INTELLIGENCE MEMORANDUM VENEZUELA: CHANGING ENVIRONMENT FOR DIRECT FOREIGN INVESTMENT

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• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700030024-1
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• Document Page Count: 20
• Document Creation Date: December 22, 2016
• Document Release Date: January 18, 2011
• Sequence Number: 24
• Publication Date: February 1, 1972
• Content Type: IM

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Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Venezuela: Changing Environment for Direct Foreign Investment
DOCUMENT SERVICES BRANCH Confidential
ER im 7224
FILE CPY
-
February 197o
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WARNING
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
February 1972
INTELLIGENCE MEMORANDUM
VENEZUELA: CHANGING ENVIRONMENT
FOR DIRECT FOREIGN INVESTMENT
Summary
. Following World War II, Venezuela attracted large amounts of
direct foreign investment, chiefly from the United States. By the end of
1961 the book value of US direct investment in Venezuela had reached
$3.0 billion, by far the largest in any less developed country (LDC) and
25% of our Third World total. The investment climate became less attractive
in the 1960s, however, as Venezuela raised taxes and imposed restrictions
on the largely foreign-owned oil industry. Although Caracas continued with
considerable success to encourage foreign involvement in most other sectors,
oil company disinvestment cut the book value of US direct investment to
$2.7 billion by the end of 1970.
2. Since late 1970, nationalistic actions against foreign firms have
accelerated sharply as President Caldera, elected in 1968 with only 30%
of the vote, engaged opposition parties in Congress in a tug-of-war for
popular support. Tax increases and restrictive legislation aimed mainly at
the oil companies have been followed by presidential decrees that have gone
even further. Presidential and Congressional measures since November 1970
have preempted development of natural gas exports for the government,
greatly toughened regulations governing reversion of company oil
concessions scheduled for the early 1980s, and boosted the government's
share of gross oil profits from 71% in 1969 to an estimated 90%. The
government also has imposed oil export quotas on the companies. These
quotas are to be enforced by heavy penalties that under certain
circumstances could absorb one-half or more of a company's net earnings
after taxes.
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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3. Foreign firms were shaken by these measures but, after initial
outrage, have restrained their complaints for fear of provoking immediate
nationalization. The oil companies are disturbed because the higher oil prices
required to maintain profit margins in the face of greater tax bites would
narrow their markets and because export quotas restrict their ability to adjust
Venezuelan output to changes in world oil demand and cost conditions.
Under present circumstances, Venezuelan producers are faced with a more
severe profit squeeze than are Middle East producers. Nonpetroleum
companies are disquieted because they fear similarly harsh restrictions for
them may be only a matter of time.
4. Substantial output cutbacks already forced on the two largest oil
companies by reduced demand sugg:.st that the industry may fail to meet
its first quarter sales quotas, thus possibly triggering the penalty issue in
early April 1972. Because further escalation in actions against the companies
could lead to their pull-out or immediate nationalization, with heavy losses
to Venezuelan budget revenues, export earnings, and economic growth, it
is reasonable to expect Caracas to seek some accommodation with the
companies. On the other hand, the companies probably would accept
substantial reductions in their still-large profits in order to keep operating
in Venezuela, hoping that nationalist pressures might relax after the
December 1973 elections. In an effort to help ease political pressures on
the industry, the companies may seek official Washington action, such as
providing Venezuela greater US oil import preferences. Such preferences
would also allow the companies to pass on cost increases to US consumers.
The environment for nonpetroleum sectors, partly dependent on the
outcome in oil, may also be adversely affected by nationalist pressures in
the months ahead, but it is not likely to deteriorate sufficiently to cause
investment inflows to dry up.
Discussion
Investment Climate and Growth Up to 1971
5. In the first decade or so following World War II, Venezuela offered
a fair degree of political stability, generally responsible monetary, fiscal,
and foreign payments policies, and a minimum of government restrictions
as incentives for foreign investment in its rich petroleum and iron resources.
In response to this favorable environment and to rapidly growing world
demand, foreign companies (mainly US but also British and Dutch) rapidly
expanded their already sizable petroleum investments, and US companies
initiated large-scale iron ore exploitation. Moreover, an expanding domestic
market during the ensuing boom stimulated foreign investors to enter
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manufacturing, trade, and other sectors. During the 1950s, US direct
investment in Venezuela about tripled, and at its peak of $3.0 billion in
1961 it accounted for one-fourth of total US investment in the LDCs. These
large capital inflows helped to boost per capita output rapidly, and by 1959
Venezuela's per capita gross domestic product of $820 (on a purchasing
power parity basis) ranked third in Latin America, being exceeded only
by Argentina and Uruguay.
