This is a bit of a head-scratcher. Venezuelan President Hugo Chavez boosted taxes on oil companies Thursday night. Since the price boom in 2008, a “special contribution” has kicked in when oil prices are above $70 a barrel. Until today, the “contribution” was 50% of every marginal dollar above $70, and 60% of every marginal dollar above $100. In other words, in addition to all the usual taxes and royalties, at $120 a barrel, an oil company had to pay an extra $27 in “special contributions.” (Note that this is not a tax. A tax must be paid to the treasury and be paid to the states and municipalities. This contribution is paid to the off-budget infrastructure fund, Fonden, and is spent entirely at presidential discretion. You got a problem with that, take it to the courts.)
The contribution will now take 80% of each dollar above $70 a barrel, 90% of each dollar above $90 and 95% of each dollar above $100 a barrel. In other words, if a company sells at $120 a barrel, it now has to pay $44 of that to Fonden — making it the same as selling oil at $76 a barrel, without the special contribution. The $76 a barrel is then taxed at the usual rate for extraction tax, royalties, income tax, and so forth, taking a minimum 50% off of gross sales.
Now, it’s important to keep this in perspective. Producing oil in Venezuela is easy enough that even $38 a barrel (the maximum company take at $120 a barrel) can leave a company with plenty of money to make some projects profitable. This will not destroy all oil plans. What it does is it caps the upside of upward price spikes for oil companies, who must still deal with occasional downward price spikes. That is, if oil drops to $50 a barrel, the oil companies will get at most $25 a barrel, and the long-term average sales price will now be lower. That will make investments less economical. It will cause some projects at the margin to halt or to not start in the first place.
The big question is whether this change will have any effect on current investment plans. The big plans right now are for two projects in the Carabobo area of the Orinoco belt and another few projects in the Junin area of the Orinoco. While those projects have huge reserves, their relatively remote locations and lack of infrastructure — from running water to electricity to roads to worker housing, you name it — mean the investments are huge. Billions of dollars. For a company to invest billions, it needs a nearly guaranteed positive return, and it will prefer the possibility of windfall returns during high price periods. The existing windfall tax came under intense pressure during the bid round for the Carabobo oilfields, as companies said it limited their economics. It makes sense, really — during high oil-price periods, costs of everything rise. But with a windfall price tax, companies (or in this case, joint ventures) don’t get all the cash from the high prices, so they are stuck with limited income and rising costs. So there’s a real chance that this law could cause companies to delay or even walk away from Orinoco Belt projects.
That raises the question, why did Chavez sign it? To impress the public ahead of the electoral campaign? It certainly impressed one person — Eva Golinger, the pro-Chavez editor of the Correo del Orinoco, tweeted “Good for the Venezuelan people!”
But politicians don’t sign crowd-pleasing announcements at 10:15 p.m. on an official holiday in the middle of Holy Week, while everyone in Venezuela is at the beach. And Chavez doesn’t make his crowd-pleasing moves via telephone call to state television — he saves them for live audiences. This wasn’t the action of someone who was doing it to get applause.
So why? As Devils Excrement says, the decree will give the president an extra $11 billion to play with in his discretionary funds, which can’t hurt ahead of an election campaign.
There may also be a government liquidity issue here. Venezuelan central bank reserves have fallen $4.5 billion, or 15%, this year, to $25.7 billion, a four-year low. Reserves are now 60% gold, so the rising price of gold may have also masked as much as $1.4 billion in additional declines in cash reserves. (I got this 60% number from a finance industry source who in turn got it from the Bank for International Settlements. There is some wiggle room around the $1.4 billion, depending on what date the country hit 60% gold in its reserves pile.)
All this is happening amidst oil prices that are at their highest since 2008. If either oil, gold, or both decline, look out below!