NATIONALIZATION1 TRENDS IN THE OIL INDUSTRY2 (ENGLISH AND SPANISH VERSIONS)

• Jurisdiction: Derecho Internacional

Mining and Oil and Gas Law, Development, and Investment - Book 2
(Apr 2007)
CHAPTER 22C
NATIONALIZATION¹ TRENDS IN THE OIL INDUSTRY² (ENGLISH AND SPANISH VERSIONS)
Gabriela Rachadell de Delgado
Natalija Vojvodic
Attorneys
Macleod Dixon, S.C.
Caracas, Venezuela

A. Historical background

The first nationalization affecting the oil industry in the Bolivarian Republic of Venezuela ("Venezuela" or the "Republic") took place in 1976, but major legal changes have recently been enacted that have restricted private investors' participation in this industry.

Prior to the nationalization of August 29, 1975, the Venezuelan oil industry was managed on a concession basis, whereby private companies explored for and produced hydrocarbons, paying royalties and taxes to the Government. After the nationalization, Petróleos de Venezuela, S.A. ("PDVSA"), a company owned by a single shareholder, the State of Venezuela, acquired all of the rights of the former concession holders. Under the Organic Law that Reserves to the State the Industry and Trade of Hydrocarbons, commonly referred to as the Nationalization Law, PDVSA was granted monopoly rights over exploration, production, transportation, storage, refining, exportation and retailing of all hydrocarbons. Article 5 of the Nationalization Law allowed for the execution of Operating Services Agreements and Association Agreements, also providing the legal basis for such Association Agreements, namely At-Risk Exploration, Profit-Sharing Agreements and Strategic Associations. The Operating Services Agreements, on the other hand, were governed by Venezuelan private contract law, except for taxation matters, which were subject to the provisions of the Nationalization Law and the 1943 Hydrocarbons Law.

During the early 90s, under the Oil Opening Process conducted by PDVSA, commonly referred to as the Apertura, Venezuela embarked on a policy shift aimed at attracting private investors to the oil industry. Within the framework of the Apertura, 32 Operating Services Agreements, eight At-Risk Exploration and Profit-Sharing Agreements from which only three have survived, four Strategic Associations were executed between different affiliates of PDVSA and private investors and one Association Agreement for the production of Orimulsion.

Operating Services Agreements were, in essence, regular contracts for the provision of services by a third party. In At-Risk Exploration and Profit-Sharing Agreements, a PDVSA subsidiary, Corporación Venezolana del Petróleo, S.A. ("CVP"), entered into joint-venture agreements with winning bidders for at-risk exploration areas. In these agreements, the third party partners assumed all exploration risks, and if a commercially viable hydrocarbons discovery was made and was declared as such by the private investors, CVP had the right to participate in the profits of the find. Finally, Strategic Associations and the Orimulsion

[Page 22C-2]

Association Agreement covered the exploration, extraction, gathering, transportation, storage, upgrading (or refining or industrialization) and commercialization of hydrocarbons. Under these agreements, in some cases PDVSA affiliated entities joined specially incorporated joint-venture companies and in other cases entered into joint-venture agreements, in all cases as a shareholder or partner with a minority interest that oscillated between 30 and 49.9% of the capital stock, the other partners being private investors.

On January 1, 2002, the current Organic Hydrocarbons Law ("OHL") entered into force. Pursuant to Article 9 of the OHL, the exploration, extraction, gathering, initial transportation and storage of hydrocarbons are defined as primary activities. Moreover, pursuant to its Article 22, all primary activities are reserved and can only be carried out (i) directly by the Venezuelan State; (ii) through 100% State-owned companies; or (iii) by a mixed company ("Mixed Company") in which the State's participation as shareholder must be greater than 50%. Therefore, private participation in primary activities may only occur through Mixed Companies incorporated with a State equity of more than 50%.

On the other hand, pursuant to Articles 10 and 50 of the OHL, refining and industrialization activities can be performed by the State or private entities, either jointly or separately. The difference between these two activities is relevant because they have different entitlement procedures. While the right to perform refining activities is granted through a license régime, the right to perform industrialization activities is granted through a permit régime.

