VHeadline.com oil industry commentarist Oliver Campbell writes:  Orimulsion is an emulsion of 70% bitumen — more about this later on — and 30% water which can be burned in power plants. It’s a Venezuelan invention of which its citizens can be justifiably proud, and it has been sold in many countries, including Canada, Denmark and Italy … though there is a bias nowadays towards Asia (China, Japan, Korea and Singapore).

When the product was launched in 1990, oil in the Orinoco Belt was considered a problem since it was so viscous at ambient temperature … like a thick tar … that it did not flow.

Oil prices were also low at the time, so any new product that produced additional income was most welcome.

However, the income per barrel was modest because Orimulsion was launched to compete in price with steam-raising coal in those power plants that burned coal. The initial price also allowed the customer to recoup the cost of installing burners to burn Orimulsion rather than coal. The product had its teething problems … the emulsion was unstable and difficult to keep on spec and, when burned, it emitted ash into the atmosphere … but these were solved and the product has been successful.

Its slogan: “A reliable product at competitive prices” has been lived up to.

But the government was determined to improve the income from the Orinoco Belt and ten years later encouraged a new development with the formation of four consortia to produce extra-heavy crude in the Orinoco Belt and upgrade it into a more commercially attractive product. Petrozuata produced the first upgraded crude in 2001.

With the then existing low oil prices, the companies were doubtful they would make an adequate return but, to Venezuela’s great satisfaction, they have been hugely successful.

The consortia upgrade crude oil of an average 9º API into one between 16º and 32º API, depending on the complexity of the upgrading plant. The transport problem from the field was cleverly solved by mixing the extra-heavy crude with a diluent which allows the mixture to be pumped north to the upgrading plant on the coast. The gasoil is then recovered and pumped back to the field.

  • It is no exaggeration to say the results of these four consortia have changed Venezuela’s future. From having huge reserves of a supposedly problematic oil of under 10º API, Venezuela now have huge reserves of an oil that can be upgraded to over 30º API.

The success of the consortia was doubly welcome when oil prices took off a couple of years ago, tripling the price of upgraded crudes and leaving the price of Orimulsion, tied to the price of coal, far behind. The government then decided they would accept no new clients for Orimulsion, ceased its production themselves, and let Sinovensa (a joint venture with a Chinese company) meet all present and future demand.

The government has now stated Sinovensa will stop producing Orimulsion and instead will blend extra-heavy oil with light oil to produce a crude of some 16º API until such time as upgrading facilities are available. The government has been caught unprepared with insufficient upgrading plants, and this bottle neck is likely to last some time since these plants are like large refineries, cost billions of dollars and take years to construct.

But let me return to the subject of bitumen. As any cook knows who puts a nub of butter in the saucepan and watches it melt, heat is the most important factor affecting viscosity. So the substance in the Orinoco Belt’s subsurface at a 50º C temperature is a liquid which can be pumped to the surface like any heavy crude oil. Thus it can be justifiably called an extra-heavy crude despite the fact that, on reaching the surface and cooling down, it becomes a thick tar-like substance.

Venezuela was anxious to have the hydrocarbon component of Orimulsion classified as bitumen so that its production was excluded from the OPEC quota and did not reduce the amount of other oil which could be produced. By dint of much persuasion, in 1987 the Society of Petroleum Engineers issued a definition that was based on dynamic viscosity … the rate or speed at which a substance flows.

a) Crude oil was defined as that which has a dynamic viscosity equal to or lower than 10,000 milliPascals/second at the reservoir temperature, and

b) Bitumen was defined as that which has a dynamic viscosity over 10,000 milliPascals/second at the reservoir temperature.

This definition may be entirely logical to petroleum engineers, but those of us who are not find it difficult to see how a liquid of 10,000 milliPascals/second, which is a crude oil, metamorphoses into bitumen when reaching 10,001 milliPascals/second.  Put the two side by side in a test tube and there is no practical difference.

  • Several of my colleagues feel the definition was agreed to help Venezuela keep the oil in Orimulsion out of the quota. However, OPEC never showed any interest in Orimulsion as it was designed to compete with coal, and not fuel oil or any other petroleum product.

