The Devil's Excrement

General Francisco Usón became another political prisoner of the Chávez administration when he was sentenced to five years and six months in prison for insulting the Venezuelan Armed Forces. Usón’s crime was to say on TV that the Fort Mara soldiers were burnt by a flame thrower and not by an accidental fire.  This charge was made by Usón in a TV program where he was being interviewed.

What is remarkable about the case is that to this day, the military has not shed light on exactly what happened that day in Fort Mara. The case was turned over to a civilian Court, but the witnesses were never presented by the military. Initially, the military said the soldiers had died when a fire caused by a cigarette butt ignited a mattress. The press made a big deal out of it and Chavez laughed on his Sunday TV program about much ado about nothing, only to have the first of the soldiers die that night. Later that week one of the soldiers that was getting better taped a video in which he said a big flash came into the jail cell through the door which led to the flamethrower theory. That soldier died of a heart attack that same night, before it was known that the video existed.

Maracaibo fireman, the National Guard and experts from the Armed Forces have all backed the theory that the fire in the cells that killed three soldiers was induced from the outside by either using a flamethrower or some form of chemical. This evidence was taken into account by the military court.

Usón was Chavez´ Minister of Finance until the events of April 2002. He said then that he saw from his office how the trap was set for the opposition march and converted the parking lot of his Ministry of Finance into an improvised hospital. He now will be able to appeal, while in jail, but becomes another political prisoner of this vengeful and intolerant Government.

All of a sudden the genius and all powerful CNE Director Jorge Rodriguez realizes that the voting process may take too much time: “We have time problems, due to the difficulty of the process, this is due to the difficulty in the process”….”this is much more complex than that of the presidential recall vote”.

You mean to tell me they did not consider this when they bought the machines? Could it possibly be that they were thinking only of the recall vote when they bought them and considered their design? So, they spent a zillion dollars on machines that were ideal for a Yes/No vote that did not even require electronic voting? What is going to happen when next summer those same voters will have to vote, not for one Mayor and one Governor, but for dozens of choices for Deputies of the National Assembly?  They did not think of that? Bunch of amateurs!

In fact, when I went to the practice run of the voting system on Jul.18^th. I said: “Simple enough for a single vote, I thought the screen might be too small for a multiple election.” Now, this was based on a thirty second test of the machine by a non-expert, but it seems nobody thought of this when they spent more than US$ 100 million in voting machines that most of the time will be used for multiple elections rather than a simple “Yes” and “No” vote. These are the arrogant and “revolutionary” administrators of our “democracy”.

While Venezuelan officials in the local media tried to downplay the possible effects of yesterday’s announcement that Venezuela will change the 1% royalty tax to 16.6%, the reality is different. Obviously, the fear is not as the President of PDVSA said today, that foreign oil companies may leave, but that they may not find the country attractive.

Minister of Energy and Mines Ramirez said that these companies “would not protest”  and that the Venezuelan Government had “excellent” relations with foreign oil companies.

The truth is that the main problem with the increased royalty is not how it will affect the operating companies, but the precedent of unilaterally changing conditions on established contracts is not something that will encourage companies looking to invest in Venezuela. In fact, the new Hydrocarbon law says that the royalty should be between 20% and 30% on new projects, which the Chavez Government itself has been bypassing, so what is to stop it on the future from increasing the royalties even further?

This is the view in today’s Wall Street Journal (by subscription):

“The government hopes to attract billions of dollars in investment for new projects in the Orinoco area, but by changing the rules, industry watchers say, Mr. Chavez has raised doubts about Venezuela‘s willingness to honor contracts with private oil companies.”

“The latest wrinkle could send some companies back to the drawing board. An executive with a major oil company that is a partner in one of the projects said it is “too early to say” if the tax increase would derail plans for new projects in the area.”

To me, this is the bigger problem; Chavez and his administration seem to act as if they were the only choice in the world. If Canada has a 1% royalty, what could be the attraction to doing a heavy oil plant in Venezuela and not in Canada?

A better way would have been to negotiate with the companies that partner up with PDVSA in these projects. Each of these projects produces or is scheduled to produce roughly 200,000 barrels of the combination of heavy cruders and of synthetic fuels per day. They were supposed to break even at US$ 12-15 per barrel for the Venezuelan oil basket, thus with the oil basket at, let’s say US$ 30 per barrel (this may be a little high), each of the projects is generating an additional US$ 1.05 billion in profit per year!. Thus, it would have seemed reasonable for the Government to negotiate the increase in the royalty in exchange for increased production or new areas and I am sure international oil companies would have been amenable to negotiate them.

