Venezuela’s Oil Production Squeezed by Chavez’s Heavy Hand

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By Jason Simpkins
Managing Editor
Money Morning

Venezuela's oil production is already below 1997 levels, but could fall significantly lower as the country's president, Hugo Chavez, has alienated oil service companies by refusing to pay their fees, and in some cases, seizing their assets.

Chavez's government seized the assets of 60 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by the country's state-owned energy company, Petroleos de Venezuela (PDVSA).

PDVSA accumulated the debt as oil prices took a dramatic slide from over $147 a barrel last July to less than $35 a barrel in February.

PDVSA has attempted to slash expenditures 60% by reducing salaries for managers by 20% and imposing a wage freeze on the majority of its employees. But the company still owed contractors and suppliers $13.9 billion by the end of last year, according to The Wall Street Journal. The majority of that total remains unpaid and some of the debt dates back to last August.

Irate over a growing backlog of invoices, many of the companies threatened to halt operations – something PDVSA and Chavez can ill-afford. The company is accounts for about half of Venezuela's revenue, and is largely responsible for funding and administering the social programs that Chavez has employed to court popular support.

PDVSA brought in more than $120 billion in revenue in 2008, but this year, it will likely make just $50 billion.

With its back against the wall, PDVSA is demanding that service companies accept a 40% cut in their bills.

"We will not pay contractors that have tried to speculate and don't care about our company," PDVSA President Rafael Ramirez said in April. "We have to renegotiate what we pay them."

Last Friday, the government began expropriating equipment and projects from foreign oil service firms that refused to renegotiate their debt. At least 12 drilling rigs, more than 30 oil terminals, and about 300 boats were seized, the according to The Financial Times.

"To God what is God's, and to Caesar what is Caesar's," Chavez told a throng of supporters, the FT reported. "Today we also say: To the people what is the people's."

Tulsa, Okla.-based Williams Cos. (NYSE: WMB) was among the firms that saw its assets taken. The firm said last week that it would write down a $241 million payment default by PDVSA. Drilling contractor Helmerich & Payne Inc. (NYSE: HP) is due $116 million from PDVSA, and is idling seven of its 11 operating rigs in the Andean country while it negotiates payment.

"Chavez has sent a shot across the bow for the entire oil service sector," Patrick Esteruelas, an analyst with political risk consulting firm Eurasia Group, told the Journal. "This is a very strong message for oil rig companies playing hardball and reluctant to agree on a write-down of their bills."

But the brash gesture will also bring negative consequences that could significantly jeopardize the nation's oil production, which is already in decline.

Venezuela's oil production fell to 2.36 million barrels per day (bpd) in 2008, after climbing as high as 3.18 million bpd in 1997, according to the International Energy Agency (IEA). The Organization of Petroleum Exporting Countries (OPEC) estimated the country's output was about 2.24 million bpd in December.

The expropriation of the oil service companies "increases the risk of additional declines in oil production since PDVSA is not likely to be as efficient an operator of these businesses and assets as the private sector contractors," Goldman Sachs Group Inc. (NYSE: GS) said in a report.

The seizures "might turn into an expedient and quick political solution to the current large payment arrears to suppliers, they might also entail large medium-term costs in terms of foregone production and overall economic efficiency," the report said.

The expropriations will also crimp badly needed investment, which in Venezuela is declining almost as quickly as output. Private investment in the nation's oil sector fell to $500 million last year from twice that level in 2007, BusinessWeek reported.

"Venezuela's aggressive fiscal terms and the country's persistent trend toward nationalization of oil industry activities will make it more and more difficult to attract foreign investment and competitive bids from qualified operators," David Voght, a director at IPD Latin America, which advises several international oil companies operating in Venezuela, told the FT.

PDVSA has slashed investment in new energy projects by $10 billion. And now the company, which is already overburdened by Chavez's political and social agendas, will have to absorb 8,000 new workers into a permanent payroll that already exceeds 75,500 employees – nearly twice the number employed when Chavez took office a decade ago, according to the Journal.

And without adequate investment, there's little hope that Venezuela's output will reverse course anytime soon.

"PDVSA has to invest in the business," James L. Williams, heads of oil consultancy WTRG Economics told BusinessWeek. "You have to feed a cow if you expect it to give milk."

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