Trapping Investors in Venezuela

Trapping Investors in Venezuela

The foreign investors that come to Venezuela generally do so to tap into the enormous rates of return to be had in the country’s energy sector. With one of the world’s largest oil reserves and a government craving the technology and the capital to extract it, the South American country is rife with opportunity.

However, such high returns also come with extremely large risks: an overbearing regulatory regime, no judicial protection, a government that puts politics above business, and rulers that frequently seem to act on a whim.

Much of Venezuela’s oil sector is, to put it frankly, in diapers. According to the U.S. Energy Information Agency, in 2012, Venezuela had 212 billion barrels of oil in proven reserves. This is only topped by Saudi Arabia’s 267 billion barrels. Yet, much of this wealth remains untapped.

Whereas Saudi Arabia pumps almost 12 billion barrels of oil per day, Venezuela is only pumping a fifth of that amount. The gigantic Orinoco oil belt in southeastern Venezuela, which holds much of the country’s reserves, is not being exploited to its full capacity.

This unfulfilled potential also lurks in other areas of the economy. For example, Venezuela has the largest proven reserves of natural gas in South America, and yet it exports none of it. Much of this has to do with lack of technology. For example, neighboring Trinidad and Tobago — which has opened up to foreign firms that brought with them significant technological advances — is a natural gas exporting powerhouse.

Since high oil prices would more than enough cover production costs, the returns on investing in oil are there for the taking — provided you get on the government’s good side. In hyper-politicized, revolutionary Venezuela, the only institution left standing is the presidency itself.  If you get in the strongman’s good graces, he will be willing to give you assets and a juicy partnership. This ensures that the courts will do your bidding, you will have no labor problems to speak of, and you will not be hassled by regulators.

This, however, comes with a huge caveat. Similarly to being in business with the mob, things can change on a dime. When you’re in the good graces of the people in power, things are very, very good. When you’re out of favor, you end up "sleeping with the fishes."

ConocoPhillips learned this the hard way.

In 2007, ConocoPhillips — then a partner of state oil giant PDVSA in exploiting the Orinoco oil belt — found it had fallen out of the good graces of the ruling clique. Then-President Hugo Chávez nationalized the company’s assets without suitable compensation, so ConocoPhillips decided to sue Venezuela in the World Bank’s International Center for Settlement of Investment Disputes (ICSID), an international court that handles these issues.

The three-judge panel ruled against Venezuela, deciding that Venezuela had indeed seized ConocoPhillips’ assets without due compensation. Curiously, it based its ruling solely on an obscure International Treaty Venezuela signed with the Netherlands in 1991 which said, roughly, that any Dutch national could bring claims regarding nationalization to the ICSID unilaterally. Luckily for ConocoPhillips, it had transferred its stakes in the joint venture to its Dutch subsidiaries a few years prior to the seizure of its assets, so this obscure treaty protected it.

In its ruling, the panel observed that Venezuelan law does not allow for international arbitration practices, but that the Netherlands treaty does. The damages phase for Venezuela is ongoing, and legal scholars have stated that any assets Venezuela holds in member countries could be used to pay for damages. Venezuela stands to lose much from this process.

Whether it was luck or strategy, an obscure investment treaty from 1991 was the only thing that saved ConocoPhillips — and that speaks volumes about the risks facing foreign investors in Venezuela. Venezuela’s laws are so arcane that investors require an international tribunal to protect them; internal legislation does nothing to protect foreign investors from being expropriated. Venezuela is the country with the second largest haul of cases brought before the ICSID for precisely that reason. Venezuela is not happy about this, and it has made it clear that, from now on, anyone interested in investing in the country will have subject themselves to the country’s notoriously corrupt courts. It has also repeatedly denounced the Netherlands treaty, and withdrawn from the ICSID.

Venezuela needs foreign investment, and it gets very little of it. Without foreign investment, Venezuela will not fully realize its potential and its economy will miss out on a chance for significant growth — this at a time when the country is suffering painful shortages. By the time production ramps up, oil prices may have reverted to the mean, and Venezuela will have lost a significant opportunity. In order to change this, it needs rules that protect investors’ assets. It needs to see foreign investors as partners and welcome them instead of leaving them out in the cold.

If Venezuela’s rulers do not get this into their heads, investing in the country will remain an extremely risky endeavor.

Juan Nagel is the Venezuela blogger for Transitions, co-editor of Caracas Chronicles, and author of Blogging the Revolution. Read the rest of his posts here.