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Sunday, March 06, 2005

OPI WEEKLY: VENEZUELA'S STRATEGIC BIND

Recent oil agreements with both India and China, as well as its flirtations with the sale of CITGO, show Venezuela’s desire to shift its strategic foothold away from the U.S. and toward markets in the Far East. However, the difficulties for Caracas surrounding a deal for CITGO, its U.S. based refining and distribution conglomerate, show that Venezuela is in a strategic bind that limits its ability to maneuver against the U.S.

THE TWO AGREEMENTS

India and Venezuela signed an agreement on Saturday to allow India’s state controlled Oil and Natural Gas Corp (ONGC) a 49% stake in the San Cristobal oil field and bidding rights for exploration and production on gas blocks off the coast of Venezuela. Venezuela’s offshore gas exploration and development is currently dominated by U.S. companies. As part of the agreement Venzuela’s state owned oil giant Petroleos de Venezuela (PdVSA) is taking a stake in ONGC's refining subsidiary, Mangalore Refinery and Petrochemicals Ltd. The refinery agreement will ease the way for future sales of Venezuelan crude to India. The agreements were signed on a visit to India by Venezuelan President Hugo Chavez.

Chavez signed a similar agreement with China in January. China’s National Petroleum Corp. (CNPC) will form a joint venture with Venezuela’s PdVSA to develop and manage 14 oil and gas fields in the Zumano area of the eastern Venzuelan state of Anzoategui. The fields hold reserves of 400 million barrels of oil and 3 Bcf of natural gas. In addition, CNPC will increase natural gas production in the Intercampo Norte and Caracoles oil fields it currently manages for Petroleos de Venezuela. Venezuela will also supply China with 100,000 bbl/d of oil, 3 million tons per year of fuel oil and up to 1.8 million tons of Orimulsion, an alternate boiler fuel.

Venezuelan officials also said the Bank of China may lend up to $ 4 billion to Venezuela for the development of energy and other projects in the country. Venezuelan Energy Minister Rafael Ramirez has said recently that PDVSA will invest $5.6 billion in exploration and production during 2005. If such a large hunk of PdVSA’s exploration and production funds comes from China we can certainly expect more agreements between the two countries as the money is spent.

TESTING THE WATERS

These agreements signal a testing of the waters for future energy relations for the countries involved. Both China and India are aggressively seeking to secure oil assets to fuel their enormous populations and booming economies, but have not ventured significantly into the western hemisphere for supplies. Besides the Middle East, China’s has looked to Russia and more recently Africa to ensure its energy security. India too relies primarily on the Middle East, but has recently signed an agreement

Venezuela’s motivations are much more geopolitical or even ideological. Venezuela’s socialist president is unhappy being so squarely within the U.S. sphere of influence and has been making moves to diversify its crude export base, which is dominated by the United States. Venezuela’s current production capacity stands at about 2.8 million bbl/d, 2.25 million of which are exported. 62% (1.39 million bbl/d) of those exports go directly to the U.S. This comprises approximately 12% of U.S. daily oil imports –not including oil sold to Caribbean refineries and then sold in the U.S. market.

U.S. relations with the leftist Chavez have always been troubled, but things have gotten palpably worse in the past several months. In January 2002 Venezuela’s new Hydrocarbons Law raised royalties charged to foreign oil companies operating in Venezuela from 1% to 16% to 20%-30% and guaranteed PdVSA at least a 51% stake in any project involving exploration, production, transportation or initial storage of oil. Then, in January of this year, PdVSA rejected ConocoPhillips business plan for the development of the huge Corocoro field, considered to be one of the most promising untapped oil fields in the country and a project that was widely expected to get the green light from PdVSA. PdVSA now says it will review 33 contracts with ChevronTexaco Corp., ConocoPhillips and other U.S. operators in the country that were signed prior to 1998 when Chavez initially became President. Also in January, PdVSA unexpectedly refused further drilling rights to Houston based Harvest Natural Resources Inc., which had long had exclusive rights to much of Venezuela’s field development.

And now the dispute has been brought to an entirely new level. Chavez has said recently that the U.S. is planning to have him killed as a pretext for invading the country and warned that any attempt on his life would result in a cut-off of oil supplies to the U.S. While U.S. officials describe the plan as nonsense, it is likely that Chavez really believes it. Chavez has also announced a shift in Venezuela’s military doctrine to a defensive posture aimed at thwarting a U.S. attack. The new doctrine will focus on “asymmetric war” wherein an inferior fighting force attempts to repel a superior fighting force by using guerrilla tactics such as those employed against the U.S. in Afghanistan and Iraq. Venezuela’s recent purchase of 40 Russian helicopters and 100,000 AK-47 assault rifles will further bolster its defenses.

