The MasterBlog: The Perils of PDVSA
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Friday, September 12, 2008

The Perils of PDVSA

The Perils of PDVSA

Global Market Brief - Stock

Venezuelan state-run oil company Petroleos de Venezuela (PDVSA) is up to four months behind in payments to a host of energy industry contractors, El Universal reported June 10. Although the delays officially have been blamed on technical malfunctions, there is some evidence that PDVSA may be at serious risk of financial ruin, spelling grave implications for Venezuelan President Hugo Chavez’s regime.

PDVSA is the main source of income for the Venezuelan government and the principal financial foundation for Chavez’s populist policies. Chavez’s reliance on PDVSA to fund his policies is increasing even as inflationary pressures in the Venezuelan economy mount, local elections approach and the government struggles to compensate for system-wide food shortages. If PDVSA’s late payments are an indication that the company is faltering, it could seriously shake the country and put the government at risk of losing control.

While PDVSA has been late in paying contractors before, the delays have never been quite this protracted. The official reason is that PDVSA’s SAP computer systems program is experiencing unspecified technical difficulties. There is, however, speculation that corruption is exacerbating the situation. PDVSA is also reportedly experiencing very high employee turnover, which has slowed all of the company’s processes.

The compromised employee situation began in 2002, when a significant portion of PDVSA’s skilled staff was laid off after the company’s participation in a coup attempt against Chavez. The move left the company without technically skilled personnel or an accounting department.

Oil production took an immediate hit after the coup attempt. With the company organizationally scrambled, daily production of crude oil fell from an all-time peak of 3.15 million barrels per day (bpd) in 2000 to 2.34 million bpd in 2003, according to estimates by the U.S. Energy Information Administration (EIA). Although PDVSA claims to have raised oil output to pre-coup levels, there is serious doubt as to whether this is true. The EIA, the Organization of Petroleum Exporting Countries and the International Energy Agency all estimate that Venezuela’s actual output of crude oil hovers somewhere around 2.4 million bpd. PDVSA’s crude upgrading output also dropped by about 200,000 bpd in 2007.

A spike in imports of refined products and inputs is also cause for concern, as the value of purchases spiked from $759 million in the second quarter of 2007 to $1.6 billion in the first quarter of 2008. Part of the increase is most likely due to the rise in global oil prices and is not necessarily an indication of dramatically increased imports of refined products. However, it is yet another sign of weakness and a burden on PDVSA. If PDVSA is rapidly losing the capacity to produce these refined products (necessitating increased imports), it is in trouble.

In the face of declining production, PDVSA is able to invest only a small amount of funds into new exploration and production. The EIA estimates that in order for the company to maintain its level of production, an investment of $3 billion per year is necessary to compensate for lowered production in mature fields. But in the first half of 2007, PDVSA invested only 4.8 percent of revenues, or $2.09 billion, into exploration and production — hardly enough to increase revenue.

Many of the company’s capital expenditures have been focused on acquiring stakes in other companies and projects following Chavez’s 2007 nationalization campaign, which required PDVSA to hold a majority stake in all Venezuelan energy operations. Such deals give PDVSA a higher percentage of revenues, but also a higher burden of responsibility.

In spite of its reduced production capacity and increased financial burden, PDVSA is largely responsible for the fiscal solvency of the Venezuelan government. PDVSA’s financial statements from the first half of 2007 indicate that the company contributed 37.8 percent of total revenues to the state. After taxes and expenses, PDVSA had only 2.1 percent of its revenue left. With such a small surplus, PDVSA has very little wiggle room for adapting to new demands.

Furthermore, PDVSA will not be able to take advantage of spiking global oil prices. A recent change in tax law will increase the tax PDVSA pays per barrel of oil sold. Oil prices had been estimated at $35 a barrel, but actual oil prices averaged $95.84 a barrel; hence, there is an excess of $60.84 a barrel. These additional earnings were used to calculate higher income tax. Some analysts have predicted that unless the global price of oil is at or above $150 per barrel, PDVSA will be in the red.

This is not to say that Venezuela is not taking action to counteract PDVSA’s financial difficulties and declining production. A series of deals with foreign governments and companies has brought further investment into Venezuela’s energy industry, and several blocks are currently up for auction. However, the flow of investment is gradual , and the demands on PDVSA are increasing.

In addition to covering its own costs and debts, PDVSA is also responsible for a host of social and economic programs that are the basis for many of Chavez’s policies, and upon which he relies for public support. These include farming, food production, food distribution and oil industry equipment production. (PDVSA is also in the process of acquiring control of Venezuelan electric utility Corporacion Electrica Nacional.) These policies extend abroad to include foreign oil and general assistance programs in Latin America that have been key to Chavez’s foreign diplomatic strategy.

With so many demands on PDVSA, it is perhaps no wonder that the company might be having difficulties making its payments to contractors.

And the political and economic strain Chavez is feeling is ratcheting up the pressure on PDVSA even further. Chavez’s recent reversal on two key policies — an authoritarian intelligence law and support for the Revolutionary Armed Forces of Colombia — shows that the president is feeling threatened. With skyrocketing inflation, periodic food shortages and the approach of November local and state elections that will test the United Socialist Party of Venezuela’s mandate, Chavez is leaning ever more on PDVSA for financial support for his populist policies.

Chavez’s populism is intended to maintain public support and the survival of his regime. But the more he leans on PDVSA to fund his policies, the more Chavez risks shattering the very foundation upon which his kingdom rests.

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