Venezuela changes tune, to pay up for natural gas

The big news last week in Venezuela oil and gas was that Repsol and Eni will spend $1.5 billion to develop the ginormous offshore Perla gas field, which they discovered two years ago. The field alone, with about 8 trillion cubic feet (Tcf) of reserves, has more than half as much natural gas on tap as the entire country of Argentina, South America’s top gas producer. Amidst Repsol’s rather hypey PR campaign — with an exaggerated reserves figure (talking about gas in place, rather than recoverable reserves) and lacking any timeline — the figure that jumped out at me was $3.69.

That is, Venezuela is now going to pay $3.69 per million BTU for the gas from this field. That is more than twice as much as the company has traditionally been willing to pay producers. For example, here (on page 32) you can see that Harvest Natural Resources’s Petrodelta joint venture receives a steady $1.54 per thousand cubic feet of natural gas in the country. $3.69 is enough to make my prior prognostication wrong, wrong and wrong.

So Venezuela has changed. It is now, apparently, willing to pay the kind of prices that will actually get gas out of the ground, rather than insisting on prices so low that companies can’t justify development. This is mostly good news for the country and its private partners. Venezuela needs gas to keep pressurizing oil fields, fueling new electricity generators, making chemicals and cooking food. The country could even, with the biggest reserves in South America, one day export gas. But paying $3.69 per million BTU (which is roughly the same as 1,000 cubic feet), now, is bizarre, because gas prices are lower than they have been in years. The average US wellhead price rose from 2003 through 2008, peaking at over $10 for that quanitity of gas. The price than collapsed in early 2009 and has since hovered around $4. Spot prices are even lower, with US benchmark Henry Hub spot down to $3.05.

Through the boom and bust in gas, Venezuela has kept paying the same low price for gas, saving money while limiting new development. Companies such as Chevron and Statoil, which had access to the offshore fields, have always said that they needed at least $3 per mmBTU to economically justify developing the offshore fields (here’s Mitsubishi saying the same thing to the US embassy, thanks be to Wikileaks). That price was available if Venezuela had wanted to charge ahead with LNG export, as international buyers have routinely paid upwards of $5/mmBTU for LNG since 2003. But Venezuela’s policy has been to promote domestic development rather than international trade. The first part of any produced gas, the government insisted, had to go to the domestic market, where prices have been fixed at less than $1 for ages. The government can’t rightly justify buying gas for $3 and selling for $1, can it now?

There were other problems as well. The initial plan to develop the fields with Exxon and Shell broke down among disagreements. There were many changes of plans in how to develop the various offshore fields. (Later, after development finally began, there were other issues such as probable corruption in PDVSA’s drill rig contracting and even a shipwreck.)

The Venezuelan government finally decided to go ahead with LNG production in about 2006, with the goal of bringing gas ashore by 2008. But it was already too late — the 2008 crisis hit when the LNG plant was still just a big cleared spot on the coast of Sucre state. Work on the undersea pipeline from the offshore fields to the coastal processing plant was halted.

Venezuela fell into a natural gas crisis. Old oil wells need natural gas injection to keep producing. Power plants need natural gas. Residential consumption rose as more and more people took advantage of a consumption boom driven by oil windfalls to buy gas stoves. Nearby Trinidad got its fields into development and exported heaps of LNG during the period when gas prices were high. But Venezuela’s fields were stuck between a government without the money to develop them, and private companies that were uninterested unless they could sell their output at a higher price. So Venezuela took the pipeline it had built to export gas to Colombia and Ecuador and Panama and beyond, and reversed it to import gas from Colombia (at prices above $4, most recently at $5.30/mmBTU). Those imports continue today.

More recently, PDVSA has continued drilling the Mariscal Sucre fields on its own to try and get some offshore gas production going. According to a reader familiar with the situation, PDVSA drilled 8 wells, but it’s more like “5.5 wells.” That is because one well failed because there was an accident between its drill ship and a ferry under tow during drilling, another has the shipwrecked Aban Pearl rig almost atop it, and another had a completion problem that will probably limit it to half its projected output. PDVSA could have been finished with the project by now, but instead is expecting half the gas in late 2012 and the other half in 2015. In any case, PDVSA is trying to get some Mariscal Sucre gas ashore in late 2012, and is spending big bucks to do this “accelerated production” ahead of the full production in 2015.

