The claims for compensation from PDVSA under the various disputes submitted to international arbitration amount to some $40 billion, but the provision the company has booked at the end of 2009 is only $1 billion. A provision of this size means PDVSA expects to win almost all the cases and this prima facie looks highly improbable.

The Notes to the accounts refer specifically to one case which is in progress, namely the dispute with ExxonMobil over the expropriation of Mobil Cerro Negro's assets in the Orinoco Belt. The Note states, "PDVSA believes that resolution of this dispute will not have a significant effect on its operations and financial position." It all depends what is considered "significant" but compensation on a fair market value basis will certainly exceed $1 billion and could easily reach $4 billion.

As regards the remaining disputes, PDVSA believes " the outcome of these claims will not have a material adverse effect on the Company's financial position, results of operations or liquidity." However, it adds the reservation that if claims are settled for amounts greater than anticipated, then it "could have a material adverse effect." This is a most unusual since the classical way of making a provision for any significant litigation is to assess the probability of winning or losing each case and then to assign an estimated amount of compensation payable under each one. The total amount is often rounded off to what seems a "reasonable" figure. I believe the latter could be in the order of $10 billion, assuming $5 billion for ConocoPhillips, $4 billion for ExxonMobil and $1 billion for Tidewater, Exterran and the rest. Admittedly, this is no more than an educated guess since there is little information on which to base a firm amount.

It is certain the compensation payable will never reach $40 billion, but it is equally certain the compensation will exceed $1 billion. I am surprised Alcaraz Cabrera Vásquez, the external auditors, did not insist the provision were higher and I wonder whether they consulted on the matter with their associates, KPMG, in the USA. I believe they may have been leaned on by PDVSA not to increase the provision simply because the net profit would not support a higher charge.

Let's look at the grounds for my conjecture. PDVSA'S accounts are unusual in that they include two optional expenses, unconnected with the oil business, in the shape of a contribution to a National Development Fund (Fonden) and another for social development. The amount of these contributions depends on the pre-tax profit made in any year. They fell from $14.7 billion in 2008 to only $3.5 billion in 2009 because pre-tax profits were so much lower. Had PDVSA made no contributions in 2009, its net profit would have been $1.75 billion higher i.e.$3.5 billion net of 50% tax. But telling the government it would make no contributions because of its low profit was never an option and PDVSA reported a net profit of $4.5 billion. But you can see if another $9 billion had been added to the provision in 2009, this amount net of tax (booked as a taxation timing difference) would have eliminated all the net profit. This would not have been acceptable to PDVSA nor the government.

It looks to me as if expediency prevailed over good accounting and the provision was left at the inadequate level of $1 billion. The external auditors either accepted this willingly or, more likely, they were leaned on by PDVSA to accept it. Perhaps they believed they covered their backs with the Note about the adverse effect being material if claims were settled at amounts greater than anticipated--hardly a mind boggling conclusion.

However, PDVSA, as a state company, is in the peculiar position that it has no private shareholders whose shares can lose value if the profits are hit in one year by large compensation payments which had not been provided for in previous years. So you could argue the company need not be as diligent as a private company in ensuring its provision for litigation in any year reflects the current assessment of its future liabilities. But this argument is not consistent with the fact PDVSA prides itself on accounting in accordance with the International Accounting Standards Board. This being so, I sincerely trust PDVSA will review the provision in 2010 and set it at a more realistic level.

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 does not necessarily share these views.


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