Re: Venezuela Briefing Paper

My comments in blue below.

Robert Johnston@ECT
01/31/2001 08:40 AM
To: Alberto Levy/SA/Enron@ENRON
cc: Scott Tholan/Corp/Enron@Enron, Emilio
Vicens/ENRON_DEVELOPMENT@ENRON_DEVELOPMENt

Subject: Re: Venezuela Briefing Paper

Alberto- thanks for the quick-turnaround on your comments. As I said on the
phone last night, we are working on a short deadline as well. Before making
the changes you suggest, it would be helpful to get clarification on a couple
of points:

1. Objective of the document- our group's task is not to promote the LNG
Project. I think that Mike McConnell and his team want multiple data points
on this issue, including both ours and yours. We were asked specific
questions about political, economic, and regulatory risk in Venezuela, first
by the RAC Group and then by Mike McConnell. At the same time, we want to be
fair and accurate, which is why you and Emilio are involved in the process.
That said, I will review the document to ensure that it is not excessively
skewed toward oil issues (although Emilio will note there have already been
major changes from the first draft). I will also add your comments to the
"Energy and the Venezuelan Economy" from the first paper.

2. Gas Law vs. Hydrocarbons Law. I seem to be getting a little bit of a
mixed message here- either we know what will be in the new law or we don't.
Our sources have said that it will "synthesize", but not fundamentally change
the Gas Law (then why bother), essentially applying the gas royalty tax
structure to liquid hydrocarbons. I believe that what the new law might say
is that the royalty scheme for the free gas will apply to the gas associated
with oil production (which is under the scope of the Hydrocarbons Law). The
tax structure for liquid hydrocarbons is specified in the Income Tax law,
which was recently changed to reflect the current tax structure (i.e., 67.7%
for oil, and 34% for gas, both associated and free). I haven't heard any
rumors about changes in the the Income Tax law.

Two issues here seem important-- first, the fact that there is uncertainty
about the law's contents. Yes, there is, but the promise that it will be
circulated among investors, and that their opinions will be seriously
considered, mitigates those risks. Second, the apparent fact that the
"sliding scale" for gas royalties might be eliminated. I hope the point above
clarifies the issue. I will definitely add your point about the plans to
circulate the law to investors for review and would appreciate clarification
on these other points.

3. PDVSA as a policy-maker- tough one here. Please look at the incentives
here. Who has incentives better aligned with Enron? My biggest concern about
PDVSA and MEM is the fact that there has been delays to the auctions for the
upstream gas projects. Shouldn't Enron look at this as a possible problem
for our project and a sign of possible regulatory delay/confusion? I strongly
believe that the regulatory risks for the LNG projects are less significant
than what might be expected. First, since this is an export project, domestic
regulations do not apply. The terms and conditions, prices, volumes,
guarantees and penalties are governed by the contracts between Enron and
PDVSA. Participation by the Ministry is to approve these contracts. The only
significant regulatory risk is that once exports start, if the domestic
market is not satisfied for lack of gas, the goverment abrogates the contract
(this was the case for Panama-Colombia pipeline, for example. We successfully
removed this possibility.) This scenario, given the abundant reserves, is
unlikely however, see for example the Bolivian case. I reject the notion that
the government is trying to setup investors. Naivete, perhaps; lack of
experience, all of the world; but no bad intentions here.

4. MEM as policy-maker, PDVSA personnel and ENAGAS- I think that we
fundamentally agree on these points and I will add your comments about the
experience of Enron people with PDVSA and with respect to ENAGAS "being
headed in the right direction." With respect to gas royalties, Emilio left
me message indicating that there was uncertainty concerning how they will be
calculated. As I understand (I'm not saying that I agree), royalties will be
calculated the following way: Independently of what Enron pays to PDVSA for
the gas, the royalty will be imposed at the hub price (MEM envisions three
hubs in Venezuela). The relevant hub will be Anaco. From that hub price, all
the costs to take the gas to the hub such as gathering, processing and
transportation, will be substracted (and not added!) This will fix the
royalty at the well head gas. Multiplied by the volume, ala, the amount of
royalties to pay. This methodology should be out in about a month. Again, I
think that it is important to point out these kinds of uncertainties to the
EGM executives reviewing the deal. Emilio also mentioned that the royalties
will be paid by the gas supplier to Enron--but wouldn't these costs
ultimately be passed through to Enron? Help me clarify this point.

