it is subject to a 67.7 percent income tax in Venezuela compared with a rate of 34 percent in the United States. Most importantly, PDV also charged to its Venezuelan accounts the financial costs of its nine billion dollar debt, largely related to its internationalisation policy. In the early 1990s PDV ‘borrowed’ a billion dollars from one of its foreign affiliates, thus making a profit on the agreed interest payments equivalent to the difference in income tax rates.
In 1989, the country started to open up its marginal oil fields to private investors. These fields produced about 500 thousand b/d in 2000. The operating contracts were structured to minimize the tax burden falling on private investors. Thus, a large part of the profits generated by these investments accrued to the private investors and were subject, not to an income tax of 67.7 percent but of only 34 percent. The reason lies in the nature of the contracts, which are service and not production agreements. In any case, PDV thus fulfilled the objective of increasing oil production, and though the company achieved only a modest or no increase in profits, the cash flow did increase significantly.
For some marginal oil fields PDV negotiated with the Ministry of Energy and Mines (MEM) the imposition of a one percent royalty, down from the customary 16.67 percent. The company also succeeded in negotiating a one percent royalty, applicable during the first ten years of the project, for four joint ventures with foreign companies in the Orinoco Belt. Moreover, the income tax law of 1993 exempted these ventures from the 67.7 percent income tax rate applied to hydrocarbons, and subjected them to the 34 percent rate applicable to the non-oil sector. One of these projects, Petrozuata, came on stream in February 2001 and it is now working close to its capacity, transforming 120 thousand b/d of extra-heavy crude into 104 thousand b/d of synthetic crude. In June 2001 a similar project, Cerro Negro, will come on stream. Thus, in the second half of this year the production of very lightly taxed syncrude will total 208 thousand b/d.
A paradoxical situation has arisen in this context. Last year the upgraders were not ready yet to process the 128 thousand b/d of extra-heavy crude, which they were then producing. Hence the stuff was sold as crude oil at about US$ 15 per barrel (to be diluted with lighter crudes), and therefore paid a royalty of 16.67 percent, that is US$ 2.50 per barrel. The extra-heavy crude produced this year, and for the next ten years, being processed in the upgrading facilities which are now operating will benefit from a reduction of royalty from 16.67 percent to one percent.
In 1993, PDV also convinced Congress to phase out the system of ‘fiscal export values’, which actually was an excise tax on exports of about 29 percent. At the same time the new income tax law allowed some adjustments for inflation, which brought the effective income tax rate from about 59 percent pre-1993 down to an average of 43 percent in the years 1993-2000.
Ever since 1983, when PDV initiated its internationalisation policy, the company used its foreign affiliates to ‘export’ profits through transfer pricing. This explains the extraordinary dynamism of PDV’s internationalisation policy. At present these transfers amount to about half a billion dollars annually.
An extreme case of transfer pricing is to be found, however, within the country, with PDV’s affiliate Bitor producing Orimulsion. In 2000, PDV used 74 thousand b/d of extra-heavy crude to produce Orimulsion (consisting of extra-heavy oil diluted in water in a proportion 70:30 with the help of an emulsifier). However, in this case the transfer price is calculated according to a formula based on coal, and not on crude oil. Thus, in 2000, those barrels were priced at about US$ 0.70 instead of US$ 15.00, with the consequent reduction in royalties and income taxes.
OPEC Quotas and Extra-heavy Oil
The Orimulsion and syncrude projects have been designed irrespective of the interests of the country in the generation of fiscal revenues through hydrocarbon exports. Moreover, if the extra-heavy crude were to be considered as part of the country’s OPEC quota, the result would be disastrous, as they would then displace more highly taxed conventional crudes. The loss in fiscal revenues at a price of US$ 20 per barrel (for the Venezuelan export basket) would amount, roughly, to US$ 10 per barrel. As things stand, the Venezuelan government has accepted the argument that extra-heavy crude is not subject to OPEC quotas because it is actually much closer to bitumen than to crude oil. Whatever this argument may be worth legally or technically, it may not impress other OPEC members when volumes of extra-heavy oil become significant. This moment may be quite close. There are indeed another two projects of syncrude already under way, which will bring the total production of syncrude to 570 thousand b/d (i.e. processing about 650 thousand b/d of extra-heavy crude) in 2005. According to the company’s plans, production of syncrude would increase to 1.2 million b/d by the year 2010. Bitor will also double its capacity to process about 150 thousand b/d of extra-heavy crude into Orimulsion by the end of the year 2001, and plans to double again its production within a few years.
