Venezuela to Exempt New Oil Projects from Changes to Windfall Tax But Other Companies Will Be Hit Hard

Plans announced last week by President Hugo Chávez to increase social contributions from a windfall oil-profit tax are set to reduce profit margins for oil projects in a country where the government take is already considerably higher than in most other oil-producing nations (94% according to an earlier study by two Venezuelan scholars Monaldi and Manzano, although it may now be higher, compared to 70-90% in other parts of the world). The new legislation has already been approved under an Enabling Law approved by the previous National Assembly, which allows President Chávez to pass laws without having to consult the legislature, but has still to be published in the Official Gazette.

President Chávez explained during a ministerial meeting yesterday (26 April) that the tax would be applicable on 80% of the increased profits when the oil price average exceeds USD70 per barrel, 90% on additional income generated by an oil price above USD90 per barrel and 95% when it exceeds USD100 per barrel. These rates compare with a windfall oil-profit tax approved in 2008, which called for a special tax levied at a rate equivalent to 50% of the increased profits, when the monthly oil price average for a basket of Venezuelan crude exceeds USD70 per barrel and 60% when it exceeds USD100 per barrel. In practice, the sharp drop in oil prices during the global financial crisis meant that the earlier windfall oil-profit tax did not take effect for much of its life, however, the rise in international prices this year due to unrest in the Middle East means that it is currently being applied. The new rates will allow the government to take a larger share of windfall oil profits. Under the tax changes, if international oil prices reach USD110 per barrel then USD38 would be payable as a special contribution, compared to USD24 under the earlier windfall tax. This is on top of other taxes levied on oil companies operating in Venezuela. According to projections by our sister company, IHS CERA, the benchmark Brent crude is expected to average USD111 per barrel in 2011 assuming that production from the Middle East remains stable and market anxiety about the reliability and adequacy of spare capacity begins to fade. This means that the Venezuelan government can expect to see a steady income from the windfall tax over the course of the year. The additional revenue generated by the tax hike will be directed to the National Development Fund (FONDEN), allowing the government to boost social spending in the run-up to next year's presidential election.

There was, however, some good news in the form of comments by Venezuela's minister of energy and petroleum, Rafael Ramirez cited in a report by Reuters, saying that mixed companies with the state oil company PDVSA investing in projects to increase production or in incremental production from existing projects would not have to pay the tax on new production until they had recouped their investment. Until the decree is published in the Official Gazette it will not be clear if this exemption is explicit or if it will be at the government's discretion.

Outlook and Implications

The new windfall oil-profit tax comes as a surprise as the government tax take is already very high and, at least with respect to oil contracts, it was hard to see how many further changes considered prejudicial to foreign investment could be made. Indeed it had appeared that the government was starting to move in the other direction with provisions included in the contracts for oil blocks in the Orinoco heavy oil belt signed with the Russian and Chinese NOCs and for the blocks awarded in a recent heavy oil round indicating a willingness on the part of the government to reduce taxes during the early production stage if companies can demonstrate that heavy oil projects would not be profitable otherwise. If the comments by the minister are confirmed, the government remains willing to show this flexibility with regard to vital investments in the Orinoco Belt. Any exemption is likely to be at the government's discretion, however, and on a temporary basis.

Meanwhile, the rule changes will send a negative signal to other investors in the country as well as increasing the fiscal burden on PDVSA. The timing could not be worse as PDVSA's finances are already in a poor state and the government has in recent months been increasing pressure on private companies to increase their share of production. The new tax will also add to existing concerns about PDVSA's cashflow and its ability to reinvest in the oil sector. Contributions by the state oil company to government-sponsored social projects have increased significantly in recent years, with the company's last annual report showing that total contributions paid to the state—in the form of spending on social development, contributions to the FONDEN fund, production royalties, income tax, and other tax contributions and dividends—totalled USD27.793 billion in 2009, of which USD24.71 billion were fiscal payments. The new tax law should generate several billion dollars of additional revenue for the government in order to improve its electoral prospects but it will not help to reduce regulatory uncertainty in the oil sector or to encourage new companies to invest in less productive fields outside of the Orinoco Belt.