Commercialization activities of natural hydrocarbons are reserved to 100% State-owned companies. The OHL expressly states that Mixed Companies carrying out primary activities can only sell the natural hydrocarbons they produce to 100% State-owned companies.

With respect to the marketing of hydrocarbons derivatives, the OHL provides that the Executive, by Decree, is entitled to reserve the commercialization of certain hydrocarbons derivatives to 100% State-owned companies. If the Executive does not reserve the commercialization of a specific hydrocarbon derivative, it can be commercialized by private entities.³

The OHL did not establish the obligation to convert previously executed oil opening agreements into Mixed Companies.

B. Procedure for authorizing private participation under the OHL

As said, private participation in primary activities may only occur through Mixed Companies incorporated with a State equity of more than 50%. The participation of private entities, through the incorporation of a Mixed Company, requires the following:

I. Approval of the project by the National Assembly

Pursuant to Article 33 of the OLH, the National Assembly shall grant prior approval for the incorporation of the Mixed Company and the conditions that will govern the performance of primary activities ("Conditions"), to which effect the Ministry of the People's Power for Energy and Petroleum ("MENPET") shall previously inform the National Assembly of all

[Page 22C-3]

circumstances pertinent to such incorporation and Conditions, including the special advantages provided in favor of the Republic, such as an increase in the royalties, contributions or other considerations established in the OHL, the use and handing over of new and advanced technologies and the granting of scholarships, technical training and other human resources development opportunities. The aforementioned article also establishes that the National Assembly may modify the Conditions proposed by MENPET or establish any conditions that it deems appropriate.

The Conditions shall comply with the following minimum requirements:

(a) A 25 year maximum duration, renewable for a period to be agreed upon by the parties, but which shall not exceed 15 years. This extension shall be requested after half the term granted to perform the primary activities has elapsed and five years before its expiration.

(b) Indication of the location, extension and shape of the area where the activities are to be carried out.

(c) The following clauses must be included in the Conditions and, if not included, they are deemed incorporated to such Conditions:

(i) The land, facilities, accessories and equipment which are an integral part of it and any other assets acquired for the performance of the activities, whatever their nature or acquisition title, shall be maintained in good condition, so that they may be handed over as property of the Republic, free of liens and without any indemnification whatsoever, upon extinguishment for any reason of the rights granted, so as to guarantee the continuity of the activities, if such is the case, or their termination with the least economic and environmental damage possible; and

(ii) Doubts and disputes of any nature which may result from the performance of the activities and that cannot be amicably settled by the parties, including arbitration in the cases permitted by the law governing the matter, shall be decided by the competent Courts of the Republic, in accordance with its laws and no foreign claims shall arise for any reason or grounds whatsoever.

II. Selection process or direct award

Private entities wishing to participate in the primary activities through the incorporation of a Mixed Company may be selected (i) through a selection process carried out by MENPET or, (ii) directly, due to public interest reasons or special circumstances related to the activities, with the prior approval of the Council of Ministers.

[Page 22C-4]

III. Assignment of the geographical areas by MENPET

According to Article 23 of the OHL, MENPET shall set the boundaries of the geographical areas where the Mixed Companies are to perform the primary activities, which areas shall be divided into lots with a maximum extension of one hundred square kilometers (100 km²).

IV. Transfer of the right to perform primary activities

According to Article 24 of the OHL, the Executive will transfer to the Mixed Company, by Decree, the right to perform primary activities. This article also establishes that the Executive may assign to the Mixed Company the ownership or other rights over real or personal property of the private domain of the Republic that is required for the efficient performance of the primary activities.

Pursuant to Article 36 of the OHL, this transfer instrument may establish special advantages in favor of the Republic, such as an increase in the royalties, contributions or other considerations established in the OHL, the use and handing over of new and advanced technologies and the granting of scholarships, technical training and other human resources development opportunities.

Also, according to Article 24 of the OHL, the National Executive may revoke the right to perform primary activities if the Mixed Company fails to comply with its obligations in such a way that it...