5. Political/Economic paper- congrats for your superb comments here, which I
accept virtually unchanged. The only questions I have concern inflation
(which I will revisit with my contacts for the Institute of International
Finance in Washington) and the telecoms law. Your estimates of inflation are
in line with our expectations. With respect to the telecoms law, what was the
timing of its passage? Depending on how you count because it was in the works
for a long time, but debates on the law that was finally passed lasted about
a year. I must admit that there was a lot of pressure to pass the law because
the concession to the basic telephone service monopoly was about to expire
and therefore the law received fast-track to be approved in time for the
introduction of competition.

6. Experiences of other firms--we have specifically been asked to look at
this question. All the majors, except ExxonMobil (Shell has marginal
involvement but has significant investments in gasoline distribution) in the
operative and profit-sharing agreements. For example, BP-Amoco is deeply
involved. Chevron has the largest oil field in Venezuela (100.000 bpd). All
the majors, in one way or another have significant investments in Venezuela.
I any event, the pressure to renegotiate the contracts (except the
Williams-Enbridge, who's terms were grossly beneficial to them and most
people agree that the country was being ripped off) come from the investors.
Can you shed more light on where you think we are being "speculative"?
"However, companies like Shell are likely to stay away and pursue only
technical studies over the next several years waiting the next down cycle for
the economy";..." It is important to note that the question of gas tariffs
are seen as a low priority by the Chavez government, which views oil exports
as the easiest and most lucrative source of revenue for the state. The
all-encompassing goal of expanded fiscal returns from energy production and
exports centers around oil." A perceived gas deficit, the need for
additional gas to compensate pressure loss at the wells, the realization that
gas is an important component in the strategy to industrialize the country,
is creating pressures within the government to finally get the process going.
Relevant people is working hard, world class consultants have been brought
onboard. We believe there's a real chance that the gas bidding rounds will be
completed this year.

Let's take one more crack at this this morning before we submit our final
paper. I sincerely appreciate your efforts on short notice.

Thanks again,

RJ

Alberto Levy@ENRON
01/30/2001 09:44 PM
To: Robert Johnston/HOU/ECT@ECT
cc: Scott Tholan/Corp/Enron@Enron, Emilio
Vicens/ENRON_DEVELOPMENT@ENRON_DEVELOPMENt@ECT, Guido
Caranti/ENRON_DEVELOPMENT@ENRON_DEVELOPMENT, Richard Shapiro/NA/Enron@Enron
Subject: Re: Venezuela Briefing Paper

