Venezuela Exit Would Challenge ConocoPhillips Output Targets

Orinoco Heavy Oil Belt
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HOUSTON Jun 26, 2007 (Dow Jones Newswires)

The most immediate effect of ConocoPhillips' decision to exit Venezuela's oil-rich Orinoco river basin and seek redress through arbitration will be to challenge the U.S. oil company's short-term production goals.

Conoco, the third largest U.S. oil company by market capitalization, in 2006 garnered about 4% of its production and 9% of its oil and gas reserves from the Venezuelan heavy-oil projects, according to the company's annual report. Rather than accede to Venezuela's terms, Conoco plans to challenge Venezuela's seizure of the ventures through international arbitration, the Wall Street Journal reported Tuesday.

In a move that continued a broad restructuring of Venezuela's oil assets, state oil firm Petroleos de Venezuela said it has taken an average stake of 78% in four multi-billion dollar extra-heavy oil projects in the Orinoco belt, effectively doubling its previous average equity interest in them.

Venezuelan oil minister Rafael Ramirez confirmed that Conoco and Exxon Mobil Corp (XOM) will end participation in the Orinoco, home to vast reserves of Venezeula's heavy, tar-like oil. Of the six oil majors active in the area, Conoco was the most exposed to Venezuela, with its 50.1% stake in Petrozuata, 40% stake in the Ameriven, or Hamaca, heavy-oil project. Conoco also has a stake in Corocoro, a large, shallow-water oil field in Venezuela's eastern waters.

Analysts at Eurasia Group, a political risk consultancy, contrasted Conoco's leverage to Venezuela to the comparatively small holdings in the South American country of bigger rival Exxon. Exxon's departure "had long been rumored as a strong possibility," Eurasia said. Exxon didn't respond to a message seeking comment.

"The companies are basically saying that despite the possibility of continued profits from Venezuela, the overall operating climate is on such a downward trajectory they would rather concentrate their efforts in other areas - the Canadian tar sands being just one alternative area with similar type projects," said David Kirsch, head of the market intelligence service at PFC Energy in Washington.

Conoco shares were down $1.36 to $76.68 in early afternoon trading, a weaker performance than most of its peers among the oil majors. Exxon shares were up 41 cents at $82.78.

A Conoco spokesman didn't immediately return a call Tuesday after not responding to messages on Monday.

Although the loss of the Venezuela operations is "clearly unfavorable" for Conoco, Standard & Poors said it wouldn't affect company debt ratings, because such a possibility had already been considered. "Current strong commodity prices should allow ConocoPhillips to achieve its near-term goals, including funding its capital budget and meeting debt reduction targets, despite the loss of cash flow," the ratings agency said.

"Major Surprise"

Still, the Eurasia Group called it "a major surprise." "ConocoPhillips has strong incentives to stay in Venezuela, as both the largest private producer and the most heavily exposed company in the country, thanks to today's high global oil prices, an attractive rate of return and an acceptable break-even price of about $30 for the Orinoco projects despite facing tighter terms," said Eurasia Group, a political risk consulting firm.

But energy consultant Richard Gordon said that despite some likely near-term pain for Conoco, a departure from Venezuela would "probably be relatively negligible" over a longer horizon, in part because the Chavez administration in Venezuela has been gradually whittling away at the projects, making them less attractive investments.

Gordon, whose clients include Conoco, said the company has lined up enough other prosperous ventures to dilute the impact of the lost Venezuela business. In particular, he praised the establishment of a joint venture with EnCana Corp. (ECA) in October 2006, which ensures Conoco access to a long-term source of high-sulfur - or heavy - grades of crude for its vast U.S. refining network, similar to the tarry oil found in Venezuela.

"By doing the deal with the Canadian firm, it gave Conoco options it might not have otherwise had," Gordon said. "Conoco prepared themselves to be in a position where they could do this."

At an investor gathering in New York earlier this year, Conoco projected that 2007 output would be about 2.375 million barrels of oil-equivalent per day, essentially flat with 2006. Its two heavy oil ventures, Hamaca and Petrozuata, allotted the company 101,000 barrels per day in 2006, according to its annual report to the Securities and Exchange Commission. Analysts at HSBC valued Conoco's assets in Venezuela at roughly $10 billion.

There is recent precedent for a larger U.S. oil company opting to challenge a change in contract terms by a South American government. In May 2006, Ecuador terminated Occidental Petroleum Corp.'s (OXY) contract for an oil field amid an international arbitration claim launched by the U.S. company following a dispute.

In 2006, Occidental recorded a net after-tax charge of $296 million related to the Ecuador investment, which had accounted for 42,000 barrels per day in 2005, or 7% of Occidental's total production. In 2006, Occidental pumped 616,000 barrels of oil-equivalent, about 3% less than the amount produced in 2005.

Copyright (c) 2007 Dow Jones & Company, Inc.


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