Focusing on the proposed Hydrocarbons Bill and the framework analysis described earlier, the reforms are a positive development, but further details are required to understand how they will be implemented.
This chapter takes a closer look at a revised December 2020 version of a proposal for a new Hydrocarbons Bill – originally submitted to Venezuela’s National Assembly in October 2020 – analysing its main institutional, legal and fiscal reforms. While most policymakers agree that the current framework has severely hindered activity in the oil and gas sector for many years, there is not necessarily an agreement on the extent of the required reforms. Throughout 2019, the National Assembly debated two options: a short-term amendment of existing laws to improve conditions and fiscal terms for investors but to retain the underlying institutional and legal framework; the second option was a long-term institutional, legal and fiscal overhaul that would rebuild the sector’s governance and improve competitiveness. The current version of the Hydrocarbons Bill could signal a political compromise by introducing deep institutional and legal reforms but incorporating several short-term amendments under a transitory regime. Enaction of this bill would require a political transition as the National Assembly elected in December 2020 has already signalled its intention to discard this bill and work on drafting different reform legislation. Regardless of the political changes, lessons that can be taken from the analysis in this paper are also relevant for future reform efforts.
The first reform outlined in the Hydrocarbons Bill is to consolidate the oil and non-associated gas sectors under a single regulatory regime. As the bill aims to create a general framework, further regulations can be expected to address more specific technical and contractual issues.
In terms of sector governance, the Hydrocarbons Bill proposes to separate the policymaking role under the Ministry of Petroleum from the regulatory role of a new independent agency, the Agencia Venezolana de Hidrocarburos (AVH). This reform seems to follow the models in Brazil, Alberta and Mexico where a technical agency oversees the sector and administers the contracts to extract hydrocarbons. The AVH could also strengthen Venezuela’s weak institutions for the oil and gas sector, a concern expressed by potential new investors.
The AVH could also strengthen Venezuela’s weak institutions for the oil and gas sector, a concern expressed by potential new investors.
The proposed specific functions of the AVH have evolved during discussions within the National Assembly. Early versions envisioned a very independent and ambitious agency that would regulate all activities of the oil and gas industry as well as control all the allocation processes of oil and gas fields – isolated from the political control of the government. Successive versions of the Hydrocarbons Bill have still granted operational autonomy to the AVH but progressively reduced its scope, assigning further functions to the Ministry of Petroleum and the National Assembly. For example, the Ministry of Petroleum would be responsible for selecting the areas to be offered in any future bidding round as well as for regulating all downstream activities and the domestic market. A new government agency controlled by the Ministry of Petroleum would enforce competition and regulate trade practices for downstream natural gas activities.
This evolution could be the result of a more realistic assessment of the actual capabilities of a new state agency, which may not have all the technical or financial resources needed. Other countries’ independent regulators also share some roles with different state agencies. On the other hand, the recent changes also indicate that the proposed AVH’s role will hinge on the balance struck between the different interests and stakeholders, furthering the risks that political compromises may hurt the effectiveness of future reforms.
The Hydrocarbons Bill proposes to maintain PDVSA as a state-owned NOC, although it would no longer be the main actor in the sector. This signals that private companies will play a central role in operating all activities throughout the oil and gas value chains. This is to be expected after PDVSA’s poor performance and consistent with the goal of maximizing FDI. The Hydrocarbons Bill, however, gives little indication of how the state would address the company’s ongoing financial and operational crisis, or how its assets would be transferred to private companies. Prior versions called for a ‘Round Zero’, as seen in Mexico and Brazil, but that language has been dropped from the current iteration of the bill.
As noted, the required institutional reforms go beyond the oil and gas sector and, as a precondition, would require the re-establishment of the rule of law in the country and limits put on the discretionary power of government in policymaking, which has had disastrous consequences for the country.
Legal and contractual reforms
The Hydrocarbons Bill proposes to allow the AVH to use any type of contractual model for upstream oil or gas activities, such as service contracts, licences or PSCs. The terms of these contracts would include fiscal and other obligations for companies, lease duration, rights allocations and applicable investor protections. Most other jurisdictions analysed here have some degree of contractual flexibility, but Venezuela’s proposal seems to approach the Mexican policy of allowing the regulator to choose the best contractual option for each type of field. This policy would allow future governments to pursue different objectives without the need to go through new legal reforms, as occurred in the late 1990s or early 2000s.
While the AVH would have the authority to design the contracts, the National Assembly would need to approve the general terms before each bidding round, as well as any subsequent modifications. The bill also requires a vaguely defined verification process from the National Assembly once the AVH assigns contracts. These requirements significantly differ from the experiences of the five other countries analysed in this paper, where the legislative body of government has no specific role in this phase. The process to select a company as operator or investor usually falls within the ministry or the agency that governs the oil and gas sector, while designing the bidding terms (including which areas to offer) is in some cases a task of the government, whether through the Ministry of Finance or another entity, like Brazil’s CNPE.
