VENEZUELA - From The US Perspective.

The Republican administration of George W. Bush has been closely watching the situation in Venezuela since a brief coup in April 2002 against Chavez failed. For his part, Chavez has been watching Bush's behaviour since a brief US-led invasion of Iraq toppled Saddam Hussein's Baathist regime on April 9, 2003.

In the process, however, Chavez has proved his readiness to become a far more useful supplier of oil to the US than Saudi Arabia - still Washington's closest ally among OPEC states. In January 2003, at Chavez ' direct orders, the Caracas government and a little known oil trading company of New York signed an agreement to negotiate supply of Venezuelan crudes to the US Strategic Petroleum Reserve (SPR).

The promoters of this deal are two interesting figures: Venezuela's Ambassador to Washington Bernardo Alvarez, who has become a key marketer of his country's petroleum business among the US majors, and Jack Kemp - a Republican power broker in Washington and candidate for vice president in 1996.

With Alvarez having carte blanche from Chavez in his US efforts, including a latent political rapprochement with the Bush team, Kemp has powerful listeners in the White House.

Kemp, a former US congressman from New York, is a board member in the New York trading company, Free Market Petroleum (FMP). But Kemp's ambitions, and those of Ambassador Alvarez, go far beyond the FMP deal with Caracas (see OMT No. 20). They encompass a long list of projects, including huge LNG export deals, which should lead to "real economic integration" between Venezuela and the US.

So one should distinguish between the rhetorics being exchanged by Chavez and Bush and what is happening behind the scenes between power brokers representing these two leaders. To those of the Bush team who are involved in quiet negotiations, Chavez is a potential convert to free trade, rather than a student of Fidel Castro.

Chavez has learned first hand from the mistakes he made during and after the nationwide strikes that began last Dec. 2 and ended in February - which, among other things - led to serious structural damage in Venezuela's oilfields that can only be repaired by the US majors. Chavez got the lessons first hand simply because he became personally involved in every detail of the petroleum sector's problems from Dec. 2, 2002.

From this angle one can perceive the importance of meetings being held occasionally between Chavez and visiting executives from ChevronTexaco, ConocoPhillips and other US majors. This was perceived also from the way the Caracas government has recently offered to enlarge foreign operators' marginal oilfields or increase their exploitable reserves in exchange for including them in projects to be launched under a new interpretation of the Hydrocarbons Law, which was issued in late 2001.

According to the new interpretation, there is no limit to which Caracas may go in granting foreign companies additional E&P incentives or in privatising any of PDVSA's units.

The Chavez constitution says the state will own all PDVSA shares, "except those of subsidiaries, strategic associations, businesses, and whatever that has constituted or constitutes PDVSA as a result of the development of its business" (see OMT No. 19).

The bargaining process between the state and foreign oil companies will be handled by a resurrected PDVSA unit, Corporacion Venezolana de Petroleo (CVP). Headed by Deputy Minister Luis Vierma since last August, CVP now has a new status and additional powers.

Vierma has recently told Platts in an interview: "What the CVP is going to do is evaluate the possibility of modernising the (E&P) contracts and see which of these - specifically those from the third licencing round - could be transferred to the new (Hydrocarbons) Law". CVP may bypass PDVSA's board in making its decisions.

Venezuela has 33 marginal or abandoned oilfields that were awarded to foreign and domestic oil companies in three licencing rounds in the 1990s. The third round, held in 1997, saw foreign companies paying $2.2 bn in cash bonuses to acquire 18 inactive fields.

The 2001 Hydrocarbons Law sets royalty payments at 30%, up from 16.7% under the old law. But Vierma told Platts: "We are going to open negotiations and offer incentives like increasing the areas where they (foreign or local companies) can operate, or increase the reserves, in order to persuade them to convert to the new law. It will be optional. We are looking for a good deal for them and a good deal for PDVSA".

As an incentive to convert to the new law, the operators would be offered 49% ownership of the field, thus increasing their assets. (Currently, the operators have no ownership rights).

The CVP is already in charge of administering contracts between PDVSA and the four extra heavy crude upgrading projects in the Orinico Belt. Its new role remains strictly administrative, says Vierma, and it will not control production from the fields or have any say in operations, contrary to reports in the local press.

The CVP's other new function is overseeing sustainable development projects in communities adjacent to oil installations.

The CVP serves as a point of contact between PDVSA and the infrastructure ministry. It is seeking funds from Venezuela's development bank, Bandes.

PDVSA's Decline: Critics of Chavez, including former executives of PDVSA who lost their jobs because they joined the nationwide strikes, allege that the populist president is personally responsible for the decline of the state's petroleum company.

Jose Toro Hardy, an influential former member of PDVSA's board, said last October the state company would have to spend $10 bn per annum to reverse its operational deterioration. Speaking at a forum in preparation for the 14th Congress of Venezuelan Workers, Hardy said a PDVSA recovery requires numerous resources, which cannot be fully provided by the government alone.

Hardy suggested that private investment or creation of pension funds might help revive the petroleum sector. He said PDVSA would have been able to produce 5m b/d now - rather than 2.5m b/d - had it implemented an $8 bn petroleum business plan before the Chavez regime came to power in early 1999. If Chavez presses ahead with his "fundamentalism", he warned, the country's oil production will drop to 1.5m b/d.

Private contractors who provide equipment or services to PDVSA say they are billing only 60% of what they did last year. In the oil-rich area of Lake Maracaibo, tugs and rigs are sitting idle on the docks rather than drilling wells or exploring new fields.

Contractors who service wells and equipment say their business has plummeted, and some even talk about leaving the country. Several of them have already begun concentrating on operations in the US, with their management and business development units based in Houston.

Buyers of Venezuelan oil complain of high water content of crudes being exported. With quality control measures having become lax, some of the oil products offered to the US market are said to be inferior to counterparts from other Latin American countries.

Contractors report high sand presence in wells and constant problems maintaining reservoir pressure. Where they should be drilling three wells, contractors are drilling two. Each drilling takes longer; there is more time between each of the new wells.

It is estimated that 15-20% of PDVSA's rigs are out of commission and that 80-90% of its equipment is due for maintenance. One contractor was in October quoted as saying: "We have seen a total paralysis in well maintenance" and alleging that this has caused a spate of accidents. One oil rig operating in Lake Maracaibo caught fire.

Says economist Robert Bottome of the business magazine Veneconomy: "Quite apart from what happened in the strike, in the coming months we are going to see production declines resulting from five years of underinvestment". Although PDVSA output figures have been in dispute since February, almost all signs point to continued production slumps.

Venezuelan wells face annual decline of 25-29%, meaning that PDVSA must have an average of 55 drilling rigs active at any given time to make up for lost output in older wells. Baker Hughes' rig count recently showed between 30-40 active rigs - at a time when Venezuela was trying to make up for production lost during the strikes.

Experts indicate that an increasing proportion of drilling rigs are run by international companies, which by Venezuelan law are required to operate in marginal fields.

Contractors indicate noticeable declines in work-over rig activity, which spell considerable future declines in production, especially in western Venezuela's mature fields. According to Larry Goldstein, president of the Petroleum Industry Research Foundation, Venezuela cannot be faulted for not bringing production back to pre-strike levels, because most expected the strikes would cost the country at least 500,000 b/d. He adds: "A company can't fire 18,000 employees without losing the institutional memory of how to operate its fields".

Goldstein says the primary problem facing PDVSA is a lack of expertise in everything from well maintenance to billing. And the strikes, which cost the country an estimated $7 bn, have left a cash-strapped state with few options to reinvest in future output.