Now, international gas prices have fallen hard, thanks in large part to the US’s push for “unconventional” gas, mostly from extracting gas from historically useless beds of coal and shale. The US is importing less LNG, creating a glut on the market. Imports are down 24% year over year, according to the Energy Information Administration. And now that prices are depressed, PDVSA pays more than it has ever been willing to pay. I suppose you could argue that it’s all good business — they have a stronger negotiating position with the oil companies now than they did with gas at $10. On the other hand, Venezuela is also now in a weak position, with its desperation for gas.

So now, after years insisting on paying oil companies prices way below international prices for natural gas, now, it’s $3.69/MMBTU. Well, you know, “a foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.”

13 thoughts on “Venezuela changes tune, to pay up for natural gas

  1. Quase Carioca

    Great stuff, Setty! It’s always been striking to me how badly Venezuela has handled its natural gas bonanza. The 23-year delay in the Cristobal Colon project (later to be known as Mariscal Sucre) had all the trappings of chavista ideological blinders — they refused to allow an export project on the grounds that the gas should go to a domestic market that didn’t need it. Now they’ve gone ahead and created conditions for foreign investment in natural gas to spur exports at a time when the international market doesn’t need it. Of course part of the culprit is the $0.60 price per million BTU that is far below production costs. It’s still not clear to me how they’re going to finance the difference with the $3.69 they’re gonna pay for Perla gas — is PDVSA going to swallow the difference just like they do with the China oil deliveries?

    Great stuff as usual, Setty.

  2. Editor

    What’s wrong with paying $3.69 / mmBTU?, if you are paying now imported gas from Colombia at prices above $4, most recently at $5.30/mmBTU.

    1. sapitosetty Post author

      There’s nothing at all wrong with it. Sorry if I wasn’t clear, but I am not criticizing the new price. Mostly I just find it frustrating to see them miss the 5-year gas boom by insisting on their very low price of $1.25 or $1.50, and now be willing to pay higher prices exactly when LNG gas becomes competitive with the Colombia prices. It’s clearly better to pay $3.69 than $5.30 and to have a fixed price rather than LNG’s variability. Just frustrating, is all.

  3. westslope

    Fascinating stuff Setty.

    Natural gas producers in neighbouring Colombia are being paid north of US$5 per unit (MBTU if I recall) for onshore natural gas. Among other notables, Pacific Rubiales produces considerable dry gas from La Creciente field in the lower Magdalena River basin and makes a decent netback on a barrel of oil equivalent basis. The netback is tiny compared to oil, even heavy oil, but given the background of secure economic property rights, firms seem happy to exploit it. As you note Venezuela is importing natural gas from Colombia at rates above $5 per unit.

    (The operating netback per barrel is roughly akin to saying the gross profit per barrel.)

    Will US$3.69/unit of natural gas be sufficient to cover all the costs of this offshore operation? Those wiki-leaked minimum price estimates date; offshore exploration and production costs have not gone down in the succeeding years. Or has Venezuela relaxed safety and environmental standards in order to reduce the cost of exploitation?

    The Chavez crew is on principle opposed to capitalist ‘profit’ because as all good Catholics know, ‘profit’ is evil. Like all good neo-marxist economic planners, the Chavez crew is woefully ignorant of risk management–or self-loathing beyond words, there is no half way here–so we can readily expect Chavez crew to set prices that will generate a ‘normal return on capital’ given ideal circumstances.

    I suppose the critical takeaway here is that domestic consumers will continue to pay the highly subsidized prices. That is the key. The shape of democratic oversight in Venezuela suggests no fundamental change of course in public resource management. The overall status quo will prevail as negotiating positions evolve.

    Well said Quase Carioca: Great stuff as usual, Setty.

    ——————————————————-

    Question if I may: How much natural gas is flared in Venezuela?

    If you get a chance, look at the satellite night photos of the USA. Gas flaring in the Baaken shale field in North Dakota makes the area show up like a large city. I know it is not scientific and largely emotional, but there is something about flaring dry natural gas that profoundly irritates this Lutheran-baptized boy.

  4. westslope

    setty wrote: It’s clearly better to pay $3.69 than $5.30 and to have a fixed price rather than LNG’s variability.

    westslope continues: If I understand correctly, you are saying that lower dry gas prices paid offshore multi-national producers are better than higher prices? Why?

    What happens when market conditions change and the companies are no longer covering costs? What then? Brow-beat private investors into deliberately losing money and destroying wealth?

