Venezuela's War Talk Suggests More Trouble For Andean Oil

Venezuela's President Hugo Chavez raised the possibility of a war between Andean neighbors Sunday in a heightening of political tensions that may spell trouble for the oil industries of two OPEC member nations.

Venezuela and Ecuador, Latin America's members of the Organization of Petroleum Exporting Countries, could end up in a war against Colombia, Chavez warned, as he broke diplomatic relations with its neighbor and sent troops with tanks to guard the border.

Tensions came to a boil a day after the Colombian military stepped onto Ecuadorian soil to kill the second most senior rebel commander for the Revolutionary Armed Forces of Colombia, or FARC, a maneuver that also drew a strong rebuke from Ecuadorian President Rafael Correa, who called back his ambassador in Bogota.

"We don't want a war...(But) if we have to give (a war), we will, and it will be in Colombia," Chavez said during his radio and television show as he publicly ordered the troop deployment and the closing of the Bogota embassy. Ecuador "will always count on Venezuela for anything under any circumstance," Chavez said. The troops, he said, will guard against similar attempts to enter Venezuela.

Military and political tensions in the region may mean difficult days ahead for Venezuela's and Ecuador's embattled oil industries, in need of attention. State oil company Petroleos de Venezuela or PdVSA, is now facing a battlefront of its own in a multibillion dollar compensation dispute with Exxon Mobil Corp. (XOM), one of the world's most powerful oil companies.

For Ecuador, the spat comes days after the country was forced to declare force majeure for part of its oil exports, following the failure of a state-run pipeline. Under force majeure, an oil producer notifies clients that orders will not be fulfilled because of a problem that goes beyond the producer's control.

An official for Venezuela's oil ministry declined to comment. Ecuador oil industry officials could not immediately be reached.

Oil production in both nations has problems that need to be addressed. Venezuela's industry continues to struggle with underinvestment, as PdVSA devotes billions of dollars of company funds to finance Chavez's social spending plans. Venezuela's aging infrastructure, coupled with higher production costs, have constrained PdVSA's ability to raise output.

Some of Ecuador's state-run oil infrastructure has also come under scrutiny for recurring problems, particularly the SOTE pipeline. To alleviate the problems, Ecuador is considering transporting oil through OPC, a privately-owned pipeline, a situation that has already threatened to bring down production.

Venezuela and Colombia already froze a joint gas pipeline deal due to recent tensions, but an interruption of commercial relations that could follow would presumably worsen food shortages in Venezuela, making that a priority over oil investment. As food staples with price controls have disappeared from store shelves, Chavez has responded by forcing PdVSA to create a food distribution network, further stretching the company's responsibilities beyond its core oil production mandate.

Chavez failed to mention what his moves would mean for trade during his Sunday appearance, but in previous instances of diplomatic spats with Colombia, trade between the neighbors has seen some obstacles at the border.

In a worst-case scenario that fighting between countries actually broke out, however unlikely, it's unclear what that would do to world oil prices, which are now close to historic levels, or what kind of risk premium energy markets would place on oil production in the region and in Venezuela, which holds some of the largest crude reserves in the world.

Even now, however, a high-profile dispute with Exxon has become a war of sorts in its own right that has demanded Venezuela's full attention.

Exxon has filed for arbitration proceedings after Chavez nationalized four oil ventures in the Orinoco basin last summer. PdVSA took majority stakes in heavy oil upgraders, the jewels of its oil industry, and offered foreign companies minority stakes, contractual terms that Exxon and ConocoPhillips (COP) rejected.

Earlier this year, Exxon obtained court orders to freeze more than $12 billion of PdVSA's assets in the U.S., Europe and the Caribbean. PdVSA is now fighting the move in several hearings in London, an issue that Venezuela has vowed to bring up during this week's OPEC meeting in Vienna.

Copyright (c) 2008 Dow Jones & Company, Inc.

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