THE CORPORATE STRUCTURING OF OIL AND GAS PROJECTS IN SOUTH AMERICA: VIEWS FROM THE NORTH AND THE SOUTH
| Jurisdiction | Derecho Internacional |
(Mar 1999)
THE CORPORATE STRUCTURING OF OIL AND GAS PROJECTS IN SOUTH AMERICA: VIEWS FROM THE NORTH AND THE SOUTH
Despacho de Abogados Miembros de Macleod Dixon, S.C.
Caracas, Venezuela
FOR THE ROCKY MOUNTAIN MINERAL LAW FOUNDATION
SPECIAL INSTITUTE ON OIL AND GAS DEVELOPMENT
IN LATIN AMERICA
MARCH 17-19, 1999
INTRODUCTION
Hydrocarbon projects in Latin America do not benefit from a regulatory framework as open, clear or relaxed as the North Sea or the United States. For that reason, acquiring a good understanding of the regulatory framework is a key component of evaluating new prospects in new jurisdictions.
Changes in the regulatory framework in Latin America in the 90s have been unpredictable but have followed a general trend to relax the rules, to allow further investment and to become more competitive in attracting foreign oil producers.
This paper addresses, in the context of the main factors for an oil project, how choice of entity, form of association with partners (if any) and preferred jurisdiction, produce a final outcome: an integrated legal, tax and accounting business structure, usually involving a combination of corporate and contractual relationships. Those main factors include the parent company's tax goals, liability considerations, corporate image and the price of stock.
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10.1 VENEZUELA: STILL PARADISE?
In implementing its oil opening policy ("Apertura Petrolera"), early in the 90s Petróleos de Venezuela, S.A. ("PDVSA") sought to allow participation of foreign oil producers in many areas of the oil industry. In order to increase its production capacity but at the same time share some of the risks involved, PDVSA has sought to take advantage of anticipated medium- and long-term opportunities to place its crude oil and refined oil in the market, while benefitting from the technical expertise of national and international partners.
Regardless of the difficulties encountered by foreign oil producers in Venezuela, it is still the only South American country with demonstrated world-class reserves, and also benefits from a well-understood (if not generous) fiscal/tax regime, without the chronic or periodic political instability and civil disruptions suffered by some of its northern competitors for oil company investment.
10.2 REGULATORY FRAMEWORK
10.2.1 General
In order to present in context comments on corporate and tax structures in Venezuela, it is important first to describe the regulatory framework available to private producers, whether domestic or foreign.
Venezuela, like other countries in Latin America, nationalized its oil and gas industry in the 1970s. However, the drafters of the Nationalization Law1 provided for the future by including an "escape clause". In hindsight, it has proven wise to avoid the emotional and political controversies involved in denationalizing the strategic oil industry, in the country with the world's fifth largest reserves of medium and light oil, and largest reserves of extra-heavy oil.
Article 1 of the Nationalization Law reads as follows:
For reasons of national convenience, all matters relating to the exploration within the national territory for petroleum, asphalt and other hydrocarbons, the development of fields of the same substances, the manufacture and refining, transportation by special means and storage thereof, the internal and external commerce of produced and refined substances, and the works required for the handling thereof, are hereby reserved to the State, upon the terms set forth herein.
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Article 6 of the Nationalization Law provides that the Article 1 reserved activities will be carried out on an exclusive monopoly basis by a national oil company (today PDVSA and its affiliates).
The "escape clause" appears in Article 5 of the Nationalization Law, in two paragraphs. It provides for participation by private producers through: (i) Operating Agreements, including operating agreements to reactivate production fields (First, Second and Third Round Operating Agreements)2 ; (ii) Strategic Associations to produce crude oil and Orimulsion(R) in the Orinoco belt and offshore natural gas production3 ; and (iii) Association Agreements to explore new areas and to produce hydrocarbons under profit sharing agreements (the "Exploratory Round")4 .
