Why did Chavez boost oil “special contribution”?

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!

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26 thoughts on “Why did Chavez boost oil “special contribution”?

  1. otto

    The immediate flippant answer i had for the title question was “Because it’s easier than nationalizing everything”, but i see your point when it comes to the projects in pipeline. Does PDV just take control of them? Doubt it, cos they don’t seem to have the cash to build these things.

    Hey Setty, where do the Chinese/Russian etc (belorus?) deals fit into this equation? Maybe that’s why he’s not making such a fuss?

    Sorry about more Q’s than A’s in this comment.

    1. sapitosetty Post author

      Otto: If a partner walks away from a planned project, then yes, PDV ends up in control. But usually that means it gets put into suspended animation. For example Junin 10, which was to be developed by Total and Statoil, and then either Total or Statoil, and then finally both proposals were rejected and now PDV has no plans to develop.

      The Chinese won’t be affected much as they mostly buy oil and sell services, both in oil and in many other industries. CNPC is not a major oil producer in Venezuela. By all accounts the Russian consortium hasn’t been very enthusiastic in getting its Orinoco project off the ground. The problem is that you’re dealing with the boards of not just one, but five equal-weighted oil companies in the Russian consortium, so decisions take forever. Plus, money hasn’t been forthcoming. Companies are apparently loath to invest hundreds of millions of dollars in a non-operated project where the guys from another company might be able to pocket all the spoils of operatorship, legal and otherwise. The rumor in Venezuela is that the Russians couldn’t even come up with the $2 million fee to become certified bidders in the Carabobo round.

      So if you’re trying to say that the Russians and Chinese and Belarussians etc will backstop any departure by the private sector, I just don’t see it. They haven’t done so thus far.

  2. Kepler

    Set,
    I think Hugo does this kind of things when everybody is on vacation.

    Amazing how we fail to get nervous about how this destroys chances for sustainable development. The sad part is that oil prices are very unlikely to fall for many years to come. I am convinced the fuel shift will come within this generation and then it will be doom for Venezuela, but a generation is a long way…at least for individuals.
    But then Venezuelans are the world specialists for the hic et nunc.
    Regarding Belorussians: I will try to find out about the actual projects for exploration with Belorussian companies. What I find absolutely puzzling is how Belorussians and Venezuelans tried for so long, so very long to actually investigate the possibility of transporting oil from Venezuela to Belarus – through Odessa in Ukraine, through the Baltic states, etc. A Belorussian friend told me a long time ago when the deal was announced: it has to be a swap. And that is what they have done so far, but they also tried to discuss with all possible governments and undertook some sample transports to see if – after all – they could just take the oil from Venezuela to Belarus.

  3. quasecarioca

    I honestly don’t think there’s anything wrong with countries wanting higher returns when oil prices are higher, that’s not the problem — the point is that if you want successful project development you have to pick one set of rules and stick to them. This could very easily have been resolved five or six years ago by creating a royalty that increases or decreases depending on oil prices. That way companies can decide for themselves at the outset whether the deal is good for them, and will have a good idea ahead of time how much they will pay in tax when oil prices are at any given price level.

    That’s not what Chavez/Ramirez/Mommer & Co. did. First they raised royalties (2004), then they retroactively raised taxes on a group of oil projects (2005), then they created an “extraction tax” (2006), then they created a windfall tax (2008), and now we’ve got a revamp of that tax (2011), in addition to a “shadow tax” that fits in there somewhere.

    Whining and bitching about how oil companies are evil does less for the Venezuelan people than ensuring you get tons of money from them. The latter requires ensuring that they produce oil. Give them one set of terms, and say ‘take it or leave it’, then stick to the terms — that is the most likely formula for getting the cash you need to build schools and hospitals (whether you can actually get it together to build them is quite another matter). But I’d have to say I don’t agree with Eva Golinger that this particular way of doing things is good for the Venezuelan people.

    And I also have no idea why this came over Semana Santa instead of in a loud Alo Presidente tirade …

    1. Kepler

      I don’t get why you don’t get it.
      This is not an “exprópiese thing”. Here we are talking about a clear measure to use funds without any transparency whatsoever. He will announce in the Aló Presidentes things like “we are distributing washing machines to everybody in Portuguesa” and “we are going to get 2000 Chinese tractors to the Llanos”. He is going to use a fraction of that money for that. A lot of the rest will be used for something else: weapons, intelligence, buying more people for the milicias and, in the end, even if the Líder does not know it, for some people within the boliburguesía.

