While Venezuelan officials in the local media tried to downplay the possible effects of yesterday’s announcement that Venezuela will change the 1% royalty tax to 16.6%, the reality is different. Obviously, the fear is not as the President of PDVSA said today, that foreign oil companies may leave, but that they may not find the country attractive.
Minister of Energy and Mines Ramirez said that these companies “would not protest” and that the Venezuelan Government had “excellent” relations with foreign oil companies.
The truth is that the main problem with the increased royalty is not how it will affect the operating companies, but the precedent of unilaterally changing conditions on established contracts is not something that will encourage companies looking to invest in Venezuela. In fact, the new Hydrocarbon law says that the royalty should be between 20% and 30% on new projects, which the Chavez Government itself has been bypassing, so what is to stop it on the future from increasing the royalties even further?
This is the view in today’s Wall Street Journal (by subscription):
“The government hopes to attract billions of dollars in investment for new projects in the Orinoco area, but by changing the rules, industry watchers say, Mr. Chavez has raised doubts about Venezuela‘s willingness to honor contracts with private oil companies.”
“The latest wrinkle could send some companies back to the drawing board. An executive with a major oil company that is a partner in one of the projects said it is “too early to say” if the tax increase would derail plans for new projects in the area.”
To me, this is the bigger problem; Chavez and his administration seem to act as if they were the only choice in the world. If Canada has a 1% royalty, what could be the attraction to doing a heavy oil plant in Venezuela and not in Canada?
A better way would have been to negotiate with the companies that partner up with PDVSA in these projects. Each of these projects produces or is scheduled to produce roughly 200,000 barrels of the combination of heavy cruders and of synthetic fuels per day. They were supposed to break even at US$ 12-15 per barrel for the Venezuelan oil basket, thus with the oil basket at, let’s say US$ 30 per barrel (this may be a little high), each of the projects is generating an additional US$ 1.05 billion in profit per year!. Thus, it would have seemed reasonable for the Government to negotiate the increase in the royalty in exchange for increased production or new areas and I am sure international oil companies would have been amenable to negotiate them.
In the end, the net result on collection by the Government is smaller than the 15.6% difference in royalties. PDVSA owns roughly 42% of each of the projects, so that the new royalties in some sense represent a transfer from PDVSA profit to Government royalty. Moreover, there will also be lower taxes. My back of the envelope calculation is that the Government will receive US$ 400 million more in royalties, but will lose about US$ 150 million in taxes and PDVSA will receive US$ 150 million less in profits. Of course, the Government will now receive the royalties directly and regularly rather than via PDVSA dividends. Unfortunately, this difference may not be compensated by future dividends if one takes into account new projects that go elsewhere in the world.