The Trump administration has announced a deal to give us Venezuela’s oil. We don’t know a lot of details, but we’re already getting some incorrect opposition. For example, Eurasia Group analyst Gregory Brew (the author of an excellent book on Iran), tweeted this:
The problem is already obvious. The 1948 agreement split profits 50-50 between the government and the private companies. The agreement outlined by President Rodríguez gives the Venezuelan government 29% of the gross revenues. ($19 ÷ $65 ≈ 29%.) Not same thing at all; in fact, that’s a great deal for the government. It’s the kind of error that I live in fear of making, so don’t take this is as criticism of Brew, who’s a great scholar.
In other words, it’s not clear that the deal is a bad one for Venezuela. We’d need to dig deeper. Here’s my first pass at doing that. New information could easily invalidate these calculations; I will update them in a new post should that occur.
Here’s what I could cobble together:
The agreement covers greenfield and brownfield production, not existing production. From the Financial Times, quoting President Rodríguez’s televised address: “The deal included the development of eight greenfield blocks in Venezuela’s Orinoco Oil Belt.” It also includes nine brownfields.
The brownfields probably produce about 200,000 bpd at present, if this estimate of Blue Energy Partners current output is correct and if Blue Energy Partners currently controls the brownfields. (The New York Times repeated the estimate.)
Also from her televised address: the “minimum” royalty rate will be 16% of gross revenues, in addition to an income tax of 34%. The word “minimum” implies that the royalties will be on a sliding scale, but she did not provide details. Under current law, the government can raise royalties as high as 20% for greenfield ventures. (The link goes to Cleary-Gottlieb, one of the best law firms in the world for these issues.)
According to the President of Venezuela, the amount of new production should reach 1.5 million barrels per day.
The U.S. government (USG) will get a 35% stake in a company called Blue Energy Partners that will manage the fields. According to the Wall Street Journal, the U.S. won’t pay for that stake. Presumably we get a 35% share of the after-tax profits.
The USG also gets the right to purchase 20% of production at cost.
The USG provides a (thus vague) investor guarantee.
Let’s put it all together. Does this deal make sense, and if so, for whom? I expected this to take an hour or two. Six hours later, I’m paywalling the analysis; the data are available in tabular form below.
We’ll assume that the brownfields are currently producing at one-third of their potential, in line with Venezuela’s overall output decline under Socialist Party rule. They can probably be ramped up to full production within three years. The greenfield projects will take much longer. I assume seven years until first production and then an additional three years to get up to full nameplate output. I’ll assume operating expenses around $17 per barrel.
Here are my capex assumptions (from Rystad data):
Annual cost of greenfield expansion = $75 billion per million bpd capacity;
Annual cost of rehabilitation expansion = $47 billion per million bpd capacity;
Annual maintenance capex = $3.2 billion per million bpd production.
Here is the data:
At a 12% hurdle rate, the project barely makes sense. It requires $43 billion in external capital (the rest is financed out of earnings). Its NPV is negative on a 25-year time horizon but (barely) positive on an infinite one and reaches payback in 2041. So it’s marginally-investable at those numbers. At a 15% hurdle rate it’s still not crazy but becomes harder to justify.
The 25-year project IRR is 9.6%. In other words, the project works if investors are willing to accept a hurdle rate of roughly 10%. That is not unreasonable if we take the U.S. government “guarantee” at face value. The Office of Strategic Capital (OSC) within the Department of War has the statutory authority to provide loans and loan guarantees, and some offshore upstream projects in U.S. waters have been valued using a 10% rate.
Investors might take this deal, but it’s not a no-brainer.
The Bolivarian Republic, however, comes out ahead. When the project makes money, it gets a 29% cut of the revenues and — on the definitions used above — a steady-state 53% share of project cash flow.1 That’s not bad at all and a little bit above the 50-50 split negotiated in the iconic 1948 agreement.
But we have a huge “but.” Which is simply that the project doesn’t make sense if the USG is going to take 35% of the profits as its equity share without putting up any capital. Even at a 9.6% hurdle rate, the project won’t go into the black until 2044 and it is NPV-negative even for an infinitely-lived investor.
In other words, something is seriously off with that 35% share being taken by the U.S. government. It simply doesn’t make sense for anyone to invest if Washington is going to take 35% without putting up any capital.
This is speculation, but there are a few ways this could be squared with investor interest. (So far, note, we don’t know how much of that there is.) Perhaps the 35% stake isn’t really a claim on ordinary project profits as reported. The government guarantee might be much more valuable than we assume. Conversely, the USG might be providing direct low-cost financing via the OSC. Maybe everyone expects real oil prices to be well above $65. More of the production growth might come from the brownfields, or maybe the brownfields are currently producing more than 200,000 bpd. Finally, the whole thing might simply be political theater that will be revised before anyone writes a check. We don’t know which. But right now, with the information we have, I would not take the reported 35% stake at face value.
“Project cash flow” is defined here as free cash flow before royalty payments. The project turns positive on that measure in 2035, whereupon the BRV takes 76%, falling to a steady state of 53% after 2038.