Well of trouble for Venezuela’s state oil giant

BLOOMBERG NEWS

A sign shows Venezuelan President Hugo Chavez at the gas processing plant in the Jose in Anzoategui state. The complex, that makes refined crude from the heavy oil of the Orinoco Belt, is a joint venture between Venezuelan state owned PDVSA and foreign companies. Photo: Bloomberg.

Venezuela received an enviable honour last month: Opec said it was sitting on the biggest reserves of crude oil globally – even more than Saudi Arabia.

But the Venezuelan oil industry is also sitting atop a well of trouble.

The South American nation has struggled to take advantage of its bonanza of expanding reserves. And a scandal over embezzled pension funds at state oil company PDVSA has renewed concerns about corruption and mismanagement.

Retired workers from the oil behemoth have taken to the streets in protest. Their beef: nearly half a billion dollars of pension fund money was lost after it was invested in what turned out to be a Madoff-style Ponzi scheme run by a US financial adviser closely linked to President Hugo Chavez’s government.

The fraud case centres on Francisco Illarramendi, a Connecticut hedge fund manager with joint US-Venezuelan citizenship who used to work as a US-based adviser to PDVSA and the finance ministry.

Several top executives at PDVSA have been fired since the scandal, which one former director of the company said proved that Venezuela under Chavez had become “a moral cesspool”.

Pensioners are not the only ones still wondering how such a large chunk of the firm’s $2.5 billion (R17.8bn) pension fund was invested with Illarramendi in the first place.

The question cuts to the heart of the challenges facing PDVSA, one of Latin America’s big three oil companies alongside Pemex of Mexico and Brazil’s Petrobras.

Opec issued a report last month showing Venezuela surpassed Saudi Arabia as the largest holder of crude oil reserves in 2010. PDVSA is ranked by Petroleum Intelligence Weekly as the fourth largest oil company thanks to its reserves, production, refining and sales capacity, and it has been transformed in recent years into the piggy-bank of Chavez’s “21st Century Socialism”.

The timing of the scandal is not good for Chavez: the charismatic, 57-year-old former coup leader underwent cancer surgery in Cuba in June and is fighting to recover his health to run for re-election next year. He needs every cent possible from PDVSA for the social projects that fuel his popularity.

Multi-tasking

The company does more than pump Venezuela’s vast oil reserves. Tapped constantly to replenish government coffers, PDVSA funds projects ranging from health and education to arts and Formula One motor racing. From painting homes to funding medical clinics staffed by Cuban doctors, the restoration of a Caracas shopping boulevard and even a victorious team at the Rio carnival, there is little that PDVSA does not do.

Jeffrey Davidow, a former US ambassador to Venezuela who now heads the Institute of the Americas at the University of California, San Diego, points to the occasion when PDVSA senior executives turned down invitations to a regional energy conference at the last minute in May, saying they were too busy because of PDVSA’s leading role in the government’s “Gran Mission Vivienda” project. It aims to build two million homes over the next seven years.

“In poorly-managed societies, national oil companies tend to be the most efficient organisations, so the government gives them more work to do, instead of letting them focus on being better oil companies,” Davidow told industry executives.

That is the kind of criticism that Chavez, who has nationalised most of his country’s oil sector since he was elected in 1999, says is rooted in a bankrupt “imperial Yankee” mindset. He purged perceived opponents from PDVSA’s ranks in response to a crippling strike in 2002-2003 that slashed output, firing thousands of staff and replacing them with loyalists. Since then, the company has endured one controversy after another.

In an apparent damage-limitation exercise after the pension scandal, five members of the PDVSA board were relieved of their duties in May, including the official who ran the pension fund. They were replaced by Chavez loyalists including the country’s finance minister and foreign minister.

Gustavo Coronel, a former PDVSA director in the 1970s and later Venezuela’s representative to anti-graft watchdog Transparency International, said the fraud had been going on right under the noses of the PDVSA board.

