ConocoPhillips (COP) raised eyebrows in Venezuela this week by skipping an event where it could have signed over the rights to run its local oil operations to state-owned oil firm Petroleos de Venezuela SA, or PdVSA.

Industry watchers said the slight could mean Conoco is preparing for a legal battle if new contract terms offered in Venezuela's ongoing oil nationalization don't meet the firm's expectations.

Even if Conoco caves in before Tuesday's deadline for relinquishing operational control, the incident puts it on shaky ground heading toward a June 26 deadline for handing over actual shares in the oil ventures.

PdVSA is demanding a minimum 60% stake in four projects, currently owned by private-sector companies, that pump and upgrade tar oil from the Orinoco river basin.

Houston-based ConocoPhillips has more at stake in Venezuela than any other foreign firm, with majority stakes in two of the four Orinoco deals, Hamaca and Petrozuata, and stakes in two untapped conventional oil fields in the Gulf of Paria. Nearly 10% of Conoco's total reserves are estimated to lie in the OPEC nation.

"Conoco is taking a stand that they don't want to agree to anything," said Miguel Octavio, an analyst at Caracas-based BBO Servicios Financieros who tracks the four Orinoco projects.

"They are protecting the legal route in the event of an arbitration," as ceding operational control could give PdVSA an advantage if the dispute reaches the court room, he said.

PdVSA's other five partners in the Orinoco basin buckled under nationalistic pressure and signed agreements Wednesday that put the state firm in charge of day-to-day operations while talks about the ownership structure continue. Exxon Mobil Corp. (XOM), Total SA (TOT), Chevron Corp. (CVX), Statoil ASA (STO) and BP PLC (BP) all signed over control of their various parts of the operations, including the Sincor and Cerro Negro projects.

Exxon's acquiescence in particular surprised some observers, who had expected the Irving, Texas-based firm, not Conoco, to pick a fight with the nationalistic government of President Hugo Chavez.

Exxon officials had said they could leave Venezuela if terms for the current negotiations weren't adequate. The company said Thursday that this week's deal only involved "operatorship" of the Cerro Negro project, and that talks on the new "mixed company" remain open.

Conoco was quick to downplay the fact that it hasn't signed, saying it would continue discussions with Venezuela's Oil Ministry.

Conoco On Bad Terms With Ramirez

But the company appears to be on Venezuelan Oil Minister Rafael Ramirez's black list. Ramirez, the head of PdVSA, said Wednesday that Conoco was mishandling the negotiations, and that the state will take over Conoco's Orinoco operations on May 1 even if no deal is reached.

Friday morning, spokesmen for both Conoco and PdVSA said they had no word of a deal yet.

Ramirez has a track record of following through on his threats. Last year when Total and Italy's ENI SPA (E) refused the government's terms during a similar overhaul of conventional oil field contracts, PdVSA seized the fields the following day in a televised event.

Paris-based Total managed to work out a compensation scheme this year where it will be paid in oil, not cash. ENI took its battle to international arbitration, a path analysts said Conoco's chief executive James Mulva may be contemplating.

"Mulva is acting just like ENI acted last March," said one veteran Caracas-based oil executive. "I would say Mulva's style has irritated Ramirez."

Three other oil executives consulted by Dow Jones Newswires said Conoco's recent moves indicate maneuvering toward arbitration - an alarming prospect for some, as this puts the firm's choice assets in one of the world's richest oil provinces at risk.

"They're forgetting about Venezuela, there is no other reason for their actions," said one of the executives.

Mulva and Ramirez met in Caracas at the end of March. One person close to Conoco described the conversations between the two oil men as "cold."

Since then, things haven't warmed up. BBO's Octavio said Conoco has been pulling key staffers, including Venezuelan executives, from Petrozuata, where the U.S. firm holds a 50.1% stake.

Future Production Could Decline

PdVSA is having a hard time retaining private-sector Orinoco staff members, since employees from the private companies have to accept lower salaries if they move over to the state firm. Many Orinoco staffers are launching job searches.

PdVSA is already facing chronic maintenance problems at its conventional oil refineries, and the other companies' Orinoco heavy-crude upgrading plants involve far more specialized technology, much of which was developed on site over the past decade.

Analysts said PdVSA will have trouble maintaining the same operating standards without enough specialized personnel, and production could decline over the medium term.

This could have led Conoco to think it has increased negotiating power over PdVSA in the final stages of contract talks.

But such technical limitations have not stopped PdVSA before in its quest to have "full sovereignty" over its oil wealth. Output is in decline at both fields PdVSA took from ENI and Total last year. Regardless, Chavez continues to applaud the takeovers as victories of his 21st Century Socialism.

Conoco, unlike the other Orinoco players, had no assets at stake last year during the first stage of Venezuela's oil nationalization, when Ramirez took control of 32 conventional oil fields in drawn out negotiations.

At that time, Exxon, anticipating a showdown with Ramirez, sold its stake in a small oil field in late 2005 before the final phases of negotiations. This time Exxon has been more accommodating with its Orinoco project, entering the last stage of talks with Ramirez and Chavez over the 120,000-barrel-a-day Cerro Negro venture.

Conoco, however, has more than double the output of Exxon's Cerro Negro in the Orinoco, making the stakes even higher in its gamble with the government.

"For Conoco, leaving is not an option," the veteran oil executive said.

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