Cut-Off Big Oil; A Case Study

AFTER winning a new term as president by a landslide a year ago, Hugo Chávez decided that it would be a nifty idea to squeeze the remaining private oil companies operating in Venezuela. So he ordered the tearing up of the contracts they signed in the 1990s, under which they were investing to develop deposits of super-heavy crude. In their place would come joint ventures in which Petróleos de Venezuela (PDVSA), the state oil company, would wield the controlling share. A year on, however, one of the multinationals, Exxon Mobil, is fighting back. This has prompted Mr Chávez to complain that the United States is waging “economic warfare” against his country. But such fiery talk cannot disguise the fact that both he and PDVSA are in a swamp of trouble.

On February 7th Exxon announced that it had obtained interim court injunctions in the United States, Britain, the Netherlands and the Dutch Antilles preventing PDVSA from disposing of over $12 billion in assets. It had sought the freeze as a preventive measure, to ensure that PDVSA could pay Exxon's claim for compensation for the seizure of its operation in the Orinoco heavy-oil belt.

Several rivals accepted the government's new terms. Exxon, along with ConocoPhillips, another American firm, chose to invoke the arbitration clause in its contract (which had over two decades to run). More than the money, it is reputed to want to send a firm message to the world's resource nationalists. Or, as Venezuela's deputy oil minister, Bernard Mommer, put it, to “intimidate other producers”.

Such procedures grind slowly. The International Centre for the Settlement of Investment Disputes, a body linked to the World Bank, has yet to convene the panel that will hear the case. In parallel, and seemingly without PDVSA's knowledge, Exxon sought the court rulings. The Venezuelan government insists that the freeze applies directly only to one American bank account (with $315m) belonging to PDVSA. That ruling was upheld at a full hearing in New York on February 13th.

Mr Chávez responded, not for the first time, by threatening to halt oil exports to the United States. These run at around 1.2m barrels a day (b/d) and represent about three-quarters of Venezuela's total export earnings. Under Mr Chávez, Venezuela's economy has become heavily dependent on imports, especially of food. Few believe he can afford to implement his threat, and the oil price rose only slightly.

Not so PDVSA's bonds, whose value dipped sharply on investors' fears that lenders may face a higher risk of eventual default. On the face of things, that makes little sense. With around $100 billion in assets worldwide, including refineries in the United States, the Caribbean and Europe, PDVSA can easily pay any compensation award, which is unlikely to total more than $6 billion at most.

But there are many signs that the once-mighty PDVSA may be running short of cash. Since January 8th, for instance, its customers have been required to settle their bills eight days after shipment, rather than 30 days after receipt, as is customary. By the end of the month it was offering eight super-tanker loads of fuel oil at below market price for cash. In 2007 the company's debt burden rose from under $4 billion to over $16 billion. The uncertainty caused by the Exxon dispute means its borrowing costs may rise.

PDVSA is no longer just an oil producer. Mr Chávez has made it into what Elie Habalian, a former Venezuelan governor of the Organisation of Petroleum Exporting Countries (OPEC), calls a “parallel state”. The company has transferred billions of dollars to funds controlled by the president, and directly finances and runs a range of social projects. “There's a ministry of education—but PDVSA educates too,” says Mr Habalian. “There's a housing ministry, but PDVSA builds houses, and so on.” In response to shortages of basic foodstuffs, last month Mr Chávez ordered PDVSA to create a new subsidiary to distribute food, most of it imported.

At the same time, PDVSA's investment spending has been slashed, leading to a decline in oil output, the motor of the economy, for ten consecutive quarters, according to José Guerra, a former Central Bank director. A much-trumpeted government plan to increase oil production to 5m b/d by 2012 does not seem to have got off the ground. Officials claim that daily production is holding steady at over 3m barrels, but other sources (including OPEC) put the figure at less than 2.5m, and falling. Venezuelans use more oil themselves, thanks to a consumer boom and Mr Chávez's reluctance to raise the price of petrol. Officially, consumption is 600,000 b/d; it may be a third higher, reckons Ramón Espinaza, a former chief economist for PDVSA. Meanwhile, Mr Chávez is shipping 300,000 b/d to Caribbean neighbours (notably Cuba) at subsidised prices.

No important new deposits have been found since the president took office in 1999. Officials admit that PDVSA is short of drilling rigs for exploration (though Mr Chávez recently loaned two rigs to Ecuador). Much therefore hangs on the development of the Orinoco belt, with its estimated 250 billion barrels of heavy crude. But many of the companies recently invited (without competitive tender) to take part in these projects are state-owned outfits from countries, such as Iran and Belarus, whose governments are friends with Mr Chávez; most lack both the expertise and the financial muscle to develop them.

Several years of high and rising oil prices, along with PDVSA's policy of secrecy, have helped conceal its difficulties. With a slowing world economy making a further rise in the oil price unlikely in the short term, concealment will get harder. Waiting in the wings is ConocoPhillips, with a compensation demand much higher than that of Exxon. Venezuela's oil company will “fall apart the moment that prices drop to realistic levels,” Mr Habalian says. Unless he changes course, so might Mr Chávez's government.