In the end, the net result on collection by the Government is smaller than the 15.6% difference in royalties. PDVSA owns roughly 42% of each of the projects, so that the new royalties in some sense represent a transfer from PDVSA profit to Government royalty. Moreover, there will also be lower taxes. My back of the envelope calculation is that the Government will receive US$ 400 million more in royalties, but will lose about US$ 150 million in taxes and PDVSA will receive US$ 150 million less in profits. Of course, the Government will now receive the royalties directly and regularly rather than via PDVSA dividends. Unfortunately, this difference may not be compensated by future dividends if one takes into account new projects that go elsewhere in the world.

While Venezuelan officials in the local media tried to downplay the possible effects of yesterday’s announcement that Venezuela will change the 1% royalty tax to 16.6%, the reality is different. Obviously, the fear is not as the President of PDVSA said today, that foreign oil companies may leave, but that they may not find the country attractive.

Minister of Energy and Mines Ramirez said that these companies “would not protest”  and that the Venezuelan Government had “excellent” relations with foreign oil companies.

The truth is that the main problem with the increased royalty is not how it will affect the operating companies, but the precedent of unilaterally changing conditions on established contracts is not something that will encourage companies looking to invest in Venezuela. In fact, the new Hydrocarbon law says that the royalty should be between 20% and 30% on new projects, which the Chavez Government itself has been bypassing, so what is to stop it on the future from increasing the royalties even further?

This is the view in today’s Wall Street Journal (by subscription):

“The government hopes to attract billions of dollars in investment for new projects in the Orinoco area, but by changing the rules, industry watchers say, Mr. Chavez has raised doubts about Venezuela‘s willingness to honor contracts with private oil companies.”

“The latest wrinkle could send some companies back to the drawing board. An executive with a major oil company that is a partner in one of the projects said it is “too early to say” if the tax increase would derail plans for new projects in the area.”

To me, this is the bigger problem; Chavez and his administration seem to act as if they were the only choice in the world. If Canada has a 1% royalty, what could be the attraction to doing a heavy oil plant in Venezuela and not in Canada?

A better way would have been to negotiate with the companies that partner up with PDVSA in these projects. Each of these projects produces or is scheduled to produce roughly 200,000 barrels of the combination of heavy cruders and of synthetic fuels per day. They were supposed to break even at US$ 12-15 per barrel for the Venezuelan oil basket, thus with the oil basket at, let’s say US$ 30 per barrel (this may be a little high), each of the projects is generating an additional US$ 1.05 billion in profit per year!. Thus, it would have seemed reasonable for the Government to negotiate the increase in the royalty in exchange for increased production or new areas and I am sure international oil companies would have been amenable to negotiate them.

In the end, the net result on collection by the Government is smaller than the 15.6% difference in royalties. PDVSA owns roughly 42% of each of the projects, so that the new royalties in some sense represent a transfer from PDVSA profit to Government royalty. Moreover, there will also be lower taxes. My back of the envelope calculation is that the Government will receive US$ 400 million more in royalties, but will lose about US$ 150 million in taxes and PDVSA will receive US$ 150 million less in profits. Of course, the Government will now receive the royalties directly and regularly rather than via PDVSA dividends. Unfortunately, this difference may not be compensated by future dividends if one takes into account new projects that go elsewhere in the world.

President Hugo Chavez was awarded the Moammar Gadhafi Human Rights Award this weekend according to a CNN report. The award was given to Chavez for resisting “imperialism” and being a champion of the poor. It also praised Chavez for his “brave heart, intelligent mind, eloquent oratory and firm hand.”

Well, let’s analyze the award and we will se that is actually quite well deserved. First of all, given Chavez’ record on human rights, it is quite fitting that he should win an award named after Gadhafi, since I am imagining it means human rights “Gadhafi style”, i.e. repression, intolerance, , persecution of reporters, threats against the media etc..

Second, champion of the poor is also very well deserved. When Hugo Chavez became President, according to the National Institute for Statistics there were 11.41 million people living in poverty in Venezuela. Today according to the same institute there are 14.50 million, thus Chavez deserves the title “Champion of the poor”, since he has helped create 3.1 million new ones in the last five years, despite oil prices increasing four fold.

Third, he was cited for his “eloquent oratory”, also well deserved, as every Sunday he talks for five or six hours and surprises Venezuelans two or three other times a week with two or three hours of improvised speeches. 

Finally, the prize cites him for his “firm hand” which I imagine means exactly the opposite of tolerance, compassion, unity and democracy, where Chavez also has definitely not done a great job in the last five years.

Fidel Castro was a previous winner of the award, leaving no doubt as to why Chavez is being awarded this prize. Castro’s name, together with the namesake of the prize certifies who Hugo Chavez is and what he stands for.

