There’s been a lot of discussion about whether the new Venezuela oil deal is legal and, more importantly, whether a future administration could simply tear it up. Phillips O’Brien, whom I greatly admire, argues that the answer to the second question is basically yes. The Trump administration’s deal isn’t legal under Venezuelan or American law, O’Brien avers. Therefore the 35% U.S. equity stake can be handed back, the cheap-oil commitment can be unwound, and there isn’t much the current administration can do to bind its successors.
Another commentator whom I deeply respect, Max Boot, likewise writes in notes, “I also don’t see how it’s legal under U.S. law. Where does Trump get the power to do this?”
Neither of these gentlemen are easily dismissed.
Nonetheless, I’m not convinced. I don’t think that the deal is illegal under Venezuelan or American law. I’m also not sure that the deal will be that easy to undo, although that depends on how the administration structures it.
The question is what happens to that 35% American stake. Right now, the structure is that the U.S. government’s (USG’s) stake will take the form of “penny warrants,” i.e. options to buy shares in the Venezuelan oil enterprise (called “Blue Energy”) at pennies on the dollar. If the USG exercises those warrants immediately, however, it will be taking a 35% share of the profits in Blue Energy without putting up any significant share of capital, which will blow holes in the economic viability of the enterprise.
Given that, one of three things will happen. First, Washington leaves the warrants unexercised for a long time. In that case, the deal should be fairly easy for a future administration to reverse. Second, it finds a way to put federal money behind the investment, making the stake economically viable and harder to unwind. Third, the whole equity component turns out to be vaporware, in which case there is nothing to unwind. Note, however, that the equity stake isn’t the whole of the deal; there’s also provision that would require Blue Energy to sell one-fifth of its output to the USG at cost. (Any resemblance to the Spanish quinto real is certainly coincidental.) The 20% at-cost oil provision is a separate matter and will likely prove considerably stickier.
Allow me to make both arguments, if you will.
Regarding Venezuelan law: the Bolivarian Republic retains de jure ownership of the oil; thus the 16% royalty payments. And just as a company in Texas can book ownership of reserves leased from a private landowner, a company in Venezuela can book ownership of reserves leased from the Venezuelan state. There are also barriers to renationalization. If the BRV went that route, it would find itself tied up in international arbitration. If it lost, then a legal nightmare would rapidly descend around its oil exports. And, of course, the U.S. government could reimpose sanctions.
Regarding American law: The numbers, however, make it unlikely that the U.S. will actually take that 35% stake, at least given the information we have. I’ve run through the full analysis at this post. The upshot is that the deal is quite good for Caracas and marginally-investable for private companies — but it won’t make sense for private investors if the USG claims 35% of the profits without putting up any capital.
There is an important distinction, however, between the government having the right to take 35% and actually taking it. Warrants will cost the private investors very little today if everyone expects them to remain unexercised. But the moment Washington converts it into a 35% equity stake without contributing any capital, the private investors have effectively surrendered more than a third of their upside while retaining all the investment costs. That would render the project inviable. So we don’t only have to ask whether the administration legally obtained its 35% option. We also have to ask what needs to happen for the exercise of that option to be compatible with tens of billions of dollars of private investment.
The Trump administration has two obvious tools at its fingertips to make the above happen.