In addition, the Ministry of Energy & Mines ("MEM") and PDVSA have engaged in a vigorous reevaluation of the gas industry. The policy of the Venezuelan government is now to encourage the use of methane, ethane and natural gas liquids in the internal market to free crude oil for expert. Decree 2.532 of May 20, 1998 represents an important milestone in the development of the Venezuelan legal framework for gas.5
Other laws governing oil and gas in Venezuela are less relevant for the issue of structure6 .
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With very limited specific regulation of the industry beyond these laws, it is not difficult to conclude that the rules on corporate and tax structures are the general rules applicable to any company doing business in Venezuela. One exception is in connection with certain tax matters: special rules have been passed, applicable only to hydrocarbon producers (e.g., higher tax rates and accelerated depreciation7 ).
Different tax rates apply to hydrocarbon producers under Association Agreements, as opposed to service companies, even though some Venezuelan upstream projects are structured as service contracts. True hydrocarbon producers' income is taxed at 67.7%, whereas service income (including the Operating Agreements to reactivate production fields) is taxed at 34%8 .
For that reason, when evaluating the economics of an upstream project, it becomes important to decide whether to participate in an Association Agreement, take title to hydrocarbons and be taxed at 67.7%9 (plus the hydrocarbon royalty of 16 2/3%), or, forego title to the hydrocarbons by entering into a mere services agreement but be taxed at 34%. Foreign tax credits may also have an impact on this determination. One apparent disadvantage in the latter case is accounting for reserves. However, several companies have in fact included within their reported reserves the reserves of their Venezuelan reactivation fields, even though they do not own the hydrocarbons, and have added to their annual report a footnote acknowledging this issue.10
Lastly, it is worth noting that in the projects contemplated in the second paragraph of Article 5 of the Nationalization Law (Association Agreements, including Strategic Associations), the State, through its national oil company, must retain control of the project in question11 . This limits flexibility in structure and decision-making. The State control imposed by the Venezuelan Congress in approving such associations12 sometimes include several levels of control and creates a fairly complex structure.
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10.2.2 The Exploratory Round Structure
One of these complex structures may be found in the Exploratory Round Association Agreements.
Under the provisions of the Congressional Accord approving those agreements, there are three parallel structures: the control structure, the financial structure and the operating structure.
a) Control Structure
The control structure consists of two entities that assure the State control required in Article 5 of the Nationalization Law. As emphasized by the Venezuelan Supreme Court, control is not necessarily a majority of equity. In its April 23, 1991 decision13 , the Venezuelan Supreme Court stated that Article 5:
...refers in a general way to association agreements with private entities, with such participation that guarantees State control for a specific period of time, rather than "joint venture companies", which is one type of association, but not the only one, and whose control is exercised through shareholding. In accordance with Article 5 of the Organic Law, the determining factor is the control of the agreement, which is a more legal than economic or patrimonial idea, and for this reason, it refers to "participation" without any type of classification.
In the Exploratory Round, project decisions require the approval of control entities. Depending on the nature of the decision, approval by the Control Committee and by the Management Company, or solely by the Management Company, may be required.
Control Committee
The Exploratory Round agreements provide for the creation of a Control Committee composed of four principal members and four alternates. Two principals and their respective alternates are named by the State's designate, the PDVSA affiliate known as Corporación Venezolana del Petróleo, S.A. ("CVP") and the rest are named by the private investors through common agreement. The President of this Committee is appointed by CVP and has the deciding vote in the case of a tie. The Congressional Accord and the Agreements list decisions that require the approval of the Control Committee, which are essentially those decisions which are fundamental to national interest. These decisions include: approval of evaluation and development plans; modification of the minimum
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exploratory work program; extension of operating periods; entering into agreements for the joint production of deposits; and reduction of levels of production under international treaties.14
Management Company
The Congressional Accord also provides for the creation of a Management Company in the form of a Venezuelan corporation to supervise the project. The State controls the Management Company through preferred shares which give the State veto power. Certain decisions of the Management Company, such as those made by the Board of Directors and of the Shareholders Meeting, require qualified majority. The effect of this is to require the affirmative vote of CVP. Disagreements regarding certain decisions of the...
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