6. From the 1958 overthrow of the Perez Jimenoz dictatorship
through '967, however, rising competition from lower-cost oil producers
elsewhere and a number of nationalistic moves by the new Venezuelan
government made petroleum investment less attractive. Tax measures in late
1958 and again in 1966 raised the government's share of gross oil profits('
from 52% in 1957 to 68% by 1967. Moreover, President Betancourt's
administration, largely for conservationist reasons, adopted the policy of
granting no new petroleum concessions. The petroleum companies, being
uncertain about their future Venezuelan operations, thus were hesitant to
make further large investment expenditures. Following completion of
projects in progress, the companies sharply 1-ut their investment spending.
Substantial net disinvestment occurred each year during 1962-67 as
depreciation allowances exceeded new capital spending, and the book value
of US oil holdings dropped from $2.4 billion to $1.8 billion in the six-year
period. For most other sectors, however, the government's
import-substitution policies improved the foreign investment outlook, and
the book value of US nonpetroleum investments increased almost 20%
compared with 1961. Nevertheless. this rise was not sufficient to offset
the drop in oil holdings, and the book value of total US investment shrank
to $2.6 billion at the end of 1967, about 85% of the 1961 peak.
7. During 1968-70, growing concern about Venezuela's declining
share in world oil reserves and output brought some change in government
attitudes but little tasting improvement in the attractiveness of oil
ins stments. New service contract arrangements were supposed to encourage
oilfield exploration and development, but the government moved slowly
on applications and no investment of this type actually took place. To
protect their existing holdings, however, the companies constructed
desulfurization facilities to meet stiffening US anti-pollution requirements,
and this spending offset most of the industry's amortization of previous
oil investment. Not yet threatened by government restrictions,
manufacturing investments continued 0 increase rapidly and largely
accounted for the rise in book value of US direct investment of $141
million - or 5.5% - during these three years.
1. Defined as profits before deduction of Venezuela's royalties and income taxes.
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Present Structure of Foreign Holdings
8. US direct investment of $2.7 billion(2) greatly overshadows the
holdings of other foreign countries, making up 63% of the estimated book
value of total direct foreign investment of $4.3 billion. US holdings account
for about 67% of direct foreign investment in petroleum, virtually all of
that in iron mining, and 65% of that in manufacturing. Although US direct
investments in- Venezuela still are the largest in any LDC, their share of
total US investment in the LDCs has declined to only 12.5% - one-half
the 1961 level.
9. During the past decade, manufacturing's sham of US direct
investment in Venezuela increased from 6% to 17% while the share of oil
investment dropped from 79% to 64% (see Figure 1). US manufacturing
investments, which include a large number and variety of operations, are
dominated by holdings in food processing, motor vehicle assembly, and the
production of chemicals, pharmaceuticals, and textiles. US investments in
trade also are important, with a large number of US-based corporations
maintaining sales and distribution facilities in Venezuela. A breakdown by
type of activity of the 440 Venezuelan firms in which US companies have
full or substantial equity interest is shown in the following tabulation:
Activity
Number of
Companies
Agriculture and fishing
12
Mining and metal products
18
Petroleum and oil services
33
Manufact'tring
177
Construction and engineering
13
Trade
110
Banking and other finance
45
Other services
32
2. Book value at the end of 1970, the latest date for which data are available. In
addition to direct investment holdings, US investors held other assets in Venezuela
totaling an estimated $336 million at the beginning of 1970, as follows: long-term
commercial hank loans to the central government and its autonomous agencies, $238
million; Venezuelan company securities, $88 million; and Venezuelar -wernment bonds,
$10 million.
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Figure 1
Venezuela: Book Value of US Direct Investment
(Year-End)
Million US $
4,000 r?
Transportation
3,000 and Utilities
Mining, Smelting,
and Other
Trade
2,000 Petroleum
1,000 - ^ $982 1%
8%
191,10
'Breakdown , t available for other sectors
513073 2 72
10. British and Dutch direct investments make up most of the
remaining foreign holdings. The major part of their investment is in Royal
Dutch Shell, Venezuela's second largest petroleum producer. The remaining
UK holdings are in manufacturing and banking, while the Netherlands' other
investments are mainly in trade and banking. The small holdings of other
European countries - notably France, Italy, Spain, and Sweden -- and
Canada are scattered among manufacturing, trade, services, and finance.