“What this scandal shows is that Venezuela has become a moral cesspool, not only restricted to the public sector but to the private sector as well,” he wrote on his blog.

Show me the money

US investigators say Illarramendi, the majority owner of the Michael Kenwood Group hedge fund, ran the Ponzi scheme from 2006 until February this year, using deposits from new investors to repay old ones. He pleaded guilty in March to multiple counts of wire fraud, securities and investment adviser fraud, as well as conspiracy to obstruct justice and defraud the US Securities and Exchange Commission (SEC). He could face up to 70 years in prison.

By those outside the circles of power in Venezuela, Illarramendi was seen as one of the “Boli-Bourgeoisie” – someone who was already wealthy but grew much richer thanks to the “Bolivarian Revolution”, named by Chavez after the 19th century South American independence hero Simon Bolivar.

An ex-Credit Suisse employee and Opus Dei member in his early 40s who lived in the US for at least the last 10 years but travelled frequently to Venezuela, Illarramendi is on bail with a bond secured on four US properties he owns.

He was close to PDVSA board members and Ministry of Finance officials, but is not thought to have known Chavez personally. The son of a minister in a previous Venezuelan government, Illarramendi did enjoy some perks – including using a terminal at the capital’s Maiquetia International Airport normally reserved for the president and his ministers, according to a source close to his business associates.

His sentencing date has not been set yet, but a receiver’s report by the attorney designated to track down the cash is due in September. In June, SEC regulators said they found almost $230 million of the looted money in an offshore fund.

That was just part of the approximately $500m Illarramendi received, about 90 percent of which was from the PDVSA pension fund, according to the SEC.

PDVSA has assured its former workers they have nothing to worry about, and that the money will be replaced. But what concerns some retirees are allegations the company may have broken its own rules for managing its pension fund, which should have provided for more oversight by pensioners.

A representative of the retirees should attend meetings where the use of the fund is discussed, but no pensioners have been called to attend such a meeting since 2002.

PDVSA’s investment in capitalist US markets may seem to be incongruous given the president’s anti-West rhetoric, but the scale of such transfers is not known, and the investment options for such funds at home in Venezuela are sharply limited, not least by restrictive currency controls.

Energy Minister Rafael Ramirez said that Illarramendi only had an advisory role with PDVSA, and that it ended six years ago. So quite how he came to be managing such a big chunk of the pension fund is a hotly debated topic. Ramirez said the pension fund had been administered properly, and that the losses were of great concern to the company.

In July, PDVSA boosted pension payments to ex-employees by 800 bolivars (R1 328) a month, or about $188. The government also allocated nearly half the income from a new 2031 bond issue of $4.2bn to the company’s pension fund – probably to replenish deposits lost in the scandal.

Still, ex-PDVSA worker Luis Villasmil says his monthly stipend barely meets the essentials for him, his wife, a diabetic son and a niece. One morning in April, he rose early and met several dozen other PDVSA retirees to march in protest to the company’s local headquarters in Zulia, the decades-old heartland of Venezuela’s oil production.

“I never thought we would be in this situation,” the 65-year-old told Reuters with a sigh. “I think PDVSA should show solidarity with the retirees and pay their pensions whatever happens because it is responsible. But that’s not the heart of the issue, which is to recover the money, if possible.”

Ramirez, who once proclaimed that PDVSA was “rojo rojito” (red) from top to bottom, says the firm’s 90 000 staff have nothing to worry about. “Of course we are going to support the workers,” he told Reuters in March. “We will not let them suffer because of this fraud. We have decided to replace it (the lost money) and to make ourselves part of the lawsuit (against Illarramendi).”

The latest scandal comes at a time when observers are focused on the future of PDVSA, given Chavez’s uncertain health, next year’s election and Opec’s announcement on reserves.

Opec said in July that Venezuela leapfrogged Saudi Arabia last year to become the world’s biggest reserves holder with 296.5 billion barrels, up from 211.2 billion the year before. – Reuters