VENEZUELA - Part 1 - The Prospects, Geology & Exploration.

Venezuela now can only produce 2.5m b/d of oil and and liquids, down from a capacity of 3.6m b/d in late 2001. But unlike the previous regime, Caracas under President Hugo Chavez is deeply committed to OPEC's supply discipline. Chavez wants OPEC's price defence band to be increased from $22-28 to $25-32/b, but Saudi Arabia and other OPEC members say this will not be sustainable.

Under-investment and lack of qualified E&P personnel at the state-owned Petroleos de Venezuela (PDVSA) since a crippling oil strike last December and January have caused Venezuela's fields to decline by an alarming rate of 20% per annum. Speaking at a forum in preparation for the 14th Congress of Venezuelan Workers on Oct. 10, former PDVSA director Jose Hardy said the company needed to spend $10 bn per annum to reverse its operational deterioration. He said a PDVSA recovery requires numerous resources, which cannot be fully provided by the government alone. Private investment or the creation of pension funds might help revive the petroleum sector.

Hardy added that PDVSA would by now have been able to produce 5m b/d of crude oil had it implemented an $8 bn petroleum business plan before the current government took office. He warned that, if Chavez pressed ahead with his "fundamentalism", the country's oil output will drop to 1.5m b/d (see profiles of Venezuela's fields and their operators in Part 2).

After Chavez took office in early 1999, PDVSA dropped a $70 bn plan to raise the production capacity to 6.5m b/d for crude oil, condensate and NGL by 2010, excluding Orimulsion (see background in Vol. 57, No. 21).

Caracas is concentrating on natural gas and offshore oil in exploration efforts. New E&P openings for foreign companies and Venezuela's private sector will be for gas (see E&P regime in Gas Market Trends).

Despite its being leftist and opposed to the liberal approach of previous regimes, Caracas has a long list of energy-related and industrial projects for the private sector. But the economy is facing the worst crisis in the history of Venezuela, due to "The Oil Curse" (see Downstream Trends).

PDVSA managements since 1999 have not altered any of the upstream deals with foreign oil companies signed by the previous regime. But because of a radical new constitution, a shifting energy policy and a new hydrocarbon law, foreign firms have been very cautious. Many of the 70 foreign oil companies operating in the country have realised that the pre-1999 PDVSA management had offered them the least profitable fields, while the state concern retained the most attractive.

PDVSA is one of the world's main oil exporters and wants to revive plans to export gas in LNG form (see Part 3), with downstream assets covering important parts of the US and European markets (see Part 4).

The petroleum sector has lost most of its highly qualified decision makers, from those in charge at the ministry of energy and mines to those in PDVSA. Chavez controls the petroleum sector (see who's who in Part 5).

Comparing Risks As Moscow Freezes Yukos Shares & M.E. Instability Worsens: An abrupt change in Russia and worsening instability in the Middle East have caused international oil companies (IOCs) to look more favourably at the prospects in Venezuela. Despite his erratic behaviour, President Chavez is sending clear signals for the IOCs to consider investing heavily in both the upstream and downstream branches of the petroleum sector in Venezuela. A highly placed APS source in Caracas says Chavez is personally involved in new efforts to improve incentives for the IOCs to channel capital and technology to his country.

On Oct. 30, Moscow prosecutors froze a 44% block of shares in Yukos, the largest oil group in Russia in a sharp escalation of the crisis surrounding the company and its owners. The move, which was immediately denounced as illegal by the company, followed the arrest on Oct. 25 of Mikhail Khodorkovsky, Yukos' CEO and largest shareholder, on criminal charges of fraud and tax evasion totalling $1bn. Menatep, the holding company that controls the shares, said most belonged to international companies and were no longer owned by Khodorkovsky.

Yukos is the most significant of a number of Russian companies seeking investment by western counterparts. ExxonMobil and ChevronTexaco of the US have both been in talks about taking a multibillion-dollar stake in the company. And the biggest question now is whether the new Moscow campaign is the beginning of a reversal of the 1990s privatisation of the Russian economy, as every merger and acquisition deal has been put on ice.

On Oct. 30, President Vladimir Putin accepted the resignation of Alexander Voloshin as the head of the presidential administration. Voloshin, seen as a counterweight to the hawkish "siloviki faction" in the Kremlin that has been behind the anti-Yukos campaign, was replaced by Dmitry Medvedev, a soft-spoken Putin loyalist. Voloshin's departure heralded a shift in power away from those close to former president Boris Yeltsin in favour of Putin's circle from his native St Petersburg.