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Acceleration of Nationalistic Moves
11. Since late 1970, foreign firms, mainly in the cil industry, have
confronted a sharp acceleration of nationalistic government measures.
Caracas has moved decisively to extract greater profit shares, gain greater
control over company policies and operations, and exclude foreign investors
from certain economic activities. Although such measures have not gone
as far in Venezuela as in some other Latin American countries - Chile
very recently and Mexico starting in the 1930s, for example - they have
raised new doubts about the future of oil investments and disturbed the
environment for nonpetroleum investments. Recent government actions
were precipitated partly by growing budget strains but to a far greater extent
by increasing competition for political support between President Rafael
Caldera, elected in 1968 with only 30% of the vote, and the opposition
parties. Because nationalistic moves against foreign industry enjoy wide
popular support, they have escalated in a seemingly endless political
tug-of-war. Although an alliance between Caldera's Christian Democrats and
the majority Democratic Action (AD) party has given them nominal control
of Congress, the alliance has consistently broken down when legislation
affecting foreign investors was under consideration.
Measures Affecting Petroleum
12. Because of their high profile and large net profits of some $5 15
million in 1969, the foreign petroleum firms were naturally the prime target
of nationalist actions. To help ease budget difficulties, President Caldera
in lat-. 1970 submitted a comprehensive tax reform bill to Congress. The
AD, :tensing an opportuntiy for major political gains, significantly altered
the bill. It greatly increased the proposed maximum corporate income tax
rate (affecting mainly the petroleum and iron mining companies), eliminated
Caldera's proposals to establish a sales tax and to increase tax rates on
down -stic business income, and steamrolled the bill through Congress. The
law finally signed by Caldera in December raised the maximum tax rate
from 52% to 60%, retroactive to 1 January 1970. It also gave the
government unilateral power to raise tax reference values (used in valuing
oil exports for income tax purposes), which previowaly had been set through
negotiations with the companies. Even with unchanged tax reference values,
the new tax rates raised the government's share of gross oil profits from
71% in 1969 to 78% in 1970 (see Figure 2), for which the AD received
the public credit.
13. To establish his nationalist credentials, President Caldera in March
1971 used his new authority to boost tax reference values sharply, which
raised the government's share of gross oil profits to an estimated 85% for
1971. He also submitted to Congress a law authorizing government
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Figure 2
Venezuela: Crude Oil Production and Industry Profits
Net Company Profits
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Thousand Barrels Per Day
4,000
Ll I I I I I I I I I I I I I I I I it 1
1950 55 60 65 70
develo?ment of liquefied natural gas exports - private initiation of which
had been proposed earlier by the companies. The gas in question is a
by-product of crude oil output. Only three-fifths of this gas is presently
utilizeu (largely for oilfield injections to maintain well pressure); the
remainder is flared. Under Caldera's proposal, much of the gas would have
been taken from the companies at low prices, inconveniencing company
operations but boosting government revenues and producing political gains
for Caldera. To deny him these gains, the AD amended the measure to
restrict gas for export to that presently being flared. The amended measure
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also excludes private participation in gas liquefaction but apparently allows
participation in the acquisition of gas-carrying tankers.
14. Meanwhile, two minority parties tried to outdo these political
moves by pushing through Congress with AD support yet another measure
attacking the oil companies. Signed by Caldera in July 1971, this measure
empowers the government to regulate drilling and exploration activities,
under threat of concession cancellation if companies do not comply. It
also substantially toughens requirements concerning concession reversions,
many of which are scheduled to occur in the early 1980s. The new measure
expands the definition of oil properties subject to reversion to the
government to include pipelines, refineries, office buildings, and other
company properties not located in the concession areas. Perhaps reflecting
experience with previous disinvestment policies of the companies, the law
also requires that they deposit 10% of annual depreciation allowances in
an escrow fund for repair or replacement of equipment officially judged
to be in poor condition when concessions expire. Any amount left over
would be refunded. The companies estimate that these payments could
amount to as much as $45 million annually - equivalent to about 11%
of net company earnings in 1970. The law's failure to establish standards
for determining "poor" condition puts the amount that would be refunded
in considerable doubt.