Next year the prize may go to a “soft” choice in Jimmy Carter unless the committee decides to give it to the only one that can top Castro, Gadhafi and Chavez: Robert Mugawe. The problem is, if Mugawe gets it, how can the prize top itself in the future? In fact, if Mugawe wins it, shouldn’t they change the name of the prize and  name it after him?

President Hugo Chavez was awarded the Moammar Gadhafi Human Rights Award this weekend according to a CNN report. The award was given to Chavez for resisting “imperialism” and being a champion of the poor. It also praised Chavez for his “brave heart, intelligent mind, eloquent oratory and firm hand.”

Well, let’s analyze the award and we will se that is actually quite well deserved. First of all, given Chavez’ record on human rights, it is quite fitting that he should win an award named after Gadhafi, since I am imagining it means human rights “Gadhafi style”, i.e. repression, intolerance, , persecution of reporters, threats against the media etc..

Second, champion of the poor is also very well deserved. When Hugo Chavez became President, according to the National Institute for Statistics there were 11.41 million people living in poverty in Venezuela. Today according to the same institute there are 14.50 million, thus Chavez deserves the title “Champion of the poor”, since he has helped create 3.1 million new ones in the last five years, despite oil prices increasing four fold.

Third, he was cited for his “eloquent oratory”, also well deserved, as every Sunday he talks for five or six hours and surprises Venezuelans two or three other times a week with two or three hours of improvised speeches. 

Finally, the prize cites him for his “firm hand” which I imagine means exactly the opposite of tolerance, compassion, unity and democracy, where Chavez also has definitely not done a great job in the last five years.

Fidel Castro was a previous winner of the award, leaving no doubt as to why Chavez is being awarded this prize. Castro’s name, together with the namesake of the prize certifies who Hugo Chavez is and what he stands for.

Next year the prize may go to a “soft” choice in Jimmy Carter unless the committee decides to give it to the only one that can top Castro, Gadhafi and Chavez: Robert Mugawe. The problem is, if Mugawe gets it, how can the prize top itself in the future? In fact, if Mugawe wins it, shouldn’t they change the name of the prize and  name it after him?

President Chavez announced today that he was increasing oil royalties to the heavy oil projects from 1% to 16.66%. These projects are Petrozuata, Hamaca, Cerro Negro and Sincor. Reportedly hamaca already pays the 16.6%. These are all projects in which heavy crudes are transformed into synthetic fuels. These four projects produce a combined total of about 500,000 barrels a day today, but production is expected to reach 600,000 barrels within the next two years. Venezuela’s state oil company PDVSA is a minority partner in all of these projects.

Three years ago, Venezuela’s National Assembly approved a new hydrocarbons bill, that increased all royalties from oil exploitation to 16.6% but in Venezuela, laws can not be applied retroactively, so it did not apply to projects approved before the law. In general, at current levels of oil prices, this should not be a problem for these projects, most of which were planned assuming West Texas Intermediate prices of US$ 15 per barrel. They were all given a 1% tax for the first nine years of the production as an incentive to start them. Before these projects came into existence, there were no similar projects in Venezuela.

Most of these projects were built using debt issued in US dollars by the projects themselves. Bonds were issued which were guaranteed by the company’s partners until the projects met certain technical specifications of actual production. Many of the bonds are of the sinking fund type, in which after a certain date, they pay not only interest on the principal, but also part for the principal. This structure is used whenever investors may find that it is hard to look down the line to the maturity of the bond.

As an example, the Cerro Negro 2009 bond has a coupon of 7.33% per year, but has returned principal since three years ago at a rate of 6% per semester, so that only 70% of its principal is still outstanding. It currently has a yield of 5.75%, which is quite attractive given worldwide interest rates. Another project, Petrozuata, has a bond maturing in 2017 which pays no principal until 2008 and has a coupon of 8.22%. I consider this bond to be one of the most attractive fixed income investments in Venezuela.

While it is reasonable, given current oil prices, to increase the royalty to this level, I am not comfortable with the way it has been done. First of all, these were contracts signed by PDVSA in which that royalty percentage was negotiated. Second, it would seem more reasonable to negotiate it with the companies, establishing a sliding schedule in case prices go down in the future. Third, I understand that all of the projects are looking to expand their operations in Venezuela; maybe this could have been negotiated rather than imposed, as it does not send the best signal to investors looking for new oil deals in Venezuela.

The biggest problem in my mind with the decision is one of competitiveness; Canada and Venezuela have the biggest heavy oil reserves in the world. These projects are similar to much larger projects in Canada such as Suncor, which have found a way to exploit these heavy crudes. In Canada, according to the Suncor report, the royalty is 1%, which is probably the reason why PDVSA negotiated that rate when the projects were started. Note that there are royalties and there are taxes, in both countries the royalty was 1% until today. Suncor as a company pays an effective tax rate of 36% which is probably similar to Venezuela’s. Thus, Canada is more attractive from that point of view.

