Venezuelan Oil And Gas Projects
The new “hydrocarbons law” that took effect in Venezuela on January 1 will make it very hard — if not impossible — for developers to finance oil and gas projects in the country on a project finance basis.
The new law was announced in a decree by President Hugo Chavez on November 2 under special powers granted to him by the National Assembly. Unfortunately, it fails to address serious concerns and criticisms raised by both the international oil and gas community and by business and legal experts in Venezuela about earlier drafts.
One key concern with the earlier drafts was the requirement that the state must take a majority interest in all new upstream exploration and production projects. Another criticism focused on the increase in royalty payments to the state by producers, from 16.6% to 30%, an increase that industry and other observers viewed as contrary to the trend in other hydrocarbon-producing countries of reducing royalties.
The new law fails to address either of these concerns. As a consequence, it continues to generate controversy and criticism to the point where the president of the National Assembly has committed the assembly to review it, notwithstanding the special decree powers granted to President Chavez.
Much of the controversy and criticism focuses on the requirement that “primary activities,” defined as exploration, production, gathering, transportation and storage of hydrocarbons, must be conducted by the state. This effectively amounts to what many commentators view as a second nationalization of the oil and gas sector in Venezuela.
Under the new law, primary activities “shall be performed by the State, either directly by the National Executive or through exclusively owned companies. Likewise, these activities may be performed by companies in which the State has decision making control by holding over 50% of the capital stock, which for purposes [of the new law] shall be denominated joint venture companies.”
While the new law does not explicitly refer to Petroleos de Venezuela SA, the state-owned petroleum company (PDVSA), most industry participants interpret this provision as effectively requiring PDVSA to have control of any joint venture companies.
Much has also been made of the fact that this provision will increase PDVSA’s financial burden, saddling the company with significant additional costs of exploration and production activities.
Negative Pledge Problems
There has been little or no discussion of the implications of the World Bank negative pledge provisions on PDVSA’s ability to access financing to fund such additional activities, or to structure project financings for such activities.
A brief primer on the World Bank negative pledge: The “general conditions” that apply to all World Bank loan and guarantee agreements include a negative pledge provision that limits the creation of security in favor of other external creditors over assets of member countries, including assets of subdivisions of member countries, entities owned or controlled by member countries and entities operating on member countries’ account or for their benefit.
While the negative pledge clause — found in section 9.03 of the general conditions — does not prohibit the creation of security in favor of other creditors, it prevents the establishment of a priority for external debts owed to other external creditors over the debt due to the World Bank in the allocation, realization or distribution of foreign exchange, and it requires that the World Bank share pari passu, or ratably, in any security created in favor of any external creditors. The World Bank has taken the position that the clause clearly “catches” not only obvious assets such as gold and foreign exchange reserves, but also exportable assets, such as crops or minerals, to the extent they can be construed as “public.”
This means the following for the new hydrocarbons law in Venezuela. PDVSA is a state-owned entity; Venezuela is a member country of the World Bank, and oil and gas are foreign exchange earning assets. Thus, under the terms of the negative pledge clause, PDVSA would arguably be prevented from granting security over its oil and gas assets, unless the World Bank shares pari passu in such security.
Anyone involved in project finance will immediately recognize the potential problem: if, as mandated under the new law, PDVSA is to have majority ownership and control over a joint venture project entity, how will the project entity be able to grant its lenders any form of security that is customary for a project finance transaction? In order to comply with the negative pledge, the project entity must grant the World Bank a pari passu security interest. Given the huge lending exposure of the World Bank in the many Venezuelan state projects in which it has participated compared to that of any potential project financiers to the particular new oil and gas project, this effectively renders the security meaningless from the perspective of project lenders. For example, if the World Bank’s exposure in Venezuela as a whole — including the new project — is $12 billion, and the project financiers are being asked to lend $300 million toward the new project, the security claim the World Bank requires is in the ratio of $12 billion out of $12.3 billion. Alternatively, the project entity may seek a waiver from the World Bank of the negative pledge provisions. Unfortunately, the World Bank’s waiver process is complicated and cumbersome. Moreover, there is very little positive track record of the World Bank agreeing to such waivers in favor of project lenders.
Last year’s Hamaca heavy oil project financing, and the Sincor heavy oil project financing before it, relied on complicated structuring approaches for some form of security to support the PDVSA portion of the borrowings. The debt facilities in the two projects were secured by the shares and primary offshore and onshore accounts, all rights, title and interest in key agreements and subordinated loans of the private sponsors. (The sponsors were Phillips and Texaco in Hamaca, and Total and Statoil in Sincor). No similar pledge was granted by PDVSA; instead, both projects used a mechanism whereby a certain amount of PDVSA revenues were recycled into the project in the form of subordinated loans to the private sponsors, which were then held in reserve accounts to obtain a form of collateral. Moreover, both projects included limited backstop guarantees from the private sponsors, backing PDVSA’s lifting obligations.
It is hard to imagine that lenders will have the same degree of comfort with such an approach where PDVSA will be the majority owner of a joint venture project entity. It is also hard to imagine that private sponsors will continue to have the same degree of comfort in providing backstop support for PDVSA when they are in significant minority positions in a project.
If the National Assembly does indeed re-examine the new law, the issue of state ownership is clearly one that deserves more consideration. Unless this part of the law is changed, only time and the markets will tell if project finance will continue to be a viable tool for Venezuelan oil and gas projects.