15. To try to regain the political initiative, Caldera issued two decrees
in December 1971 that substantially broaden oil industry regulation. The
first decree requires the companies to submit for government approval their
annual programs for output, exports, and other operations. The second,
which goes far beyond legislative requirements, directs the companies to
maintain quarterly exports in 1972 near the record 1970 levels. Stiff
financial penalties are imposed for reuuctions of more than 2% below the
1970 base level. For example, if a company's sales fall more than 10%
below 1970, the penalties imposed could equal one-half or more of its net
earnings. Smaller and apparently more flexible penalties - which partly aim
at capturing windfall profits from improved market conditions - are also
to be imposed for exports more than 2% in excess of the 1970 levels.
Moreover, this decree increased tax reference values for 1972 to a level
that could boost the government's gross profit share to an estimated 90%,
compared with approximately 80% in Middle East oil-producing countries.
Actions Affecting Other Sectors
16. Congressional moves against foreign firms in nonpetroleum
sectors, although predictably less severe, also have been disquieting to
foreign investors. Thus far, completed legislation has been limited to the
1970 banking restrictions, but a measure requiring majority Venezuelan
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ownership of pharmaceutical firms may soon come under Congressional
consideration. Moreover, a 35-man commission representing the major
political parties was appointed by Caldera in February 1971 to prepare
legislative recommendations for regulating foreign firms in other
nonpetroleum sectors. The banking restrictions - aimed at preventing
foreign control and use of domestic savings - prohibited banks with more
than 20% foreign participation from accepting savings deposits from
Venezuelan residents and from engaging in a number of operations
important to commercial banking. Among the seven foreign banks adversely
affected by the new law are two US institutions - Chase Manhattan, which
-cut its previous 49% interest in a Venezuelan bank to 20%, and the First
National City Bank, which continues to operate a wholly-owned branch
system under the new prohibitions.
Impact of Venezuela's Actions and Initial Company Reactions
17. The oil companies were dismayed by the December 1970 tax
increase, which retroactively cut their net profits for the year by one-fifth
and their returns per barrel of output by one-fourth. As a result of the
tax rise, the government's take increased from 950 per barrel in 1969 to
$1.03 in 1970, while company net profits per barrel declined from 390
to 300. To regain their former profit margins, the companies again raised
Venezuelan oil prices in the early months of 1971. The adverse impact
of these price increases on the competitiveness of Venezuelan oil initially
was muted by price rises for Middle Eastern oil following successful demands
for greater profit shares by the other members of the Organization of
Petroleum Exporting Countries (OPEC)(3) in September 1970 and again
in February 1971. A large decline in international tanker rates during 1971
undermined Venezuela's competitive position in the United States and other
nearby markets, however, and the country's oil production dropped by 4%
for the full year, compared with a 5.3% rise in world output. At the same
time, the companies reacted to the new reversion law by initiating
proceedings in Venezuelan courts to contest its constitutionality. They were
unable, however, to take any action to counteract the gas law.
18. Although 1971 brought the first marked decline in Venezuela's
output in more than a decade, its share in the world oil market has been
declining for years. By 1970, it supplied only about 14% of world exports
3. In addition to Venezuela, the member countries of OPEC are Abu Dhabi, Algeria,
Indonesia, Iraq, Iran, Kuwait, Libya, Nigeria, Qatar, and Saudi Arabia.
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(JUN N 11)J N"1'1AL
compared with an impressive one-third a decade earlier.(4) During this
period, Venezuela's oil sales to Europe and South America declined
substantially, even in absolute terms, because of its inability to compete
with expanding Middle East exports. Its share in the US market also slipped
from almost two-thirds to little more than 40%, but its dependence on
US purchases increased (see Table 1). Its sales to the United States would
have slipped more were it not for US dependence on fuel oil supplies from
company refineries on the Venezuelan mainland and in nearby Curacao and
Aruba, which developed over the years as US domestic refineries opted
to maximize output of higher-valued petroleum products. Venezuelan sales
also benefited from the hemispheric preferences given on US imports of
No. 2 fuel oil and on crude oil deliveries to refineries in Puerto Rico and
the Virgin Islands; these preferences cover about 15% of Venezuela's present
oil exports to the US market.
19. Until December 1971, most foreign companies, nevertheless,
retained confidence in the future of their Venezuelan operations. The oil
companies in particular were counting on a "reasonable" implementation
of the reversion legislation, as privately promised by Caldera at mid-year.