Anatoly Chubais, a leader of the liberal Union of Right Forces Party and head of the state-controlled Russian electricity monopoly UES who has criticised Khodorkovsky's arrest, said on Oct. 30: "This is serious. There are dangerous signs of the change of course in Russian politics". UES then confirmed that it had offered the job of executive chairman to Voloshin. In what some interpreted as a warning shot to Chubais, on Oct. 30 the Federal Security Service raided the offices of Novosibirskenergo, a regional subsidiary of UES.

In Iraq, the US-led occupation forces are facing an escalation of attacks by an emerging alliance of Al-Qaeda Wahhabis, Sunni remnants of Saddam's Baathist regime and volunteers from Syria, Lebanon and other Arab countries. The situation is so fluid and dangerous that President Bush's Iraq stabilisation project may require a wider conflict to involve Syria and Iran, among neighbours affected by the US presence in the heart of the Arab and Muslim world (see News Service of this week's Diplomat Package). The events in Russia, part of the Greater Middle East, will have important implications for the energy world.

With this perspective, one cannot help noting that some of the largest energy reserves outside the Greater Middle East are actually to be found in Venezuela. Since the strike early this year against the leftwing government of Chavez by employees at PDVSA, the majors appear to be over-looking the country. Yet many analysts say the risk of doing business in Venezuela appears substantially less than that attached to Russia.

"In Venezuela, the long-term risk is probably less", says Amy Myers Jaffe, the Wallace Wilson Fellow for Energy Studies at Rice University's Baker Institute. "Chances are that they will not renationalise".

The possibility of renationalising is not only ever-present in Russia, but analysts say there are other risks as well. Substantial investments still must be made in the Russian infrastructure to enable companies to get oil and gas out. One cannot rule out the politically connected companies like Gazprom or LUKoil stepping in to block a foreign investment that is undercutting one of their own. And a cold winter could lead Russia to lower exports by way of huge tariffs or restrictions.

By contrast, Venezuela has made it clear that it needs foreign investment in its all-important petroleum industry and is willing to accommodate the majors to get it. Bryan Caviness, director at Fitch Ratings, notes that, since the oil workers' strike last December and January, the government has imposed capital constraints, preventing companies from trading Venezuelan bolivars for US dollars. But the IOCs have been effectively exempted from these controls. Says Bruce Schwartz, director at Standard & Poor's: "In Venezuela, there is strong incentive to support foreign direct investment because the country doesn't have the resources to exploit its only resources".

Caracas claims oil production has recovered to the 3.3m b/d level before the stoppage. However, most analysts estimate the true level at about 800,000 b/d lower, and falling. Following the strike, the government sacked 18,000 PDVSA employees, leaving the company labouring under low maintenance and investment. The impact is being felt by the economy, as oil accounts for about 75% of Venezuela's export revenue and almost 50% of fiscal revenue. The country has fallen from the world's third-largest exporter in 2000 to the fifth largest. Since Chavez took office in early 1999, Venezuela has pursued a hawkish stance in OPEC, but lost market share in the process to non-OPEC countries such as Mexico and Russia.

Nonetheless, companies such as ConocoPhillips, one of the biggest oil investors in Venezuela, have stayed, insisting: "We like our position in Venezuela". Certainly the situation has slowed new construction in that country, and ConocoPhillips' production was affected by the strikes, but it was back to normal by April and has been level since then.

It is easier to do business in Venezuela than in Russia or the Middle East. And rather than seeking investment in its traditional oil sector, Caracas is hoping to develop Venezuela's huge reserves of extra-heavy oil and its virtually untapped natural gas deposits.

Says Larry Goldstein, president of the Petroleum Industry Research Foundation: "Venezuela is going through a transition and they realise that they need to attract a substantial amount of foreign capital; their own internal revenue stream has been disappointing. A lot of money is needed just to maintain the production base, and they are going to have to have substantial foreign capital and foreign involvement".

The Chavez government is determined to attach greater importance to its heavy oil reserves at the strategic, long-term level. Although these would be hard and expensive to exploit, Venezuela wants OPEC to include them in counting its available oil, thus allowing it a much larger OPEC output quota. Venezuela has at least 275 bn barrels of extra heavy oil in the Orinoco Belt. If these were added to its existing reserves of 76 bn barrels, Venezuela would leap above Saudi Arabia, which has the world's biggest proven reserves of 262 bn barrels.

There are already four existing heavy oil strategic associations producing a total of 400,000 b/d of synthetic crude, and multinationals involved in them include ConocoPhillips, ExxonMobil, Total, ChevronTexaco and Statoil. However, under a hydrocarbons law decreed in 2001, foreign investors are required to pay higher royalties - 20%, compared with the 1% rate that made the existing associations viable. Energy and Mines Minister Rafael Ramirez insists new projects will not escape the higher royalties. But analysts say multinationals are likely to negotiate easier terms as the government becomes progressively more dependent on foreign capital.