SELLING CITGO: VENEZUELA’S CATCH-22

Venezuela’s agreements with China and India are a first very small step in possible strategic reorientation. On his travels abroad, President Chavez also invited Russian, Spanish, Iranian, Libyan and Algerian oil companies to invest in Venezuela. Clearly the primary issue that Chavez must consider in moving away from dependence on the U.S. for both production assistance and export markets is whether or not alliances with such countries –India and China included—will be reliable. The U.S. market is certainly reliable, and reliability is the crux issue of energy security. For Venezuela it is also the crux issue of national security, given the overwhelming importance of the oil industry for the Venezuelan economy.

As much as Chavez might be more ideologically comfortable dealing more with China and India, there are real problems with expanding such commitments. To facilitate oil exports to both China and India would take huge efforts and investments on the transport side. Venezuela is studying building new pipelines in either Colombia or Panama, which would take Venezuelan crude to Pacific ports -large supertankers can’t use the Panama Canal—but pipelines are expensive and take a long time to build.

But even more than these agreements with Far Eastern buyers, selling CITGO would be an expensive and significant move away from stability and energy security. CITGO’s U.S. refining capacity is over 1 million bbl/d, which is utilized to produce gasoline and other refined products. CITGO then supplies these products to approximately 14,000 independently owned and operated CITGO branded retail outlets located throughout the United States. PdVSA supplies CITGO with most of its crude oil through long-term supply contracts, some stretching as far forward as 2017.

And here’s where the catch-22 comes in. The book value of CITGO’s assets is $8 billion and some analysts put its market value as high as $16 billion. However, one of the reasons it is so valuable a company is because of its close relationship with PdVSA and Venezuela, one of the world’s largest crude oil producers. It’s crude contracts are long term and even come at a $1 to $2 per barrel discount off of market prices. If that relationship were threatened –which such a sale would clearly imply—the value of CITGO drops significantly. Crude supplies for CITGO refineries then becomes a problem, both of quantity and quality: not only would CITGO have to find almost 1 million bbl/d elsewhere, but also they would have to find heavy high-sulfur crudes similar to those produced in Venezuela, for which the CITGO refineries are tooled. While Mexican crudes are similar in quality, Mexico can not nearly provide the quantities purchased from Venezuela. These issues then effectively reduce the value company for sale, which would mean that Venezuela would be unloading his most valuable foreign asset at a loss.

TO SELL OR NOT TO SELL: THE CRUDE HARD TRUTH

PdVSA, through CITGO, clearly has a stable supply chain to a stable market that will only grow in coming years. Selling CITGO would clearly be a risky and destabilizing move for Chavez and Venezuela. It would also come at a financial loss. So would he actually do it?

In the end Chavez is unlikely to make such a move. The costs and risks are simply too high. So why all the talk of new markets in the east and of selling CITGO?

Chavez’s motivations are most-likely threefold. First, it is some pretty loud geopolitical saber-rattling. Although the U.S. could fairly easily replace Venezuelan crude supplies with supplies from the Middle East and elsewhere, it is no coincidence that most of U.S. oil comes from the Western Hemisphere, more closely within Washington’s geopolitical sphere of control. Caracas might use this bit of leverage to get unfavorable tax and royalty agreement between the two countries changed.

Second, Chavez and some in PdVSA feel as though CITGO operations had slipped out of their control of late, particularly during and after the 2002 strike by PdVSA employees. Paranoia seems to be running high these days in Caracas and Chavez to large extent does not trust the CITGO side of Venezuela’s oil business. It fears that there the U.S. business and its executives may have prospered at PdVSA’s expense. PdVSA thus recently replaced CITGO’s CEO and is currently auditing U.S. operations. These threats of sale are also meant to scare CITGO into getting back with the program.

Third, Chavez personally and ideologically would love to sell CITGO. He would love to stick a thumb in America’s economic and energy security eye. The rumors and musings of a pending sale are no doubt borne partially out of Chavez’s real desire to do so.

However, when all is said and done, the the logic of selling for Venezuela does not add up. Nor, at least for the foreseeable future, does a significant strategic orientation with China, India, or anyone else. Venezuela is strategically bound in its ability pull away from the U.S. The symbiotic relationship between producer and consumer, no matter how much either side might wish to deny it, is too functional to forgo.

That’s not to say that heads of state never do illogical things, but they do it is the exception and not the norm. In this case the norm is likely to prevail.

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