In fact, during July-September 1971 the Shell, Occidental, and Mobil oil
companies signed service contracts to exploit oilfields in southern Lake
Maracaibo beginning late in the year at an investment cost of some $200
million. At the same time, the Creole Petroleum Corp., a Standard Oil of
New Jersey affiliate and Venezuela's largest oil producer, announced a
planned $45 million expansion of its recently completed $120 million
desulfurization facilities, and US Steel hesitantly announced plans to go
ahead with a $40 million iron ore enrichment plant.
20. Most foreign companies were shaken by the December decrees
because they cast serious doubt on the reasonableness of the Caldera
administration, or at least on its ability to withstand irresponsible nationalist
pressures in the Congress. The oil companies were particularly disturbed
because the export quota system -which includes the first minimum quotas
imposed by any oil-producing country - threatens their management
prerogatives and their ability to adjust production to changing world demand
and cost conditions. To retain profit margins in 1972 in the face of the
new tax increases, the companies would have to raise crude oil export prices
to a level uncompetitive in any part of world market. Because of depressed
demand, there is also little chance of forcing fuel oil consumers to absorb
the total cost increase - as they have in the past. Moreover, any penalties
for failure to fill export quotas would substantially complicate the problem
of passing rising costs on to consumers. Nonpetroleum companies were
disquieted by the possibility that similarly harsh restrictions for them might
be only a matter of time.
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Venezuela: Exports of Crude Oil
and Refined Products a/
1960
1969
1970
1971 b/
Western Hemisphere
76
80
83
85
United States (including
Puerto Rico and Virgin
Islands)
48
55
57
58
Central America and
Caribbean
8
8
8
10
Europe
European Community
6
7
6
5
10
6
5
6
Japan
Negl.
1
1
Negl.
Other areas and countries
4
2
1
1
Total
100
100
100
100
a. The data exclude exports of crude oil to Aruba and
Curacao Ln the Netherlands Antilles and include their
exports of refined products. The refineries in Aruba
and Curacao are operated by Venezuela's major oil pro-
ducers and process crude oil almost exclusively for
export to the United States. Some Venezuelan crude oil
also is shipped to Trinidad and Tobago for refining and
exported mainly to the US market. These crude oil ship-
ments are treated as exports to the United States in
this table.
b. January-May.
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21. Because of the l I% rise in tax-paid costs, excluding penalties,
Venezuelan companies face difficulties in keeping profit margins from
declining below their 1970 level of about 30? per barrel, much less their
higher 1971 level estimated at 350. As shown in Table 2, a 160 price
hike to $2.48 (f.o.b. Tidewater) would be necessary to maintain company
profits in 1972 at 30? per barrel. At the currently low world tanker rates,
such a hike would make Venezuelan oil significantly more expensive than
Middle East oil in the US market, and its existing price disadvantage in
other world markets would be considerably worsened. Thus, under present
profit-sharing arrangements with their host governments, Venezuelan
producers are threatened with a more severe profit squeeze than are Middle
East producers. Should penalties be applied for failure to meet export
quotas, company profits, of course, would be cut even further.
22. Initial reactions to the severity of Venezuela's new decrees varied.
The Creole Petroleum Corp. almost immediately announced its intention
to force the issue by ignoring quotas and refusing to pay penalties. Most
of the companies - while cutting back investment plans - continued to
hope that the government, in the end, would face realities and seek some
accommodation with them.
Implications and Outlook
23. Venezuela's recent actions have raised questions concerning the
continued competitiveness of Venezuelan oil and the country's position as
an important source of US oil imports. Indeed, they have raised questions
about the foreign oil companies' ability to continue doing business
profitably in the country. Some pessimistic observers fear that the
repercussions of these actions end of others resulting from continuing
political competition preceding the 1973 elections could push Venezuela
far down the extreme nationalist paths of Chile and Peru. Whether or not
this will happen depends on the willingness of Caldera's Christian Democrats
and opposition parties to sacrifice rational economic considerations to
immediate political gains.
