Chávez to Heavily Tax Oil Income

| Apr. 28, 2011 |

Published by Minyanville

Looking to profit from current high oil prices, Venezuelan president Hugo Chávez announced late last week that he will charge oil companies as much as 95% on income from oil when the barrel price exceeds $100.

With the conflict in Libya and unease in many oil-producing nations, the president himself suggested that oil prices are likely to remain high. The tax is likely to bring between $9 billion and $16 billion into government coffers with the timing perfect for Chávez who is looking to invest in social projects in the run-up to next year’s presidential elections, in an attempt to bolster his core vote.

The windfall tax in 2008 called for 60% of profits to be sent toward government coffers when a barrel is above $100. The new legislation calls for 20% of income when Brent is priced between $40 and $70 a barrel, 80% when over $70, 90% when over $90, and 95% when it breaches $100.

As always, government subsidies are in effect for friendly nations such as China and Cuba. It will also not apply to domestic use, meaning that nearly half of oil the produced, thought to be 2.7m barrels a day, will not be taxed. Venezuela's 2011 budget was calculated with a baseline oil price of $40 per barrel.

The move is not likely to help the country’s sovereign debt ratings, according to the Wall Street Journal. The government’s lack of transparency coupled with its likely increase in spending before next year’s election “are likely to continue to weigh on the oil-rich country's ratings,” according to Moody’s and Fitch. Moody’s puts the sovereign credit rating at B2, five notches below investment grade, while Fitch rates the country at B+, four notches into junk status.

The concerns are leveled at the diversion of money to Fonden, a social development fund set up by Chávez. The fund is "off-budget" and so state oil company Petróleos de Venezuela is likely to contribute less to the central bank.

"Due to the opacity and lack of transparency, it's difficult to discern the financial strength of Venezuela," Erich Arispe, a director in Fitch's sovereign ratings group, told the Wall Street Journal. "In the past, high oil prices led to higher growth and higher central bank reserves. Now, higher oil prices don't really translate into that.”

The state oil company is already under considerable criticism for its lack of transparency and falling oil production. With fatter profits now being channeled away from the central bank, investors will be even more concerned about the country defaulting on international debts.

"This tax change is likely to have a chilling effect on private sector investment," Boris Segura of Nomura said. "This new tax regime borders on confiscation whenever oil prices surpass $70."

JPMorgan has recommended that investors keep away from Venezuela’s high-yield debt, citing concerns over the central bank’s declining foreign reserves. Coupled with the oil windfall tax, the bank said in a note to clients that it expects the coming months to increasingly challenge bondholders.

Also worrying the bank is Petróleos de Venezuela’s dispute with Exxon Mobil (XOM), after the company’s oil project was nationalized by the Venezuelan government in 2007. It is thought that the World Bank will order that $7 billion is paid in compensation.

Perhaps in an attempt to sweeten voters, the minimum wage in Venezuela is set to rise 26.5%, beginning on International Workers’ Day, May 1. The first 15% hike will take place then with a second 10% rise in September. This will bring the minimum monthly salary to $360. Public employees were also given a whopping 45% raise.

While high, the increase is still lower than the country’s inflation rate of 27.4% in the year to March. It is also lower than minimum wages in Argentina and Chile. The wage hike is expected to raise inflation figures, and newspapers in Caracas complain that it is still not enough to buy food for the average family.

While they may not be able to afford food, a Gallup poll recently placed Venezuela in sixth place (of 124 countries) in a well-being poll. This prompted a quick response from Chávez: “This means we are on the right path, even with all the errors that we have to put right. Nonetheless, this is the right path, the path of socialism, the redistribution of income."