Latin American Economy & Business - July 2014 (ISSN 1741-7430)

The annual accounts of Venezuela's state-owned oil company show that both it and the government are (very) short of cash.

Petróleos de Venezuela (Pdvsa), the state-owned oil company and government cash-cow, has scale by world standards. Total proven reserves of conventional and extra heavy crude oil of nearly 300bn barrels are the world's largest - and about 12% more than those of Aramco, its peer in Saudi Arabia. Just under one third of the reserves are held by joint ventures (JVs) in which Pdvsa is a majority investor.

Huge reserves, but no growth

However, as chart 1 shows, Pdvsa is not a growing business. Total crude production has stagnated at just over 3m barrels per day(b/d). Exports of crude in 2013, at just under 2m b/d, were more or less the same as in 2011. Exports of refined oil products - of about 0.5m b/d last year, have been falling. The company's refineries have been operating at near full capacity, and have not been increasing throughput.

Pdvsa's annual report for 2013 quantifies the government's (and, therefore, Pdvsa's) commitments to provide oil in support of the government's geopolitical objectives, and to service barter loans. Production dedicated to these ends has been running at about 1.0m b/d over the last three years. In effect, about one third of daily production has been pre-sold. Deliveries under these arrangements fell from 1.09m b/d in 2012 to 0.94m b/d in 2013. Requirements to supply oil to Portugal, Iran and Belarus ended in the earlier year. Deliveries to China rose from 0.53m b/d in 2012 to 0.55m b/d in 2013.

However, deliveries to other countries in the region under the Petrocaribe oil alliance dropped from 0.46m b/d in 2012 to 0.39m b/d in 2013. We suggest that this points to one (or both) of two developments, neither of which is positive. One is a slippage in demand and/or ability to pay on the part of the 17 Petrocaribe client states, which are acquiring Venezuelan oil on concessional terms (see below). The other (which we think more likely) is a reluctance and/or inability on the part of the Venezuelan government and of Pdvsa to maintain deliveries at 2012 levels.

Cutting back on the social programs

Chart 2, which looks at selected items from Pdvsa’s income statement, shows that the company's contributions to government-backed social programs have also been reduced. Contributions for social development in 2013 amounted to US$7.8bn, or about half of what they were in 2011. Net contributions to FONDEN, the national development fund, were US$5.2bn, or a little over one third of what they had been in 2011. Even so, net contributions to FONDEN, along with contributions for social development, amounted to almost one eighth of gross revenues from sales of oil and oil products. Net contributions to the Fondo Simón Bolívar para la Reconstrucción (a government-controlled fund for housing) were, last year, relatively small in the overall context of Pdvsa's operations at US$1.7bn, but significant by most other standards.

However, gross revenues have been falling, given the stagnation of output and slippage in the prices received by Pdvsa for its products.  Revenues from the sale of oil and other products were basically the same in 2012 (US$124.5bn or so) as in 2011. Subsequently, they dropped by around 9% to US$114.0bn in 2013. Lower oil prices have kept a lid on the purchases of crude oil and products that Pdvsa makes. However, production royalties and depreciation & amortisation expenses have crept upwards over the last two years or so. Most ominously, operating expenses, at US$22.5bn in 2013, were 55% higher than they were in 2011 (if marginally lower than they were in 2012). Operating expenses are among very few items in the company's income statement that are not explained in detail by a note to the accounts. They do not include exploration expenses (of US$0.2bn-US$0.4bn annually over the last three years) or sales, administrative and general expenses (of around US$4.0bn annually).

The grim truth is this: Pdvsa's gross profit from its core business of extraction, processing and shipment of hydrocarbons (i.e. the sales of oil and products less total expenses, as per chart 2) has dropped from just under US$35.6bn in 2011 to US$25.8bn in 2012 to US$16.4bn in 2013. Of course, these amounts include production royalties, but are before the payment of contributions for social development, transfers to the Fonden or income tax.

Pdvsa’s US$30bn gold mining subsidiary

However, a glance at Pdvsa's total revenues indicates that something like 15% came from 'finance income' in 2013, up from a little over 2% in 2012 and a negligible amount in 2011. An examination of the notes to the accounts shows that most of the US$20.3bn booked as finance income comes from two items.

The first of the two items is an exchange gain of US$7.8bn. Pdvsa's standard operating procedure is to hold its US dollar revenues on its own books in that currency. It only sells to Banco Central de Venezuela (BCV, the central bank) the minimum foreign currency needed to buy the local currency Bolivares that it needs within the country. This is prescribed in the Reform Law of the BCV, which has been effective since 20 July 2005.  Usually, Pdvsa is a net debtor in relation to parties within Venezuela with which it deals. In other words, it typically has net liabilities in Bolivares. These local currency liabilities include “accounts payable to the Oficina Nacional del Tesoro (ONT - the Treasury of the Bolivarian Republic); accruals payable to contractors, presented as accruals and other liabilities; accounts payable to domestic suppliers; financial debt in Bolivares and liabilities for employee benefits and other post-employment benefits from local employees.” On the other hand, local currency “monetary assets mainly consist of accounts receivable owned by [the government] and other government institutions; fiscal credits to be recovered and prepayments to contractors”.

The amounts involved are very substantial. Just before the Bolívar was devalued by just under a third (32%) in early February 2013, Pdvsa’s local currency net liabilities amounted to just over US$25.0bn. The devaluation reduced the US dollar value of the net liabilities by US$7.8bn, and this amount was booked as a gain.