  4. Tom O'Donnell

    The issue as to why Venezuela under charisma has made it so difficult for any significant Faja heavy oil project to really, unambiguously get off the ground is, as always, a topic of much debate. Chavez obviously needs the regular, long term income it could provide to perpetuate the revolution longterm. But, Setty’s well considered analysis of yet another event in the life of the revolution and the Faja clearly reveal how short term exigencies are the constant enemy of long term rationality.
    … Indeed – what if oil prices or gold prices fall. The continued lack of a significant Faja oil stream, after 12 years of promises, will be devastating.
    — Keep up the great analysis

  5. Lemmy Caution

    In any case there must be a point in taxation level at which you maximize the gains for the state from the oil companies. If you go over that level the state will loose in the future, because lack of incentives for the companies to invest. If I remember right Arturo Valenzuela stated in a book about chilean history, that the most important reason for the nationalization of chilean copper starting in the sixties were the lack of investment from the mostly US companies because taxes on earnings were too high.
    At least the oil remains in the soil for a time after Chávez.

    1. Kepler

      Hugo is only 56. Life expectancy for men in Venezuela is 70 now. Imagine he lives 20 years more. We still have until 2044. And what if his eldest daughter does get elected?
      I am sure the Earth will see a fuel shift before that time.

      1. Lemmy Caution

        And how we will get all those planes in the air after the fuel shift, Kep?
        Even if we see the massive introduction of electric cars in Europe, North America and parts of Asia doesn’t necessarily mean for me at least that we will see lots of them in other parts of the world soon afterwards.

        1. sapitosetty Post author

          I don’t know how much time you’ve spent in South America, but I think you’d be amazed at how little air travel there is here. It’s one of those things people can do without as oil gets pricey.

        2. Kepler

          Lemmy: I don’t know, but when I mean fuel shift I did not mean everything completely. We still use muscle power for our bikes and steam for others.

          I do think the proportion will become significant and prices will fall. I don’t see that happening in the next couple of decades, but I do see that a bit after that.
          Of course, it is felt firstly in places as Western Europe. In 5-10 years we will have a higher proportion of electric cars but they will still be a minority…and then we will have surpassed a critical mass and that proportion will grow more and more at least for cars.

          Do anyone of you have data about the percentage of oil used for cars and for planes?

        3. Lemmy Caution

          @Setty: 12 month in total, mostly spent in middle class households in Chile. With middle class I am refering to more like lower than upper middle class.
          Kepler, I don’t believe in much lower oil prices for the next 40 years. Even if Europe and hopefully the United States lower their demand there still will be a rising demand from emerging and middle/lower income countries. Car sales have reached record highs over the last 2 years in Chile. Bachelet and Evo Morales both failed when they tried to introduce higher taxes on gasoline. Loads of people see car ownership as an important aspect of participating in the world of today.

      2. Kepler

        Lemmy, let me explain my wild hypothesis. I think oil prices will keep going up in the coming decades, as you said because of increased consumption elsewhere. Just China would be enough to drive prices high.
        Still: 44 years is a long time. The proportion of electric cars will keep rising, first slowly. In about 25-30 years the proportion of electric cars would start to go up faster, just like in other technologies, just like car use went up from 1910 to 1950. And then the oil market will see a change. This won’t happen in the next couple of decades, so I do not believ we can count on oil prices for Chávez’s end, even if Chávez, as Miguel wrote, will find it more difficult to profit from every extra increase.

      3. moctavio

        Wow! A comment for the ages! How could you know Kep? He had at most three years oeft, you said that weeks before he got sick. Lo empavaste chico!

  6. westslope

    Great post and discussion! All this talk of ‘marginal barrels’ and some Chavista thinkers will suspect that this board is inhabited by Chicago school neo-classical apologists for western corporate imperialism.

    If there is extra money to be made on these large oil leases, auctions should dictate the terms. The firms assume all or most of the commodity-price risk. The serial currency devaluations also send very negative signals to the markets in general and would-be investors outside the petroleum sectors. Diversification is further hindered.