Robert,
Please find below my comments to your second paper on the Venezuelan Energy
outlook:
Objective of the document. The document serves as a briefing paper for a
visit that has a specific object, the promotion of the LNG Project. The
evaluation, therefore, should be made in that light, and at most in reference
to future Enron projects (basically, constrained to the gas business
downstream.) References to the Oil industry, and given the comments below, to
the Hydrocarbons Law, should be minimized, as they are of marginal
importance. The document on the political outlook, on the other hand,
sufficiently covers the implications of a reduction in oil revenues.
Gas Law vs. Hydrocarbons Law. It is not only my belief, but of many
participants in the industry, that the Gas Law will be preserved as it is and
will not be abrogated by the new Hydrocarbons Law. The source of the
confusion might be that the Hydrocarbons Law will encompass the Exploration
and Production of associated gas (gas "associated" to the production of oil.)
The other stages, as well as E&P of non-associated or free gas are regulated
by the Gas Law. Therefore, all references to this issue should be eliminated.
Hydrocarbons Law. The only copy of the Hydrocarbons Law available for review
is the original draft that was part of the set of energy laws that were
approved in 1999: Electricity, Mines and Gas. It was acknowledged that the
original Hydrocarbons Law had significant deficiencies and for this reason it
was delayed. Currently, only a petit committee is working on the new version,
basically the Ministry's Counsel and the Minister himself. A high ranking
official assured me that the draft would be circulated among investors before
approval to repeat the success achieved with the Telecommunications Law. The
draft in circulation (that BTW was very hard to find given its deficiencies),
however, clearly stipulates that it does not cover the non-associated gas.
PDVSA as policymaker. Some actions by the Chavez Administration are highly
rational and in the interests of the investors (see my comments to the
political outlook document.) For example, the fact that PDVSA is loosing its
ability to set policies is, in theory, appropriate. It must be recognized
that PDVSA, as a monopoly of the Venezuelan Oil and Gas Industry, behaves
like one. Therefore, the policies it sets are in its interests and not
necessarily in the interest of the industry, or the country. An example is
tariffs for integrated operations. In this respect, the Gas Law clearly
separates the activities of production, transportation and distribution in
order to minimize the exercise of monopoly power.
MEM as policymaker. It must be acknowledged that the Ministry of Energy and
Mines lacks many tools and abilities to formulate policies, but also that
they are making a significant effort to overcome these shortcomings. MEM is
handling very complex processes, and naively believed that they could produce
all the regulations within an unrealistic time frame This lack of experience
(as well as lack of leadership, I must admit) is the source of delays.
Contract renegotiations. Contract renegotiations have been made at the
request of investors. Some investors are loosing money big time, but this is
the nature of the E&P business (no wonder we got out of it!)
Quality of PDVSA personnel. It is acknowledged that PDVSA is not the best run
company in the world and that a significant human capital has been lost in
recent years. It is my experience as well as others in Enron, however, that
there is still people sophisticated enough to do business with, as evidenced
in the complexity of the Gas Supply Agreement and the Participation Agreement
of the LNG Project and the regulations and tariffs of transportation services.
ENAGAS, the regulatory entity (not ENERGAS). It is acknowledged that ENAGAS
lacks independence from the Administration, that it is little developed and
that it is still not fully formed. I have had two meetings with the heads of
the regulatory agency explaining who we are, what we want and how we plan to
achieve it, and they responded with clear goals, admitted the conflicts they
face, and how they plan to do about them. We are not completely satisfied
with the results, but now there is a much better understanding of what each
is looking for (and more hope that the project will go forward.)
I honestly believe that the document requires significant redrafting, in
particular those aspects that highlight risks immaterial to the project such
as the behavior of the domestic market in the short term, or that are
speculative (e.g., the behavior of large foreign firms), contradictory (e.g.,
break-even of $1.200 per capita in oil revenue vs. growth in GDP with only
$500 per capita in oil revenues), and/or repetitive. I have specific comments
that I think would be more effective if I gave them to you verbally. Please
call me if you have any questions,
ALF

Robert Johnston@ECT
01/29/2001 04:44 PM
To: Alberto Levy/SA/Enron@Enron
cc: Scott Tholan/Corp/Enron@Enron, Emilio
Vicens/ENRON_DEVELOPMENT@ENRON_DEVELOPMENt

Subject: Venezuela Briefing Paper

Hi Alberto:

I work with Scott Tholan, who asked me to forward our draft briefing paper on
Venezuela. Per his message this morning we need a quick turnaround on this
paper in order to get the final copy to Mike McConnell on Wednesday. The
comments from Emilio Vicens on the original draft have been incorporated, to
clean up some technical errors and reduce the emphasis on the oil sector.

Robert Johnston
Manager, Political and Sovereign Risk
Enron Global Markets
713-853-9934