The second, and larger item, was a profit of just over US$9.5bn booked from the sale of a 40% stake in a company called Empresa Nacional Aurífera (ENA). ENA was incorporated in December 2013 with equity of US$30.0bn. According to the notes to the Pdvsa accounts, “ENA is mainly engaged in exploring, developing, producing, transforming, refining, manufacturing and distributing any kind of material deriving from the utilisation of gold mines and fields at all phases”. In fact, ENA looks to be a shell company. As Pdvsa's own accounts make clear, ENA did not operate at all during 2013. As we discuss below, the valuation of ENA seems entirely notional.

This leads to another grim truth: but for the devaluation and the ENA deal, Pdvsa's profit before income tax would not have been US$23.7bn. It would have been US$17.3bn less, or US$6.4bn - a little over half of the US$11.6bn profit before income tax in 2012. Pdvsa simply is not in the position to support the level of contributions to government-backed social programs and to the FONDEN that it was making as recently as 2011.

Shuffling paper, but not cash, with the government

Several aspects of Pdvsa's balance sheet, which is summarised in chart 3, are noteworthy. The first is that the company does not appear to be highly geared.  Total financial debt, at US$36.4bn, is not particularly large. As is clear from the income statement, its cashflows are easily able to cope with the interest payments.

Accounts receivable have remained broadly constant. They were boosted by US$30.0bn, being gold exploration rights granted by the government to Pdvsa at the end of December 2013 as a part of the ENA deal. However, given that Pdvsa was unable to determine the true value of the rights, this amount was written off immediately.

The sale of 40% of ENA to the government did not result in a cash payment of US$12.0bn to Pdvsa. Rather, amounts owed by Pdvsa to the government (i.e. accounts payable) were reduced by this amount. At the end of the year, Pdvsa declared a dividend of US$10.0bn. This was not paid in cash. Rather, accounts receivable (specifically from the government in relation to oil provided by Pdvsa for Petrocaribe deliveries) were reduced by this amount.

These transactions reduced both accounts receivable from and amounts payable to related parties (i.e. mainly the government, FONDEN and other official institutions) by roughly the same amount. They ensured that the government did not have to pay US$12bn in cash for the 40% of ENA - effectively a shell company - that it purchased from Pdvsa at the end of last year. They also reduced the amount that the government would otherwise have had to pay for the oil that it needed for its Petrocaribe commitments. As noted above, profit before tax would have been just US$6.3bn last year had it not been for the devaluation of the currency in February and the ENA deal. At US$10.0bn, the dividend is much larger than would ever be contemplated by an enterprise that was operating according along purely commercial lines.

In essence, the government is squeezing Pdvsa for cash, even though the company's ability to support FONDEN and other social programs has diminished. Pdvsa is sharing some of the pain with its JV partners. The notes to the accounts indicate that these liabilities (mainly dividends from the operations) have risen from US$0.8bn in 2011 to US$1.8bn in 2012 to US$2.5bn at the end of last year.

One item in the balance sheet that is not a problem now, but which unquestionably has the potential to become one, is Pdvsa’s liabilities for employee benefits to employees, both present at past. The total liability of US$16.6bn is not particularly large in the context of total assets of US$231.1bn. However, it has grown by over 60% since the end of 2011.

Part-funding (inefficient) capex by squeezing the trade creditors

Pdvsa's cash flow statement, summarised in chart 4, confirms the overall picture of a financially stressed company. Capital expenditure (Capex) in 2013 amounted to around US$23.3bn. As we have seen, this was not sufficient to increase output. Depreciation & amortization has been rising, but at around US$8.3bn is much less than the capital expenditure. Given that net new borrowings were just over US$4.0bn, about US$9bn came from other all other sources. Those sources included a US$7.9bn rise in trade accounts payable. Meanwhile, Pdvsa has been husbanding cash by allowing increases in tax and other liabilities (or being permitted to do so).

In short, Pdvsa and its shareholder, the Bolivarian Republic of Venezuela, are comrades in adversity. Pdvsa's annual capital expenditure of tens of billions of US dollars is barely maintaining production volumes. Cashflow is being reduced by the relentless rise of operating costs (and, over the last two years, the fall in the price of crude oil -from US$100/barrel to US$98/barrel - and gas - from US$5.24 to US$3.97). Pdvsa already has made a significant reduction to its contributions to FONDEN and to other social programs. It is squeezing its suppliers and its JV partners.

For its part, the government has reduced the amount of money that it has to pay Pdvsa for oil that is used for Petrocaribe commitments. It has done that by extracting a US$10bn dividend from Pdvsa, even though the oil giant is marginally profitable and faces a number of strategic problems. The dividend would have been unjustifiable but for the US$17.3bn boost to earnings which came from two one-off events - the devaluation and the profit from the ENA deal. Central to the ENA deal was the concept that 40% of the new shell company was worth US$12.0bn in late December 2013, even though it had not commenced trading.

To date, Pdvsa has had sufficient financial strength and cashflow to shelter the government (through payments of royalties, taxes, contributions to social programs and dividends) from the generally downwards move in energy prices.

The latest data suggests that this is no longer the case. Both of the comrades in adversity are far more vulnerable to a fall in the price of oil - whether as a result of a crisis in China or some other reason - than they were one or two years ago.

• Petrocaribe Ts & Cs

Petrocaribe system allows for the purchase of market value oil from Venezuela’s Pdvsa on preferential payment terms, with a 5%-50% upfront payment (and a grace period of one to two years); the remainder can be paid through a 17-25 year financing agreement at 1% interest if oil prices are above US$40/barrel. Payment is also accepted in kind (goods and services).

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