In August of 2001, the government of President Hugo Chavez enacted a controversial hydrocarbons law which established new rules for investors having oil operating agreements with PDVSA (Venezuela’s state-owned oil company). The new law provides the legal platform for the Venezuelan government to convert the existing operating agreements (which cover 32 oil fields with a production of roughly 500,000 barrels of crude a day) into new contracts or convenios by which the state will hold at least 51% of the shares of the existing project companies and will collect higher income taxes and royalties by increasing the tax rate from 34% to 50% and royalties from 16% to 30%. The new law also requires that all operating contracts contain a provision requiring that investments in property and equipment made by the project companies be transferred to the state without any compensation and free of all liens upon termination (with or without cause) of the agreements. By accepting the new regime, the project companies will have also consented to the exclusive jurisdiction of the courts of Venezuela to solve all disputes that cannot be resolved through amicable means “including arbitration” and will have acknowledged that such disputes may not give rise to any foreign claims whatsoever. The Venezuelan government is requiring project companies to accept the new rules and convert their existing agreements into new operating contracts by the end of the year or face termination.

From an expropriation perspective, it will be interesting to see how the new measures will be treated by insurers and their insureds. Although a nondiscriminatory increase in taxes typically would be excluded under PRI policies for expropriation, special policy terms may apply under coverage for production sharing agreements. Moreover, some of the other measures such as the mandatory conversion to the new regime, the 51% state ownership of the project companies and the provisions requiring the acceptance of an uncompensated transfer of all investment property upon contractual termination are clearly confiscatory in nature. The mandatory conversion to the new regime and the resulting exclusive jurisdiction of the Venezuelan courts will also have interesting implications for arbitration and recovery, namely the effect on the insurers’ subrogation rights, the duties of an insured to mitigate potential losses (e.g. convert to the new regime in order to minimize losses) and the added value of denial of justice coverage.

So far thirteen (out of twenty-two) companies, including Spain’s Repsol, China National Petroleum, Teikoku Oil, Petrobras and Houston-based Harvest Natural Resources are said to have signed contracts to adopt the new regime. How some of the other major players such as ChevronTexaco and Shell will react will probably depend on whether the losses they suffer under the new regime are offset by the diminished but potentially still significant revenues associated with their projects, and how willing the companies are to subject their rights under the new contracts to the jurisdiction of Venezuelan courts. ■