Peruvian President Alan Garcia has shown in his five months in office that he likes to play high-stakes politics. At the same time Peru has rankled the international financial community by limiting repayment of its foreign debt to 10 percent of export income, it also has picked a fight with foreign oil contractors.
In late August, President Garcia ordered the unilateral revocation of existing contracts with three foreign oil companies -- Occidental Petroleum Corp. of Los Angeles, Belco Petroleum Corp. of New York (a wholly owned subsidiary of InterNorth of Omaha), and Bridas Exploraciones y Producion S.A. of Buenos Aires, under which the oil companies produce oil and share the production with the Peruvian government.
In order to restore the contracts, the Peruvian government told the companies, they must invest about $425 million to explore for new oil and pay about $45 million in taxes which the previous government of President Fernando Belaunde had forgiven "illegally," in the view of the new administration.
The tax dispute centers on a system that granted tax credits for companies that reinvested profits in exploration and development. The system was adopted under the Belaunde government in 1980 and sponsored by Energy and Mines Minister Pedro Pablo Kuczynski, now president of First Boston Corp. of New York.
Concession contracts provide for an equal production split between the government and the contractors. But because of Peru's high corporate income tax rate, 68.5 percent, the government ends up with as much as 88 percent of the profits. The reinvestment system was established to make Peru more attractive to foreign oil companies by reducing the effective tax rate on their income.
The new government, however, has charged that the tax credits should not have been used, as they were almost exclusively, for development of known reserves. The reinvestment programs of each company, which allowed them to put the credits to this use, were approved by the Ministry of Energy and Mines under the previous adminstration. The government now says the $425 million in credits must be diverted to exploration for new reserves.
With production and reserves declining since 1981, Peru needs to push exploration if it wants to avoid becoming a net oil importer by the end of the decade or sooner. Most oil industry sources agree that the state oil company, Petroperu, does not have the capacity or the financial resources to undertake this goal alone, which would require close to $1 billion a year in investment. Next year, Petroperu has budgeted $70 million for exploration.
The government says that it wants to attract fresh risk capital, and new legislation is expected to implement recommendations from the World Bank, such as allowing oil companies to reduce taxes by writing off their costs more rapidly, which would make it easier to attract capital. "We're going to compare the ways that China, Colombia and any other place attract oil foreign capital to see what realistic rules are," Garcia told Peruvian businessmen recently.
However, in the short run, the government also has been eyeing the retained profits of the foreign oil companies, which have totaled nearly $500 million so far this year. Since the end of September, the companies have been barred from moving those profits out of the country. That money, invested in finding new oil in Peru, might satisfy the Garcia administration's objections.
However, many local businessmen feel that the government may have boxed itself into a corner politically and will not be able to extricate itself without looking like it is "selling out" to the oil companies.
Government sources are optimistic that they can reach an understanding with Occidental. There are signs that the government is adopting a more flexible negotiating position. The deadline for new contracts has been extended until today, and more experienced officials have been incorporated into the government's team, which is negotiating with the oil companies hoping to reach agreement before the deadline.