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Venezuela: Why CITGO should not be sold

By Oliver L Campbel |

04.02.05 | There is a misconception that CITGO was bought to increase earnings by expanding into the USA. In fact, the downstream part of the business produces low earnings since the large profit is made upstream from crude production. The acquisition was defensive and undertaken to protect the sale of some 400,000 b/d of Venezuelan heavy oil which at the time was difficult to sell without giving large discounts.

The Oil Minister has three main complaints about CITGO which he believes make it an unprofitable investment:

1) Sales by PDVSA to CITGO are made at a discount because of the formula pricing mechanism which was adopted.

2) Sale prices at the pump are lower than those charged by competitors and so CITGO is being “robbed” by the USA consumer.

3) CITGO has not contributed enough in dividends to PDVSA’S consolidated earnings.

Let me explain why I believe none of these is a cause to sell off CITGO.

The pricing mechanism was meant to ensure CITGO did not make a loss and was part of the deal to obtain loan financing. A large part of the loans has been paid off and the remaining ones, which total $1,279 millions, can either be renegotiated or paid and replaced by new financing without the pricing restrictions.

The fact is the problem with third parties can be solved without too much difficulty and PDVSA can charge CITGO what they consider are arms-length prices. The only proviso is that, with the higher prices, CITGO does not get into a loss making position. I cannot believe the discount could be as much as $4 a barrel but, even if it were, the effect on CITGO’S net income would be less than half its estimated net income for 2004. The figure is calculated as follows: 400,000 b/d x 365 x $4 x 0.65 (after tax) = $380 millions.

I should make it clear those who believe PDVSA sold oil at a discount because the tax rate in the USA is lower than in Venezuela are quite wrong. If PDVSA reduce oil prices by $500 millions, the whole amount is lost to the nation as income tax (50 percent) and net earnings (50 percent). But the gain to CITGO is only $325 millions (65 percent) since $175 millions (35 percent) are lost to the USA treasury in income tax. It makes no sense purposely to reduce prices because of this “tax leak.”

The claim about pump prices is difficult to confirm or refute since gasoline prices vary between regions in the USA. They can also vary for other factors, for instance, a service station which is well designed, looks clean, has good access, plenty of bays and excellent service may be able to charge a few cents more. Those many miles from the next service station or on toll roads have a privileged position and can charge more. But the motorist is not stupid; he knows one gasoline is like another (except for additives) and will shop around.

One service station cannot be far out of line on price with its competitors in the area. For instance, if a gallon of gasoline is selling at $1.90 and one company in the vicinity decides to lower the price to $1.80, what will happen? Right first time! There will be a line of cars half way down the street. The other companies will have to follow suit or lose business. My point is the scope for charging different prices in the same area is strictly limited, and I trust the minister will acknowledge CITGO’S prices have to keep in line.

Incidentally, there seems to be some criticism that CITGO do not own the service stations that carry their emblem. But it has never been a secret that the services stations are tied to CITGO through contracts to sell the latter’s products but not through ownership.

This is the norm in the USA as, indeed, it was when I was the Finance Manager of Shell’s retail marketing in Venezuela. We owned a few of the very largest stations, leased others, but the majority belonged to the operators. I believe PDVSA have some 700 service stations in Venezuela but actually own only about 30 of them. It makes no sense to spend large sums acquiring real estate.

As regards the third point, CITGO paid dividends of $500 millions in 2003 and a further $400 millions in December 2004. Luis Marin, the outgoing chief executive of CITGO, recently announced the company expects to make a net profit of around $1,000 millions in 2004 so there will be scope for another large payment in 2005. If CITGO’S previous record on dividend payment was not good, it was because the funds were needed for new investment. That situation has changed and CITGO will be able to continue paying dividends in future.

I don’t know if PDVSA carries out long-term planning against various scenarios as it did in my days, but it is a mistake to assume things will continue as they are. On the contrary, if something is certain it is that things will change. The following example illustrates this.

When I was a young man, it was common on a Sunday afternoon to see mum and dad proudly pushing the new baby in a perambulator. Firms making them thought people will always have babies so there will always be a demand for prams. That seemed a reasonable assumption. However, as people started buying cars they wanted a push-chair they could fold up and put in the trunk of the car so the firms which relied on selling prams went out of business.

So I feel it is short-sighted to sell CITGO just because right now it is not difficult to sell heavy crudes. We do not know what is going to happen next year let alone in twenty years’ time. The CITGO outlet assures the sale of over 400,0o0 b/d and is the only large, integrated business from production to the ultimate consumer that PDVSA has.

Not only is this an insurance against future setbacks, but gasoline prices in the USA are at present at the highest level they have ever been, hence CITGO’S excellent earnings for 2004. This favourable situation looks like continuing in 2005 so it is hardly makes sense to think of selling CITGO. In addition, the USA has by far the largest gasoline market in the world and there is every opportunity to increase this lucrative trade.

In my opinion, CITGO can become an excellent business, providing adequate profits from which to pay dividends, and I can see no economic justification for selling it. If the reason is political in order to withdraw from the USA, that is another kettle of fish.

Oliver L Campbell, MBA, DipM, FCCA, ACMA, MCIM was born in El Callao in 1931 where his father worked in the gold mining industry. He spent the WWII years in England, returning to Venezuela in 1953 to work with Shell de Venezuela (CSV), later as Finance Coordinator at Petroleos de Venezuela (PDVSA). In 1982 he returned to the UK with his family and retired early in 2002. Petroleumworld not necessarily share these views.

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