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The Orinoco Belt has a strong and, indeed, enviable competitive position

VHeadline | August 1, 2010

Former Petroleos de Venezuela (PDVSA) Finance Coordinator Oliver L  Campbell writes: I have just read a story by Daniel Wallis of Reuters entitled “Venezuela revels in oil reserves — challenges remain.” Reading between the lines, I sense a veiled criticism much of which I believe is not merited. I have tried to give another, more realistic, and certainly more upbeat, assessment in the following comments.

Venezuela indeed intends to increase its oil reserves, but to say it “hopes to catapult past Saudi Arabia” as the world leader is colorful reporting that omits to mention the historical context.

It has been known since the 1920s, when the first exploration took place, that large amounts of heavy oil existed in the Orinoco Oil Belt. Some wells were drilled there in the 1930s, but work stopped since no commercial use could be found for the heavy oil until the beginning of the 1980s when Orimulsion was developed as a fuel for power plants. However, it was not till the end of the 1990s, when the four “strategic associations” were formed, that oil production started on a large scale.

Though it was known that huge deposits existed, no one saw a pressing need or hurry to quantify them. The present government decided to do so, primarily as a matter of national pride and the international prestige that comes from having the world’s largest oil reserves. A secondary factor is that OPEC quotas take into account both proven reserves and production capacity and, by increasing the former to Saudi Arabia’s level, Venezuela hopes in future to be allowed to increase its present production. The fact that international oil companies were prepared to bid for the Carabobo and Junin blocks before certification of the increase in the reserves shows they gave it little importance. The geologists knew huge reserves were there and certification was very much a paper exercise.

Mr Wallis refers to 513 billion barrels of recoverable oil “if costs were not an issue.” But they are not since costs are certainly much lower than those for deepwater, offshore drilling or those in the Athabasca Tar Sands. It is unfortunate the Orinoco Belt crudes and Athabasca crudes are often mentioned together as being tar sands. This is wrong since the oil in Orinoco Belt is accumulated in reservoirs in the subsurface, whereas the bitumen in the Athabasca Tar Sands is found near the surface mixed with sand, clay and minerals.

Neither is there anything unconventional about the production process in the Orinoco Belt. Wells are drilled in a cluster of up to 24 from one location using what is known as horizontal drilling — drilling is diagonal till the oil sands are reached when it switches to horizontal. With a temperature of 50ºC, oil flows easily and large electric pumps pump it to the surface without difficulty. On reaching the surface, the oil cools and becomes viscous like a thick tar. It is then blended with a light crude of 32ºAPI to produce a 16ºAPI crude of commercial quality. Alternatively, it is mixed with a diluent and pumped to the upgrader on the coast to be upgraded to either 16ºAPI or 32ºAPI depending on the plant. The diluent is recovered and pumped back to the production area.

So the only unconventional aspect of the 8º to 9ºAPI oil being currently produced is that it needs to blended or upgraded to make it commercially viable. I labour this point so the reader will understand that oil from the Oil Belt is produced like any heavy crude. Contrast this with the Athabasca crude which is obtained by surface mining that involves making huge holes in the ground and then separating the oil from the sands. Exploitation there has been called “a looming ecological disaster” and many Canadians are opposed to it. The separation process consumes a huge quantity of natural gas to heat large amounts of water. The toxic waste is stored in tailing ponds which are so huge that they cover 80 square miles and can be seen from space. The Orinoco Belt has none of these problems, and I have heard of no pressure group objecting to its development.

Mr Wallis states “The technology needed to pump the Orinoco’s ultra-heavy crude is much more complicated and expensive” than it is for light oil.

Though true, the complicated production aspect was solved a long time ago by the four strategic associations. The expensive part applies to the upgrading since blending with a lighter crude is not a costly operation. PDVSA do not publish individual crude production costs, but the average for all crudes, excluding depreciation, in 2008 was $7 a barrel. Add, say, another $3 for the Orinoco Belt extra-heavy crudes and then $5 for upgrading, plus another $5 to cover depreciation and you get a total cost of $20 a barrel at the outside. Compare this with $30 a barrel or more for Athabasca and $40 or more for deep sea production and you see Venezuela is in a privileged position. Saudi Arabia, Iran, Iraq and other Middle East countries have lower costs, but only Saudi Arabia has comparable oil reserves.

My geologist colleagues question why a 20% recovery factor has been assumed when the current rate is only 9%, and I must admit I am surprised Ryder Scott agreed to it. But, taking a practical approach, does it really matter if the recoverable reserves are stated as 500 billion or 250 billion barrels? The latter would provide a production of 5,000,000 b/d for 137 years by which time who knows if oil will be used as fuel.

I disagree with Mr Wallis that planned projects “in isolated rural areas that lack even basic infrastructure” will create serious problems. Oil is produced in much more inhospitable places than the Orinoco Belt. I accompanied General Alfonzo Ravard, the president of PDVSA, on a visit to the area in 1980 and access was not that difficult. It must have improved since then. Anyway, oil companies are used to operating in difficult terrains and far from the towns. There is no comparison with working in Alaska or Canada under freezing conditions and the permafrost of the tundra, nor with being stationed on a platform 200 miles from land which is truly isolated. Once again, Venezuela is in the privileged position of having oil on land which vehicles can easily reach.

The consultant who asked “to what extent will PDVSA let their partners participate?” should have known the answer. PDVSA owns at least 60% of the shares in each of the mixed companies. Though people refer to them as joint ventures, legally they are not since joint ventures require joint decision taking. PDVSA considers them to be subsidiaries and consolidates them as such in the accounts. But they let the minority shareholders “participate,” or play an active role, by placing their employees either on the Board or in senior executive positions. They realise many of them have key skills which PDVSA lack.

I agree the companies are a disparate bunch — some have ample experience of extra heavy oil production and others have none at all. Venezuela favours other state companies and the trouble with some of these is not just a lack of experience but also a lack of financial resource. State companies often have to compete with other sectors of the economy — hospitals, schools, housing, roads, power plants — for funds. Mr Wallis is right in expressing “doubts about when touted projects to tap the area” will come on stream. The history so far has been largely of procrastination and missed targets.

The quote that “Oil in the ground has zero value” sounds sagacious but is fatuous — companies sell or farm out acreage frequently for large sums. They paid large bonuses upfront for the oil in the ground before any production in the Orinoco Belt started. In Venezuela’s case, the OPEC quota means present oil production is restricted so, guess what? PDVSA have closed in the oil that produces least return per barrel because of its higher cost — oil from the Orinoco Belt. There is thus no immediate hurry to increase production capacity, though clearly that is what PDVSA aims for within the next couple of years.

Mr Wallis points out the risk of investing in Venezuela. But I think that risk in the Oil Belt has receded since royalty was increased to 33%, income tax set at 50% and the mixed companies were formed. These conditions are so tough that the country can hardly squeeze any more from the foreign companies. PDVSA is also strapped for cash and has trouble meeting its 60% capital investment commitment so it would make no sense to undertake further expropriations.

A risk that does exist is not being able to repatriate dividends in a timely fashion since, to conserve cash, PDVSA has delayed the payment of dividends in other mixed companies.

However, state companies in the Orinoco Belt have political clout and can also exert diplomatic pressure to ensure prompt payment–the private companies can get a free ride on their coat-tails.

I trust I have made my case that the Orinoco Belt has a strong and, indeed, enviable competitive position, certainly better than Athabasca which also holds huge reserves. In addition, the easy accessibility on land means its production costs are half those offshore in deep water.

August 4, 2010 - Posted by | Deception, Economics

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