The strange thing is that the crude oil used to make Orimulsion, to blend with lighter crudes, or to be upgraded is all the same. It just happens to be called bitumen when used for Orimulsion. The government realised this anomaly and changed the name from the Orinoco Bituminous Belt to the Orinoco Oil Belt and, more recently, to just the Orinoco Belt. They no longer use the term bitumen when talking about the Oil Belt, nor do they ever refer to the definition of dynamic viscosity.

There has been substantial criticism of the government’s decision to stop producing Orimulsion, largely based on the following factors:

1) The oil in Orimulsion is excluded from the OPEC quota. This would have importance if Venezuela were producing up to the quota and wanted to exceed it. It is generally agreed, outside the government, that Venezuela has not been producing to the quota level for some time.  Furthermore, Venezuela aims at increasing its production capacity to 5,000,000 barrels a day by the end of 2010. It makes no sense to increase capacity if the oil is not to be sold, which means the country will be asking for increases to the quota as time passes.

The two principal factors for assigning quotas are production capacity and quantity of oil reserves. I believe one purpose behind the current action to quantify and certify the amount of reserves in the Orinoco Oil Belt is to reinforce Venezuela’s case to increase its quota in due course.

2) The reserves are so huge that upgrading, blending and emulsifying can all be carried out at the same time. This appears a sound argument until you consider the economic concept of scarcity i.e. insufficient resources to do everything you want to. For one reason or the other, PDVSA does not have sufficient funds to carry out all profitable projects; neither does it have sufficient manpower capable of carrying them out. The latter is borne out by the fact PDVSA in 2005 only spent 66% of its capital budget.

This situation leads to the classical response of establishing priorities in order to maximise cash flow with the limited resources available. So, if the capacity to produce oil from the Orinoco Belt for all purposes is only 700,000 barrels per day, then you choose the best option which without doubt is upgrading.  However, in the short term there is a lack of upgrading capacity, so the government has decided that blending the oil is a better option than producing Orimulsion. The figures I show further on bear this out.

3) The internal rate of return is higher for Orimulsion than for upgrading.  I find this difficult to believe, particularly when the gross margin was only US$1.50 a barrel, but I have no figures to support or reject this assertion. The argument is based on the fact that a plant for Orimulsion can cost $300 million while a plant for upgrading can cost $3,000 million i.e. 10 times as much. However, as project analysts know, the drawback with the internal rate of return is that it does not show the absolute figures.

Most companies constrained by resources would prefer a 30% return on $3,000 million (equals $900 million) to a 40% return on $300 million (equals $120 million) … and I believe this is how PDVSA sees it.

4) As a substitute for coal Orimulsion does not affect the oil price. This is true though initially it was feared the product would compete with fuel oil, but this has only happened in one case. New Brunswick Power made an agreement with PDVSA to switch from burning fuel oil to Orimulsion which was considerably cheaper. When PDVSA recently reneged on the deal, NBP took them to court and is asking for damages of $2,200 millions to cover the difference between burning Orimulsion and fuel oil. The NBP case clearly shows there is a giveaway when pricing Orimulsion to compete with coal.

5) Orimulsion provides a cheap fuel for power plants worldwide. This statement is true enough, but I suggest PDVSA is not a charity and that its duty is to maximise income for its own citizens rather than subsidise those in other countries. Canada, Denmark, Italy, Japan and Korea are all rich OECD states that hardly need any financial support.

Venezuela is fortunate to have cheap hydroelectric power from the Guri Dam, but it also has the largest reserves of natural gas in Latin America. This is the cheap fuel power plants in Venezuela can use once the gas projects get off the ground. It is a sad reflection on the government when Venezuela has to import gas from Colombia to meet requirements in the west of the country.

Rather than comment in the abstract, as other observers have done, I have extracted the following prices from PDVSA’S 2003 SEC filing and compared Orimulsion prices with those of the average crude stream. Unfortunately, PDVSA has not published any more recent figures.

