ANALYSIS: Windfall tax yet another setback for investors - Venezuela

By Business News Americas staff reporters

Investors who had hoped for a quiet year in Venezuela following the 2007 nationalization of Orinoco heavy crude projects were sorely disappointed in April 2008 when the country's unicameral congress approved a new tax on windfall profits. Although the measure is not radical - after all, US Democratic candidates Hillary Clinton and Barack Obama have called for windfall oil taxes in their country - it's another blow to investor confidence in a nation that has sent the likes of ExxonMobil (NYSE: XOM) and ConocoPhillips (NYSE: COP) packing in recent months.

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That being said, the tax did not come as a surprise and is not likely to severely alter investment plans for companies already operating in the oil-rich country, which still is attractive to those willing to withstand the political risk. But the new tax is a worrying sign that President Hugo Chávez will continue to dip into the private sector's pockets to fund his vast social programs, which are threatened by state oil company PDVSA's declining production.

The windfall tax will provide a major boost to Chávez's spending programs, injecting several billion dollars annually, according to PDVSA president and oil minister Rafael Ramírez's calculations. The new tax entails taking 50% of oil revenue above US$70 per barrel and 60% for prices exceeding US$100/b. The tax applies to all operators in the country, including PDVSA and the Orinoco joint ventures, according to Ramírez.

Like any new tax, the windfall measure is bound to have a dampening effect on investment and production in Venezuela, James Edmiston, CEO of Venezuela-focused Harvest Natural Resources, said in an April conference call. That is especially true considering taxes already are quite high in the South American country: Oil companies pay what's called a shadow tax that starts when royalties and income taxes charged are less than 50% of total revenue from oil production. And oil companies operating under PDVSA-controlled joint ventures pay a 33.3% royalty and 50% income tax.

While Venezuela's political risk could drive away more companies, others are more than willing to acquire assets in a country they still see as promising. Investors rarely prepare their budget with price forecasts exceeding the new tax's US$70/b starting point, while some argue the tax could be filed as an expense and therefore deducted from income taxes. Add to that the fact that Venezuela boasts South America's largest reserves and it's reasonable to see why some still are bullish on the country.

One company still keen on Venezuela is PetroFalcon, which is based in Caracas but traded in Toronto. The company in April signed a binding letter of agreement to acquire for US$200mn Texas-based Anadarko Petroleum's Venezuelan assets, which include a US$58mn voucher that can be used as credit with the government. The acquisition, which reportedly followed a lengthy bidding process, values Anadarko Venezuela's assets at roughly US$19,000 per barrel of oil equivalent production per day and US$4.00 per barrel of oil equivalent in 2P reserves, according to PetroFalcon figures. Meanwhile companies from countries friendly to the Chávez administration such as Russia and Iran are mulling major investments in the South American country.

If companies continue to stick it out in Venezuela, the tax will be seen as a victory for Chávez. After all, the tax revenue will feed his spending fund Fonden, allowing his administration to redistribute the wealth to its myriad of social programs. The programs increasingly are at risk as production is slipping at PDVSA, which provides the bulk of revenue for social programs.

Paradoxically, however, the windfall tax could be a drain on PDVSA's export revenue, making it increasingly hard for the state giant to invest in E&P. If PDVSA output falls as a result, Chávez could be forced to find new ways to feed state coffers. That in turn could make life increasingly difficult for oil companies in Venezuela.