    There is a full range of natural gas contracts in effect world wide. Some are market driven determined by negotiated contracts of limited time duration. Some are spot price driven. Others are fixed. Others are set relative to some oil price benchmark or fuel oil benchmark price.

    The interest in longer-term natural gas price contracts with some kind of price stability is understandable. Private investors seem very happy with fixed price natural gas contracts from what I observe. Auctions where companies bid for x-royalties are a good way of drilling down into company profits.

    But loading all risk on to the private producer with the savoir faire is nothing but a good, sure way of hurting ordinary people.

    1. sapitosetty Post author

      Don’t worry, man. I don’t think Eni and Repsol would sign a 25-year contract at that price if they didn’t think they’d be covering costs. And if something goes wrong, I have a feeling they can take care of themselves.

      And why are you using this loaded language about “multi-national producers”? Either way, the money goes to multinationals — either Ecopetrol, Chevron and Pacific Rubiales in Colombia, or to Eni and Repsol with PDVSA in Venezuela.

      1. westslope

        With all due respect setty, I don’t think you understand the way multi-national producers work. They can also practice hold up, and they do on a regular basis. Witness Newfoundland.

        As to how ‘multi-national producers’ is “loaded language” escapes me. It is accurate. Of course they are multi-national. Your style of industrial policy tends to drive out all the local talent.

  5. Dr. Faustus

    I’m surprised that no one has yet commented on the fact that Repsol and ENI own 64% + of this venture. PDVSA contributes no money, but still gets a third. This is completely different from the percentages offered to those willing to venture into the Orinoco. The boys at PDVSA must have been desperate for this gas deal.

    1. sapitosetty Post author

      Gas has a different legal structure than oil. Private firms can own up to 100% of gas projects, while the government has to own at least 51% of any oil project in Venezuela. Assuming it all plays out as planned, PDV got a reasonable deal here — I was just trying to point out the weird timing.

  6. Editor

    The gas law is totally different from the Hydrocarbon Law , where in the hydrocarbons law PDVSA gets to be the majority owner (60%) of everything, in the gas law the licenses could be 100% own by the private company. In November 2005, Repsol and ENI with 50% interest each, were awarded a 30-year license for the Cardon Block IV of the Urdaneta project costing them $34 million. However, the said that for the commercialization of the resource they have to included PDVSA on it, so they now negotiated with PDVSA a participation of 35% share in the development of the project, with Repsol and Eni’s shares at 32.5% each and extended the development rights to 35 years.

  7. westslope

    See the wiki-page on the Hold-up problem here: http://en.wikipedia.org/wiki/Hold-up_problem. Hold up has fascinated economic theorists because of the ability of the ‘theory’–it is really more a stylized type of common behaviour to explain the limits of the modern firm. Why x firms rather than y firms? Why size A and not size B? I know it sounds esoteric. It is good stuff if one is trying to fine tune the social returns to non-renewable resources. Within a firm’s boundries, and putting all office politics aside, presumably there is no hold up problem. Fail to carry out orders and the firm will eventually fire you.

    Regimes like Venezuela or Newfoundland can in a sense “fire” large oil companies that perform most offshore work but typically they end up in long protracted negotiations. Both parties face strong incentives to keep negotiating difficulties out of public view. Contract enforcement, certainly to the letter, is often not possible. In that respect, Statoil’s publicized attempt to just say no to Venezuelan foolishness is the exception, not the rule.

    See Editor Petroleumword’s post. Well diversified multi-national companies can delay finalizing deals for years and years. It happens all the time in the upstream sector. Exploration licenses can be renewed several times in a row. Usually national regulatory agencies have little influence because they know other companies will be reluctant to pick up the expired licenses for the same reason the original owner allowed the license to expire without doing any drilling.

    If one jurisdiction attempts to drive returns to below market rates or make shareholders assume too much risk, the capital spending budget simply gets shifted elsewhere.

    In Turkey in the spring of 2011, the regulatory agency rescinded several licenses and joint-venture exploration partners stopped drilling one well that was half way to total depth, capped it, and then immediately abandoned it. Drilling pre-commitments had not been met was the official reason. I mention this because this is rather exceptional in my experience and something energy-ambitious and hungry- Turkey may not want to repeat too often.

    Anyhow, all the above underlines why economists of all stripes emphasize getting the incentives right, and why the Norwegian energy minister gives essentially the same advice to foreign governments.

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