The truth is that syncrude is competing with conventional crude oil, and that Orimulsion is competing with fuel oil in power stations. Hence, they both have an impact on the world oil price. The rush into the Orinoco Belt is about to generate a major contradiction in Venezuelan oil policy, as it is not compatible with revenue and price objectives.
MEM Recovering the Control over the Natural Resource
As soon as Rodríguez Araque took over the Oil Ministry in 1999, he began to implement a policy aiming at recovering the state control over natural resources. Ultimately, this is where the power of oil-exporting countries comes from. In this context, it appears that it was a strategic mistake to leave the negotiation of upstream contracts and the design of bidding rounds to PDV, as had happened in the years of Apertura. The consequence was that the interests of the nation as the natural resource owner were ignored. To remedy this situation, the Ministry redesigned the forthcoming bidding rounds in natural gas. Although PDV may continue to play a role on the technical side, the Ministry is now controlling both the political and fiscal sides. The new Gas Law, enacted in 1999, raised the minimum fiscal take that the government was prepared to accept. The royalty rate was set at 20 percent as a minimum, and in the forthcoming licensing round this rate will be one of the bidding parameters.
MEM also put an end to the old royalty agreements. Transfer prices are no longer accepted. PDV was obliged to pay royalties according to open market prices. However, the government still accepts low discounted transfer prices for the assessment of income tax liabilities. Furthermore, no progress was achieved on the subject of Bitor and Orimulsion.
In November 2000, the National Assembly passed an enabling law according to which the Government is now free to reform completely the existing legal framework for hydrocarbons. MEM has already announced that the new Hydrocarbon Law will also establish a minimum royalty rate of 20 percent. Generally speaking, the Ministry (now headed by Álvaro Silva Calderón after Rodríguez Araque became secretary general of OPEC in January 2001) believes that in the context of globalisation, royalty has to be the central rent-collecting device in any new fiscal regime in oil. Worldwide combined reporting of losses and profits is a fact, and that fact makes effective higher excess-profit or income tax rates very difficult if not impossible to impose. Indeed, over the last twenty years or so the worldwide trend has been away from high corporate income tax levels and in favour of excise or value added taxes. Remarkably enough, at the same time the International Energy Agency, the Secretariat of the Energy Charter Treaty, the multinational companies, and international consultants have been trying to push the oil-exporting countries into the opposite direction. They were not unsuccessful in the years of Apertura in Venezuela, with the consequent sharp fall in fiscal revenues.
Will the Petroleum Reform Succeed?
In Venezuela new Hydrocarbon Laws are not retroactive. They only apply to new licenses, concessions or contracts, not to the old ones. Regarding the latter, there is not very much the government can do but negotiate with the private companies. However, the bargaining power of the government with PDV, which is state owned, is different. MEM believes that it will be possible to reverse the disastrous fiscal reforms of 1993, at least partially. The declared aim is to increase the royalty rate applicable to PDV sharply, far above the envisaged minimum of twenty percent, but reducing at the same time the income tax rate of 67.7 percent to the usual rate of 34 percent. Of course, overall the intended outcome would be higher-than-otherwise fiscal revenues.
But there is no guarantee that this strategy will succeed. Recall that the president of PDV, General Guaicaipuro Lameda, was until October 2000 the head of the government’s Budget Office and is therefore well aware of the fiscal problem. Now he has also become aware of the problems faced by PDV. They may be summarized by reference to one figure: costs and expenditure increased in the year 2000 by a staggering 44.6 percent. The priority of the president of PDV has to be to turn around the company.
A lot of good will and hard bargaining will be required to get the oil sector on track again, from both a fiscal and entrepreneurial perspective. It is hard to exaggerate the importance of a positive outcome. The answer to the question: ‘why did PDV in the past engage in a fiscal revenue minimizing strategy?’ is that its leadership reached the conclusion that the political regime – today dubbed the IVth Republic – was beyond repair. PDV reached this conclusion as early as 1983, when ten years of booming fiscal revenues came to an end in the midst of a foreign debt and currency crisis. Hence, PDV believed that to spend a dollar was always a better option than paying an additional dollar in taxes. That same year, in 1983, Hugo Chávez founded his military movement, after having reached the same conclusion. The question today is whether a solution to the oil fiscal problem will help Chávez’ Vth Republic to solve the problems of an impoverished country. A failure to solve the problem would prolong the economic decay of the last twenty years.