Monday, May 01, 2006

Giving away the store. 

While we are heavily into the subject of oil I thought I would talk about an excellent article written by Oliver Campbell over at Vheadline. It is about the recently terminated Service Contracts. I highly encourage people to go read it.

For those who don't remember these service contracts are private oil companies that were brought in by the old PDVSA management to run old oil fields. The companies produced the oil and gave it to PDVSA who then sold it on the international market. The thing was, PDVSA was obligated to pay these companies whatever they claimed their costs were - the so called cost-plus method. Whatever a company said were its costs, plus a built in profit, had to be paid by PDVSA, no questions asked. It's the same sort of system that Halliburton uses in Iraq to charge the army $8 for a gallon of gas it buys for $1.50 in Kuwait and thereby makes a fortune with.

Needless to say, the production costs were very high, up to $15 per barrel according to Mr. Campbell, compared to regular oil produced by PDVSA which costs only $4. As this oil displaced other oil Venezuela could have been producing at $4 per barrel this cost the country $11 ($15 - $4) X 500,000 barrels per day x 365 days per year = $2 billion dollars per year. Venezuela could certainly have done a lot of things with that $2 billion dollars per year. Fortunately, Venezuela has put an end to these arrangements by assuming control over all these oil projects. It will now be able to control all costs and hopefully ensure that they are not inflated.

Why did the old PDVSA management even set up these service agreements when they were costing the country so much money? Not even Mr. Campbell can figure that out as he indicates when he says "Why the investment was made in brown field sites-mature fields -- rather than green field sites-new production areas -- has never been clear to me, but it is now water under the bridge."

Clearly, whoever negotiated these deals didn't have Venezuela's best interests at heart. It certainly wouldn't surprise me if a some money from these private oil companies wound up in the bank accounts of some of the PDVSA executives who negotiated these deals.

And this is part of a rather disturbing pattern. For example in the heavy oil projects of the Faja del Orinoco the oil companies were only charged a measly 1% royalty. The excuse always given is that oil prices at the time were very low and it wasn't known if these projects would be profitable so they charged extra low royalties. Ok, that actually makes sense and I can understand it. But why were the contracts written so that if the price went up to 50, 60, or even 70 dollars per barrel the royalty stayed at the same lousy 1% royalty? Wouldn't anyone with a little bit of forethought been able to put in a "escalator clause" that would increase royalties as the price increase? One would think so.

Ultimately, Chavez had to unilaterally increase the royalties on these projects to keep all those billions of dollars from just flying right out of the country. And the opposition then attacked him for "not respecting contracts". But what I would like to know is who negotiated these horrible deals? Why didn't they put in simple clauses to protect Venezuela's financial interests? Whose interests were they acting in if not the country's? And, what would be most interesting to know, was there any double dealing or kickbacks involved? I've have no evidence to offer on that score. But considering how unjustifiably bad these contracts were for Venezuela one would be very naive not to realize something else was probably going on under the table. And maybe this helps explain why the old management went to the mat in their fight to try to keep PDVSA under their exclusive control.


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