24. The first test of how far Caracas is willing to go in pressing
nationalist demands against the foreign oil companies could come early this
year. Mainly because of abnormally low fuel oil demand on the US eastern
seaboard this winter but also because of reduced ability to compete in crude
oil markets, the major companies such as Creole and Shell already have
cut their production rates considerably below early 1970 levels. Should their
exports fall below first quarter quotas, the Venezuelan government in early
April will be faced with a decision concerning the severity of the penalties
to be applied. Because both Venezuela and the companies still benefit
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Table 2
Relative Competitiveness of Venezuelan and Persian Gulf Oil
US $ per Barrel of Crude Oil, 25?-27? API Gravity
Venezuela
Persian Gulf
1971
1972
1972
Production costs
0.50
0.51
0.12
Income tax and royalties a/
1.47
1.67
1.30
Tax-paid cost
1.97
2.18
1.42
Net company profits
0.35 b/
0.30 c/
0.30 d/
F.O.B. Tidewater
Cost and freight to Philadelphia
F.O.B. Tidewater
2.32
2.48
1.72
Freight e/
0.21
0.20
0.85
Total
Cost and freight to Trinidad
F.O.B. Tidewater
2.32
2.48
1.72
Freight e/
0.11
0.10
0.73
Total
Cost and freight to Rio de Janeiro
F.O.B. Tidewater
2.32
2.48
1.72
Freight e/
0.37
0.34
0.60
Total
2.69
2.82
2.32
Cost and freight to Rotterdam
F.O.B. Tidewater
2.32
2.48
1.72
Freight
0.44
0.41
0.82
Total
a. Government profit shares for 1972 are based on tax rates and
tax prices existing in mid-February.
b. Estimated.
C. Based on an assumed decline to the 1970 level.
d. Computed from quotations for F.O.B. Tidewater less estimated
tax-paid cost.
e. Based on WorZdscaZe 75 tanker rates for Venezuela and on
WorZdscaZe 65 tanker rates for the Persian Gulf.
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substantially from their existing relationship, pressures to reach a modus
vivendi will be strong.
Pressures Favoring Accommodation: The Venezuelan Side
25. In deciding on the penalties issue and on other damaging actions
against foreign companies, President Caldera will have to consider their
impact on new investments required to revive the long-flagging petroleum
industry. Maintaining present economic growth rates will depend heavily
on tapping new oil reserves because production from presently developed
concessions will slip over the next few years as deposits are exhausted and
because results of economic diversification efforts so far have been
disappointing. (s) Venezuela almost certainly will have to rely on private
foreign firms to supply the large amounts of capital and extensive
technological expertise required to dei clop its untapped reserves of heavy
crude oils.
26. Venezuela's dependence on current earnings from the oil
industry - some $ 1.4 billion in 1970 - is an even more important pressure
against Caldera's letting hostilities escalate to the point of triggering
company closedowns or making nationalization politically unavoidable.
Either development would bring serious losses in government revenues -
about 60% of which now comes from the oil companies - and in oil exports,
which account for 90% of total export earnings. Venezuela would encounter
some difficulties in operating the oil companies' properties, and costs almost
certainly would rise. Moreover, it could face virtually insurmountable
problems in marketing the oil it did produce if the major international
oil companies applied a boycott. Only about 40% of Venezuelan crude is
refined domestically, and the major oil companies control the Caribbean
refineries that process most of the remainder as well as about 60% of West
European refining capacity. Also, these companies and their foreign affiliates
market almost all Venezuelan oil now sold in the world market.
27. Venezuela would suffer earnings cuts simply from a loss of
international oil company tutelage, even if the companies took no further
action of any kind. Although Venezuela's high-cost industry still is
competitive with domestic producers in the insulated US market, the major
oil companies almost certainly would use lower-priced supplies from other
sources to fill their US import quotas if they were no longer directly
involved in Venezuelan operations. Because Middle East crude oil now is
competitive even with Venezuelan deliveries to nearby Caribbean refineries,
Venezuela's corner on the US fuel oil market also depends to a large extent
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on continued oil company preferences. Independent sales sufficient to retain
its already minor market share in other consuming areas such as Western
Europe and South America evidently would involve substantial discounting
of the prices at which Venezuelan oil now moves. In going it alone,
Venezuela, of course, would incur no loss in current per-unit earnings if
it cut oil prices by an amount equal to current company profits less the
rise in operating and marketing costs deriving from a loss in company
tutelage. Under present circumstances, however, a price cut of this size
would still leave Venezuelan oil uncompetitive in Western Europe and South
America and its position in US and Caribbean markets questionable.
