- The Washington Times - Sunday, August 20, 2006

BUENOS AIRES

Venezuelan President Hugo Chavez, one of the hemisphere’s harshest critics of the United States, is receiving hundreds of millions of dollars in subsidies from Washington, thanks to an obscure 20-year-old oil pricing formula.

The formula is part of a supply contract between Venezuela’s state-owned Petroleos de Venezuela (PDVSA) and its wholly owned U.S. subsidiary, Citgo Petroleum Corp., which forces Citgo to buy PDVSA’s crude for at least $5 a barrel over market prices.

The net effect is to reduce Citgo’s taxable earnings in the United States and to boost Venezuela’s share of oil profits by as much as $1 million a day.

“At the moment, we have the strange situation where the USA is subsidizing Venezuela to the extent of the tax relief on the excess above-market prices” says Oliver Campbell, a former finance coordinator of PDVSA.

James Williams, an Arkansas-based oil analyst with WTRG Economics, estimates that Citgo has been paying $5 to $8 a barrel over market prices for the past two years, amounting to a de facto U.S. subsidy.

Mr. Williams estimates that Venezuela could be earning as much as an extra $1 million a day that would otherwise belong to the U.S. Treasury.

The ironies are ubiquitous on two fronts: demands to end tax breaks for Big Oil in the United States as gasoline prices skyrocket and Mr. Chavez’s repeated threats to cut off oil shipments.

“The government of the United States should know that if they go over the line, they are not going to have Venezuelan oil,” Mr. Chavez said as recently as February.

“I have already taken measures regarding this. I’m not going to say what because [U.S. officials] think that I can’t take these measures because we would not have any place to send the oil,” Mr. Chavez said.

Today’s record oil prices — about four times higher than in 1989, when the IRS formula was negotiated — have provided Venezuela’s verbose leader with plenty of cash for his anti-U.S. campaign.

Mr. Chavez cites the hypothetical threat of a U.S.-led military assault to justify purchases of billions of dollars of advanced weapons from Russia.

He also provides generous subsidies to Latin nations with leftist governments, ranging from anti-U.S. Cuba to longtime U.S. friends such as Argentina, which recently benefited from a Venezuelan buyout of debt owed to the International Monetary Fund.

The U.S. Congress’ Government Accountability Office (GAO) says that the United States is ill-prepared for a disruption in Venezuelan oil, which could cost the U.S. economy $23 billion in losses to its gross domestic product.

The GAO report also says that Venezuela’s economy would suffer. About 70 percent of the nation’s oil exports go to the United States.

But analysts say the potential impact on Venezuela would shrink as Mr. Chavez finds new markets and refining potential outside the United States.

During the first four months of 2006, Venezuelan oil exports to the United States fell about 6 percent, to 178 million barrels of crude and petroleum products, from 190 million barrels during the same period a year earlier, according to the U.S. Energy Department.

An analyst with the department says it is too soon to say if this represents a trend, because imports routinely fluctuate, making it difficult to determine whether production lags at PVDSA or sales in new markets caused the decline.

Nevertheless, Venezuela’s oil shipments to China clearly are rising.

In 2004, Caracas sent a average of 14,000 barrels a day to China, an amount that spiked to 80,000 barrels a day in 2005, PDVSA’s Web site says.

In May, PDVSA announced a $1.3 billion plan to buy 18 oil tankers from Chinese shipyards to boost its shipments to Asia.

“By the end of this year, we should be sending 300,000 barrels a day of oil to China,” Mr. Chavez said.

Mr. Chavez is also expanding his energy relationships to Russia and Iran. Both are oil exporters, but have the technology for new refineries that are needed to process Venezuela’s heavy crude.

During a state visit to Moscow last month, he clinched a large arms deal and oil agreements with President Vladimir Putin.

“In Volgograd, we agreed with the president of Lukoil that by the end of 2006, this Russian company will start to produce oil in Venezuela, in two regions,” Mr. Chavez said.

The trip included a visit to Tehran, where Iran’s state-owned Petropars oil and gas company said it would invest $4 billion in two Venezuelan oil fields.

Venezuela also has deals to supply countries such as Cuba and Bolivia with cheap oil, as well as new supply agreements with India, Jamaica, Haiti and Paraguay.

Argentina and Uruguay last month agreed to work jointly on oil projects in Venezuela’s Orinoco region, and Mr. Chavez continues pushing a number of oil initiatives in the Caribbean.

Venezuela is already the world’s fifth-largest oil producer. But it has yet to begin developing an oil find in its Orinoco River belt, which would give it oil reserves greater than Saudi Arabia’s, according to estimates from both U.S. and international agencies.

“What happens when the weight of global oil shifts from the Middle East to Venezuela?” Jose Cordeiro, a Venezuelan oil specialist, asked recently at an oil forum in Buenos Aires.

