Chávez Gone, Big Oil Restrictions Remain

Includes: COP, CVX, XOM
by: Charles Margolis

The Executive Vice President of Venezuela, Nicolás Maduro, announced Hugo Chávez died after a battle with cancer yesterday. Chávez reigned over the South American nation with an iron fist since 1999. This article will delve into the current state of American oil company interactions with Venezuela, Petróleos de Venezuela's (PDVSA) booming oil industry, and a fund to consider with exposure to Venezuelan oil income.

Hugo Chávez at Miraflores Palace, photos by Charles Margolis

Venezuela is home to the largest proved crude oil reserves in the world:

Venezuela Proved Oil Reserves Chart

Venezuela Proved Oil Reserves data by YCharts

Venezuela's proved reserves are believed to be over 297 billion barrels (an oil barrel, or bbl is equivalent to 42 gallons.) To put this figure into perspective, Saudi Arabia has around 265 billion bbl proved reserves, and the United States has about 30 billion bbl. Given the current $90.82 price per barrel the value of Venezuelan oil is potentially worth many trillion dollars:

WTI Crude Oil Spot Price Chart

WTI Crude Oil Spot Price data by YCharts

Exxon Mobil (NYSE:XOM) and Conoco Phillips (NYSE:COP) were forced out of Venezuela in 2007, due to Chávez's strict control. Exxon and Conoco brought multiple complaints against Venezuela and state-owned Petróleos de Venezuela. Some of the complaints were based on Chávez's 2007 nationalization of the former Cerro Negro (now Carobobo) exploration area in the Orinoco Belt, which was found to have 15 billion bbl of heavy / extra-heavy crude oil.

Exxon demanded as much as $12B from Venezuela after Cerro Negro was nationalized. The company was awarded $746M by the International Chamber of Commerce; however, Chávez said he would only repay a fraction of the award.

Exxon is "seeking the impossible, that we pay what we will never pay..."

Chávez said... that the country would only reimburse Exxon for what it had actually invested in the country.

Hugo Chávez January 2012

Though Exxon and Conoco faced difficulties under Chávez, Chevron (NYSE:CVX) has enjoyed a better relationship. Last year the oil giant extended a $2B credit line to increase output in joint ventures with PDVSA. Chevron's 2012 Venezuela Fact Sheet lists minority ownership in three Venezuelan oil fields, and majority ownership of two offshore facilities:

Total daily production averaged 259,000 barrels of crude oi...

The Boscan Field in the state of Zulia in western Venezuela is operated by Petroboscan, a joint venture with PDVSA in which Chevron holds a 39.2 percent interest...

Chevron owns 25.2 percent of Petroindependiente, which operates the LL-652 Field in Lake Maracaibo...

Chevron has a 30 percent interest in Petropiar, a nonoperated joint venture with PDVSA in Venezuela's Orinoco Belt.

Chevron also has an important presence offshore Venezuela, in the Plataforma Deltana region. Chevron operates and holds a 60 percent interest in Block 2 and a 100 percent interest in Block 3.

The difference between Venezuela's antagonistic relationship with Exxon and Conoco, versus its more friendly relationship with Chevron is representative of a classic Chávez dictatorial maneuver. Conoco's first ever overseas project took place in Venezuela in 1946, however the company left after its projects were swept into Chávez's nationalization effort. Conoco was awarded $66.8M, and again Chávez announced he would not pay.

Venezuela President Hugo Chávez disclosed he wouldn't accept rulings by the World Bank's global arbitration forum and the country has officially withdrawn from it.

Wall Street Journal September 2012

Now that Chávez is gone these dictatorial moves could ease, though the next presidential election, possibly within 30 days, may be a free-for-all. Chávez had eight different vice presidents since he first took power, and they did not enjoy the same level of popularity amongst Chávez supporters.

Simply put, if Nicolás Maduro runs and is elected, some of Chávez's policies will probably remain. If an opposition candidate were to win, drastic changes are likely. However, Venezuela does not have a two-party system, so multiple candidates can detract from one main opposition figure.