Pressures Favoring Accommodation: The Company Side
28. The oil companies' refusal to pay penalties or yield to other
government pressures would expose their large Venezuelan investments to
the risk of immediate nationalization. In the case of Standard Oil of New
Jersey and Shell Oil Co., the two largest producers, their Venezuelan
operations provide a substantial portion of their non-US output - 40% and
30%, respectively. The companies would have to absorb virtually all losses
deriving from nationalization. US oil firms' insurance coverage by the
Overseas Private Investment Corporation (OPIC) is negligible, mainly because
OPIC policy precludes insurance on oil exploration, concession agreements,
and investments in sub-surface property rights. On the other hand, yielding
to Venezuelan demands for an increasingly large share in industry gross
profits does squeeze profits, particularly if compensating price increases are
infeasible. For the international oil companies, a "soft line" holds additional
risks because of the possible spillover effects on their holdings in other
OPEC countries.
29. Because of the nature of US import controls and company
marketing decisions, the US market is dependent on Venezuelan oil for
an important portion of its imported supplies. Although US imports of
Venezuelan crude oil have declined to some 360,000 barrels a day - about
one-fourth of total crude oil imports - a shift to other sources could involve
some delays and perhaps price increases, depending largely upon available
tanker capacity. Moreover, the United States is dependent on Venezuelan
supplies for about 80% of total fuel oil imports and more than 70% of
the fuel oil consumed on the eastern seaboard. Existing US inventories
probably could cover consumer needs during the estimated three months
required to reroute Middle East and African oil to Caribbean refineries that
now process about one-half of Venezuela's fuel oil exports to the United
States. To cover a loss of supplies from Venezuelan domestic refineries over
the longer term, new fuel oil refineries would have to be built.
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Possible Resolutions
30. It is reasonable to believe that the Caldera administration
recognizes that there are limits beyond which Venezuela cannot profitably
go in obtaining a larger share of financial returns from its oil industry.
It is even possible that it realizes that wresting management control from
the oil companies also would involve considerable financial loss to
Venezuela. Thus it would seem likely that Caldera will try to reach some
accommodation with the oil companies on such vital issues as penalties -
which provide the teeth for the export q iota system. He may be tempted,
however, to use the broad escape clause provided in the decree in a
discriminatory manner, fining a high-profile company such as Creole, for
example, while accommodating the others. Although nationalist pressures
are bound to increase in coming months, part of the political api. eal of
immediate nationalization is offset by the fact that the government already
is scheduled to assume ownership of the oil properties in the early 1980s.
Considering the enormous potential costs of immediate nationalization, a
modicum of reason should compel vying political groups to be content with
token moves such as takeover of domestic distribution facilities.
31. For the companies' part, the initial outrage at the
unreasonableness of Caracas' recent demands apparently has been largely
replaced by a realization of the need to placate at almost any cost. In
seeking a more accommodating stance by the Caldera government, t;iey
have a strong case and undoubtedly will press it. But in the end, the
companies probabiy will - if necessary - accept substantial reductions in
their still-large profits in order to keep operating in Venezuela, meanwhile
hoping that the post-election climate will be more hospitable. In any event,
they can be expected to seek US government cooperation in eliciting a
more favorable attitude from Caracas. They certainly would welcome a
sympathetic Washington response to Venezuela's recent decision to renounce
the outdated reciprocal trade agreement - last renegotiated in 1952 -- while
also hoping to preserve the agreement's oil provisions which form the
statutory basis for concessionary tariffs on all US oil imports. They inay
also seek more far-reaching changes in official relations, such as a long-term
energy agreement involving broader preferences for Venezuelan oil which
would allow companies to pass on some cost increases to US consumers.
Their chief arguments for such an arrangement would be that alternative
US oil import supplies come from countries even more politically volatile
and that an attractive package offer from Washington could defuse the oil
issue in Venezuelan politics.
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32. The investment outlook for nonpetroleum sectors will be strongly
colored by developments on the far more prominent oil issue. If the
government and the oil companies reach a compromise, the outlook for
'these investments may well improve somewhat. Even so, the continuing
threat posed by political competition for nationalist support in the
upcoming election will justify a continued high level of investor caution.
The 35-man legislative commission now drawing up new investor rules is
considering some restrictions that may approach in severity those contained
in the Andean Foreign Investment Code.(6)
6. The Andean Foreign Investment Code applies to Chile, Peru, Colombia, Bolivia,
and Ecuador.
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