Some policymakers may believe that having legislative approval on the contracts can grant further legal certainty, especially in light of the opaque contracts and deals the Maduro administration has awarded and the recent Anti-blockade Law.
The National Assembly’s role could be a disadvantage for Venezuela as it creates additional political risks for investors. Some policymakers may believe that having legislative approval on the contracts can grant further legal certainty, especially in light of the opaque contracts and deals the Maduro administration has awarded and the recent Anti-blockade Law. This law, while legally dubious under Venezuela’s constitutional law, has the potential to expand government powers to sign new oil deals and limit requirements for disclosure or accountability. But additional parliamentary oversight could also allow political actors to interfere with the technical work of the AVH, undermining the agency’s original purpose. Investors would also face relatively higher costs and longer lead times to finalize deals compared to more streamlined processes in other countries in the region that are also competing for FDI, such as Brazil and Mexico.
The Hydrocarbons Bill also proposes to introduce competitive processes, such as public auctions to assign oil and gas fields. This follows recent experiences in almost all the five countries examined in the previous chapter and can significantly improve transparency in the selection of partners and operators. The AVH would be charged with designing the bidding conditions, which would be a positive development and in line with the examples of Alberta, Brazil and Mexico. More generally, the five other countries have shown that open bidding rounds, with clear conditions and transparent criteria, can efficiently allocate fields to investors and reduce corruption opportunities, while also mitigating future legal and political risks. However, building a successful bidding programme takes time – potentially years – and policymakers should set their expectations accordingly.
The Hydrocarbons Bill allows the AVH to include international arbitration clauses to protect international investors’ rights. This is a common request from potential investors in Venezuela, especially new entrants, given the country’s institutional weakness and expropriations track record. Prior proposals, however, had much stronger language favouring international arbitration – even requiring Venezuela to re-join the ICSID after its exit in 2012. This change could signal the lack of a political consensus on offering international arbitration by instead allowing the AVH and National Assembly to rely on individual bilateral investment treaties.
Finally, the Hydrocarbons Bill proposes to open midstream and downstream activities to private competition. Investors would need to apply for special authorizations from the Ministry of Petroleum. Private investments can help develop the natural gas industry, which will mostly depend on the domestic market structure. Liberalized gas transport and distribution activities would allow investors to build the infrastructure needed to expand consumption. The Hydrocarbons Bill includes general principles for regulating the domestic gas market, such as open access for infrastructure, regulated prices and tariffs, and the unbundling of production, transport and distribution activities. These principles could be expected to receive further treatment in future regulations.
The Hydrocarbons Bill retains the basic royalty and tax system traditionally used in Venezuela but would allow the AVH to make the necessary adjustments in contracts for each project to be competitive. This reflects the experience in Brazil and Mexico where the law provides a general framework, but the final terms depend on the bidding process. The bill sets a base royalty of 16.67 per cent for oil and gas production – below the current 30 per cent and 20 per cent applicable for oil and gas projects, respectively. The AVH could also temporarily reduce these royalties to a minimum of 1 per cent to secure the viability of projects. Besides the base royalty, the effective royalty rate would also depend on the selection or bidding process organized by the AVH, under which the contracts must incorporate adjustment mechanisms.
The language in the bill indicates the goal of creating a flexible fiscal regime for oil and natural gas production. The base oil royalty, however, has no connection to international prices, raising the risk that the country retains a regressive tax system that would result in the state receiving a small share of profits under higher oil prices. Even if this mechanism simplifies collecting taxes, the result would be politically unviable, especially considering the country’s large financial needs. Venezuela, instead, would benefit from a progressive fiscal regime generating higher state revenues from the more profitable investment projects. Progressive taxes can also reduce the incentives for future governments to expropriate projects, mitigating political risks. The experience with Brazil’s Special Participation Tax or the flexible royalties used in Alberta and Mexico may provide examples of how to mitigate these risks.
Venezuela’s fiscal framework for oil and gas activities would ultimately depend on the AVH’s decisions on the type of contract used and the combination of taxes. For example, licences that rely more on income taxes and less on royalties or production-sharing agreements, where the profit split has more weight, would probably be more progressive. The contract used would also depend on the type of field and how risks are allocated between the state and oil companies. The case of Iraq illustrates how the use of TSCs can impose significant fiscal pressure in a downturn, a situation for which Venezuela will not be prepared in the foreseeable future. In this sense, the discussion of the fiscal framework should enter a larger debate on the management of hydrocarbons revenues.