Orimulsion 2003 2002
Average price per metric ton 35.76 33.36
Average price per barrel (1) 5.96 5.56
Less production cost 3.00 3.00
Less emulsifying cost 1.50 1.50
Gross margin (2) $1.46 $1.06

(1)   Assumes 1 metric ton is equivalent to 6 barrels

(2) The figure of $1.46 is close enough to the figure of $1.50 quoted by the Oil Ministry in 2004

Crude oil  2003  2002
Average price per barrel 24.39 21.35
Less production cost 3.00 3.00
Gross margin $21.39 $18.35

The 2003 figure shows the oil gross margin is some 14 times that of Orimulsion, though it must be remembered the latter includes 30% water. Prices have increased substantially since 2003, but oil prices have increased relatively more than coal prices.   

We do not know what the current prices and costs are, so the figures below are only an educated guess.  In (B) I have applied the same royalty and income tax rates to Orimulsion as for crude oil for the sake of comparison.

Estimated Figures for 2006 in $ per barrel

Orimulsion
(A)
Orimulsion
(B)
Blended Crude Upgraded Crude
Price of Orimulsion CIF and crude oil FOB 20.00 20.00 42.00 54.00
Less transport cost to clients 5.00 5.00
Net price in Venezuela 15.00 15.00 42.00 54.00
Less royalty 16.67%,  33.3% 2.50 5.00 14.00 18.00
Less production costs 4.00 4.00 4.00 4.00
Less emulsifying, blending and upgrading costs 2.50 2.50 1.00 8.00
Profit before income tax 6.00 3.50 23.00 24.00
Less income tax  34%,  50% 2.00 1.75 11.50 12.00
Net profit $ per barrel 4.00 1.75 11.50

12.00

Gov’t take from private companies (royalties and tax) $4.50 $6.75 $25.50

$30.00

Gov’t take from PDVSA’S share including net profit 8.50 8.50 37.00

42.00

The figures show upgrading per barrel yields some six times more … and blending five times more, than Orimulsion does in terms of government take. The calculation for the blended crude is less certain since there is often a giveaway in quality when a light crude is blended with a heavy one.

  • However, as these results are based on ballpark figures, let us be conservative and say upgrading yields at least five times, and blending at least four times, the government take per barrel that Orimulsion does.

As noted above, the investment required for the three options varies considerably. Blending requires low plant investment, Orimulsion needs higher plant investment, and upgrading plants are very expensive. This favors blending versus Orimulsion in terms of return on investment. 

Breaking the contracts to supply Orimulsion will cost PDVSA money. In my opinion, it would have made financial sense to continue production for another three years by which time most of the contracts would have finished.

The question now is how to make compensation and I can suggest two ways.

1) The power plants can go back to burning coal since they will have burners for both Orimulsion and coal in place. PDVSA will then negotiate a lump sum payment, based on the time left for the contract to run out, to cover any loss plus a sweetener. In theory, this will be the present day value of the future annual losses incurred by the customer and it is by far the better option.

2) PDVSA can supply fuel oil instead until such time as the contracts run out. The agreed quantity will provide an equivalent BTU to the Orimulsion fuel.

This option, mentioned by PDVSA, will be very costly and should only be used as the last resort.

Switching to blending will produce additional government take per year. For instance, 100,000 b/d X 365 X ($25.50-$4.50) = $766 millions would cover close to half the cost of supplying fuel oil. Also, the government has announced the Orimulsion plant (module) used by Sinovensa will be used by them for blending crudes so, at least, that investment has not been lost.

Some critics have suggested the decision to cease producing Orimulsion is political. This is not credible since Venezuela has nothing to gain by upsetting friendly nations, China in particular, by their action as it has certainly done. I support those who maintain the reason is commercial … to maximize government take from the Orinoco Belt operations.

To summarize, PDVSA is right to make sure its limited resources of cash and manpower are used to greatest effect. This means concentrating on upgrading or blending till such times as more upgrading capacity is available.

I regret the passing of Orimulsion just as my colleagues who worked on its research, development and production do.

But that is evolution … things do not stand still and events have overtaken its relative competitiveness.

It is not that Orimulsion does not make money … but that the other two options make so much more.

Oliver L Campbell
oliver@lbcampbell.com