Chávez's Ordered Chaos

La Muerte del Libertador - Antonio Herrera Toro (1889)

To the outside world looking in, Venezuela may seem chaotic. However, you must keep in mind the population is 29M. Take a quick look at how Venezuela compares to California and Texas:

population area proved oil reserves
Venezuela 29M 353,841 sq. mi. 297.5 billion bbl
California 38M 163,695 sq. mi. 2.8 billion bbl
Texas 26M 268,581 sq. mi. 5 billion bbl

While California and Texas are home to numerous major businesses, presuming the estimates are correct, Venezuela is vastly more wealthy on paper. Though it is also expensive and labor intensive to extract oil:

Venezuela Oil Production Chart

Venezuela Oil Production data by YCharts

Venezuela's reported daily oil production trended lower under Chávez, though proved reserves soared. The decline in oil production may have resulted from Chávez's restrictions, and his effort to keep Venezuelan oil profits from competing oil companies. Additionally Venezuela's daily oil consumption has soared:

Venezuela Oil Consumption Chart

Venezuela Oil Consumption data by YCharts

Venezuela currently has a junk credit rating of B2, and a large 34% foreign tax withholding on interest paid to foreigners:

Interest paid to a nonresident individual is subject to a 34% withholding tax...

Deloitte Venezuela Highlights 2012

Though foreign banks and financial institutions are encouraged to invest in Venezuelan debt, with a comparatively low 4.95% withholding tax. One major concern, up until now, was Chávez's ability to raise such taxes on a whim. For instance Chávez recently planned to raise taxes on foreign oil companies' income drastically:

Widening a previous sliding scale, state company PDVSA and foreign partners will have to pay the state 20 percent of income from sales of oil between $55-80 per barrel, 80 percent between $80-100, 90 percent between $100-110, and 95 percent over $110.

Reuters January 28, 2013

Take a look at a few of the Venezuelan government bonds currently on the market. Keep in mind the yield does not account for what could amount to large tax withholdings.

credit rating price yield
Venezuela Rep Glbl Bd 9.25% 2027 (cusip: 922646AS3) B2/B+ $102.88 8.89%
Venezuela Rep Glbl Bd13.625% 2018 (cusip: 922646AT1) (cusip: 922646AT1) B2/B+ $122.50 8.38%
Venezuela Rep Glbl Bd 8.5% 2014, OID (95.06/9.27%) (cusip: 922646BM5) B2/B+ $103.25 6.30%
Venezuela Rep Nt 10.75% 2013, OID (90.69/12.45%) (cusip: 922646BJ2) B2/B+ $103.25 4.47%

Banks and financial institutions might be considering these, over individual investors. Some reports already anticipate Venezuelan bonds will rise on "transition hopes." Though Bloomberg reported in January PDVSA bonds dipped over a potential "succession crisis" if Chávez could not be sworn in.

Investors must realize that Venezuelan elections (particularly a potential runoff in 30 days) are unpredictable, especially without Hugo Chávez in the running. While the city of Caracas may appear to support one candidate the rest of the country might go with another. The vast majority of Venezuelans live outside of Caracas.

Investors inclined to avoid direct exposure to Venezuelan debt might consider a mutual fund such as TCW Emerging Markets Income (TGEIX). This fund picked up PDVSA bonds at deep discounts, and they have since run-up. The fund also held two sets of Venezuelan government bonds as of January 31, 2012.

In January Moody's lowered Venezuela's rating outlook to negative:

Venezuela is heavily exposed to transition risk because of the weakness of its institutions coupled with the concentration of power in the person of President Chavez. While this risk is already incorporated in the current ratings, the negative outlook reflects the increased likelihood of a downward rating migration...

The negative outlook also considers the risk of civil unrest. The longer the current impasse remains, the more likely this becomes. The opposition will not stand idly by if they perceive the Chavistas to be attempting to solidify their grasp on power through extra-constitutional means.

Depending on how long it takes Venezuela to ramp up oil production, the price of oil, and global dependence on oil; the country should have more than enough to improve the overall quality of the economy. Though currently a staggering 31% are below the poverty line, and GDP per capita is $13,200. President Chávez had a strong will, and burned some bridges with Exxon and Conoco, however, regardless of who takes his place, stronger relationships with efficient oil companies could bring more wealth to the people of Venezuela.

If you have any thoughts on Venezuela's oil industry or Venezuelan bonds please leave a comment below.

Disclosure: I am long XOM, COP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am considering TCW Emerging Markets Income Fund. This article is not a recommendation to buy or sell. Please consult a financial adviser to determine proper allocations, (if any) to suit your objectives.