I am in no position no to know or evaluate at this time whether this hurts Venezuela’s competitive advantage in heavy crudes or not. There are other issues to consider such as production costs. These projects make use of natural gas, which is cheaper in Venezuela, so that may be an advantage. Financially at current oil prices the decision should not affect any of the projects as they were planned for much lower oil prices. The one affected the most is Hamaca, which only came on line recently, the rest have benefited for quiet a while of the lower royalty.

In any case, you read The Devil’s for free and today you get, also for free, two investment recommendations: If you are aggressive buy Suncor stock (NYSE:SU), the company’s cash flow is fantastic and if oil prices stay high it will keep going up. If you just want income, buy Petrozuata’s 2017 bond with a coupon and yield of 8.22% for the next 13 years and you start getting back you principal in 2008. Benefit from the Devil’s Excrement, not this one, the real one!

(You also get to see my new blooms for free!!!)

President Chavez announced today that he was increasing oil royalties to the heavy oil projects from 1% to 16.66%. These projects are Petrozuata, Hamaca, Cerro Negro and Sincor. Reportedly hamaca already pays the 16.6%. These are all projects in which heavy crudes are transformed into synthetic fuels. These four projects produce a combined total of about 500,000 barrels a day today, but production is expected to reach 600,000 barrels within the next two years. Venezuela’s state oil company PDVSA is a minority partner in all of these projects.

Three years ago, Venezuela’s National Assembly approved a new hydrocarbons bill, that increased all royalties from oil exploitation to 16.6% but in Venezuela, laws can not be applied retroactively, so it did not apply to projects approved before the law. In general, at current levels of oil prices, this should not be a problem for these projects, most of which were planned assuming West Texas Intermediate prices of US$ 15 per barrel. They were all given a 1% tax for the first nine years of the production as an incentive to start them. Before these projects came into existence, there were no similar projects in Venezuela.

Most of these projects were built using debt issued in US dollars by the projects themselves. Bonds were issued which were guaranteed by the company’s partners until the projects met certain technical specifications of actual production. Many of the bonds are of the sinking fund type, in which after a certain date, they pay not only interest on the principal, but also part for the principal. This structure is used whenever investors may find that it is hard to look down the line to the maturity of the bond.

As an example, the Cerro Negro 2009 bond has a coupon of 7.33% per year, but has returned principal since three years ago at a rate of 6% per semester, so that only 70% of its principal is still outstanding. It currently has a yield of 5.75%, which is quite attractive given worldwide interest rates. Another project, Petrozuata, has a bond maturing in 2017 which pays no principal until 2008 and has a coupon of 8.22%. I consider this bond to be one of the most attractive fixed income investments in Venezuela.

While it is reasonable, given current oil prices, to increase the royalty to this level, I am not comfortable with the way it has been done. First of all, these were contracts signed by PDVSA in which that royalty percentage was negotiated. Second, it would seem more reasonable to negotiate it with the companies, establishing a sliding schedule in case prices go down in the future. Third, I understand that all of the projects are looking to expand their operations in Venezuela; maybe this could have been negotiated rather than imposed, as it does not send the best signal to investors looking for new oil deals in Venezuela.

The biggest problem in my mind with the decision is one of competitiveness; Canada and Venezuela have the biggest heavy oil reserves in the world. These projects are similar to much larger projects in Canada such as Suncor, which have found a way to exploit these heavy crudes. In Canada, according to the Suncor report, the royalty is 1%, which is probably the reason why PDVSA negotiated that rate when the projects were started. Note that there are royalties and there are taxes, in both countries the royalty was 1% until today. Suncor as a company pays an effective tax rate of 36% which is probably similar to Venezuela’s. Thus, Canada is more attractive from that point of view.

I am in no position no to know or evaluate at this time whether this hurts Venezuela’s competitive advantage in heavy crudes or not. There are other issues to consider such as production costs. These projects make use of natural gas, which is cheaper in Venezuela, so that may be an advantage. Financially at current oil prices the decision should not affect any of the projects as they were planned for much lower oil prices. The one affected the most is Hamaca, which only came on line recently, the rest have benefited for quiet a while of the lower royalty.

In any case, you read The Devil’s for free and today you get, also for free, two investment recommendations: If you are aggressive buy Suncor stock (NYSE:SU), the company’s cash flow is fantastic and if oil prices stay high it will keep going up. If you just want income, buy Petrozuata’s 2017 bond with a coupon and yield of 8.22% for the next 13 years and you start getting back you principal in 2008. Benefit from the Devil’s Excrement, not this one, the real one!

(You also get to see my new blooms for free!!!)