U.S. officials are concerned that Mr. Chavez will continue to use his nation’s oil wealth to reward regimes to the degree they share his anti-American agenda.

“So what is it, this [U.S.] government is trying to do? Destabilize its secure [oil] supplier?” Mr. Chavez asked rhetorically during his weekly “Hello, President” television and radio show.

He answered his own question, saying that Venezuela “has enough allies on this continent to start a 100-year war.”

Barely a day goes by without Mr. Chavez hurling an over-the-top insult or threat at the United States.

Still, Mr. Chavez has plenty of oil-thirsty neighbors. The main obstacle is technical.

Venezuelan oil is sulfur-heavy, making it difficult to refine into products such as gasoline.

Few refineries in the world are up to the task, the bulk being nine U.S. refineries that are either partly or fully owned by PDVSA through Citgo.

“While the United States is unique in its capacity to refine large volumes of the heavy crude oil that constitutes a majority of Venezuela’s oil exports, China and other countries, such as Brazil, have plans to build refineries that can process heavy crude oil, which, if built, may create other attractive markets for Venezuela’s oil,” the GAO report says.

One key to Mr. Chavez’s strategy involves developing refineries outside the United States that can process Venezuelan crude. Brazil and Venezuela are jointly building a $2.5 billion refinery in the northeastern Brazilian state of Pernambuco, which is expected to process up to 200,000 barrels of heavy oil daily.

“The crude currently going to Citgo could just as easily go there,” said Carter Beasley, an oil industry professional who works in Latin America.

“Brazil is a big importer, and if Venezuela builds the refinery, you would assume there is a clause in there somewhere about supplying the crude,” Mr. Beasley said.

PDVSA also has an agreement to upgrade a Uruguayan refinery and reportedly plans to invest in a Paraguayan facility.

Sen. Richard G. Lugar, Indiana Republican and chairman of the Foreign Relations Committee, is urging the United States to plan for the day when Venezuelan oil is no longer available.

“Venezuela’s leverage over global oil prices and its direct supply lines and refining capacity in the U.S. give Venezuela undue ability to impact U.S. security and our economy,” Mr. Lugar wrote in a recent letter to Secretary of State Condoleezza Rice.

“However unrealistic Venezuelan President Hugo Chavez’s repeated threats to disrupt the oil supply may be, we have a responsibility to plan appropriate contingencies that protect the American people,” the letter says.

It also warns of “a real risk of having Venezuela act in concert with other countries to disrupt the price of oil.”

Energy-hungry China and India figure prominently in Mr. Chavez’s plans.

But getting oil from Venezuela to China is expensive. According to one estimate, Caracas loses $3 dollars per barrel in shipping costs.

But a $4.7 billion pipeline planned by Venezuela and Colombia could someday move Venezuelan crude to the Pacific, where it could be loaded onto a new generation of supersize oil tankers that are too big to squeeze through the Panama Canal.

Though Mr. Chavez has big plans for marketing Venezuela’s crude to customers other than the United States, it takes time to build pipelines and refineries, making a sudden cutoff unlikely.

Nevertheless, it is clear that Venezuela is moving to disinvest its oil-related assets in the United States.

On Tuesday, Venezuelan Oil Minister Rafael Ramirez announced the sale of Citgo’s 41 percent stake in the Lyondell-Citgo refinery in Houston to Lyondell Chemical Co. for about $1.3 billion.

Here lies another irony in Mr. Chavez’s oil strategy. Two years ago, when Venezuela began negotiating the sale of its minority share of Lyondell-Citgo, he could say American refineries were a bad deal for his country.

That appears to have changed because of the obscure pricing mechanism that was negotiated with the IRS to facilitate PDVSA’s purchase of Citgo in 1989.

Few details are available about the complicated accounting formula.

A rare and superficial description offered in a 2005 Citgo report to the U.S. Securities and Exchange Commission (SEC) says it takes into account a variety of factors, including the market value of refined petroleum products, transportation costs, refining margins and inflation.

Because Citgo is no longer a publicly traded stock, it no longer files reports with the SEC.

Sources say the formula was designed to help obtain loan financing for the purchase of Citgo, with third-party creditors seeking to ensure the U.S. refinery would not be overcharged in supply contracts.

Before oil prices spiked in recent years, the formula favored Citgo — and, by extension, the U.S. Treasury — as PDVSA was forced to sell at below-market prices.

But the formula was structured in such a way that when prices rise above a certain threshold, the balance shifts in favor of the parent company, creating the situation that exists today with the United States subsidizing PDVSA.

Despite paying more for crude, high oil prices have also kept Citgo flush with cash.

In a May interview with the Venezuelan newspaper El Universal, Citgo’s Chief Executive Officer Felix Rodriguez said the U.S. company repatriated to Venezuela $785 million in 2005.

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