    Food price caps have risen 35% or more earlier in this year following the 40% devaluation. Che Hugo is setting himself up for social unrest. If those oil prices collapse back to que se yo ~US$70/bbl, there could be some very painful belt tightening, and a sharp spike in the pueblo’s unhappiness meter.

      1. Kepler

        I think westslope is highly imaginative. He should take a look at the newspaper articles from Notitarde (it is a tiny newspaper and you can find the results easily) for “precio petroleo 1998″: IEA announces prices will go on being low…IEA reasses and says prices are going to increase just…” These energy experts seem to predict energy prices, even middle term ones, as well as any farmer can predict the weather in a week.
        One thing is for sure: there will come a shift. I believe it will be in about 40-50 years. Still, that shift will be progressive. It will be fatal for Venezuela, though.
        Perhaps I am absolutely wrong, as Uslar Pietri was regarding the time we will run out of oil. Uslar Pietri did not know, that I am aware of, of Oil Peak or anything like that.

        1. westslope

          Keplar, I would love to have just a fraction of the IEA budget to monitor oil. :-) But to tell the truth, I don’t monitor oil markets carefully. I look at the global economy and global security situation though for the latter I’m batting about 1/10 in the past few months….

          Forecasting anything beyond 6 to 9 months is as popular game for those uninitiated in the art of numbers. That is precisely why having a good imagination is helpful. The subjective probability distribution required for budgeting and risk management has to come from somewhere!

          Many of the cashed-up producing oil companies I follow are trading as if US$75 to US$90 was the long-term, sustainable price range. The ones in the portfolio were chosen or held as good candidates for growth even if benchmark oil prices were to temporarily retrace by 40%. The cash-poor explorers are trading down as if venture capital has become more expensive and will become much more expensive.

          Oil prices seem to display some inertia like exchange rates. They also seem capable of sustaining supply-fear premiums for long periods of time which bodes well for US$100+/bbl oil going forward. On the other hand, all but one US economic recession in the post-war period has been catalyzed by high oil prices.

          US GDP-energy intensity is indeed trending lower but right now the US is already near or through thresholds that preceded past recessions.

        2. Kepler

          westslope,
          One thing is knowing how to deal with numbers and another ignoring some simple facts . One can use all the maths on Earth to calculate oil prices based on statistics on production and prices since oil was industrially extracted for short term.

          Still, one is overlooking something: oil is, unlike currency or prics, a finite resource. We simply do not know how much of it is there, but we do know some ranges and we know we are going to run out of it in som decades, whatever they are… It is not like you can go 100 kilometers down the Earth and still find oil. You can’t. It is not that oil is magically being generated down there either.
          That and other things like pollution will lead us to have an energy shift. Of course, you cannot bet on whether something is going to happen between 2040 and 2070 or between 2071 and 2100…what for?

  7. Miguel Octavio

    When you build a house of cards, it becomes tougher and tougher to add cards at the highest levels. The reason I think Chavez is doing this is that the distortions are coming back to bite him.

    When PDVSA sells oil, it pays taxes and royalties to the Government. But when PDVSA ships oil to pay for Chinese loans, there are no taxes and/or royalties involved. As the shipments of oil to China have increased, the money from taxes and/or royalties has decreased, thus the Government is lacking funds even if oil is at $100.

    That’s my take. Just a house of cards, under Chavez’ “ingenuity” and “creativity”

  8. moctavio

    I was told that’s the way it works. It makes sense, PDVSA receives no money when it pays for loans with barrels, thus it pays nothing.

    1. sapitosetty Post author

      Here’s how I understood it. PDVSA isn’t supposed to have any connection to the China prepurchase deal. The money didn’t go to PDVSA, but to the Republic. So in theory, the government gets the barrels off PDVSA as royalty payments and then turns them over to China. I think you are saying that PDVSA is producing special oil for this deal — oil that goes untaxed — which is totally possible, but I did not know that.

  9. moctavio

    I dont think PDVSA produces enough oil to pay so many barrels a day in royalties. It is Bandes that gets the loan and PDVSA ships the oil, not sure of the details, but I understand there is no royalty or tax. Part of the wonderful world of non-transparency of the revolution.

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