Harvest Running Out of Resources

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Shares of small-cap energy producer Harvest Natural Resources (NYSE: HNR) got cropped yesterday by more than 25% on word of drilling delays in Venezuela. Harvest, which generates all of its oil and gas from Venezuelan properties, had been enjoying a good run on the back of higher energy prices.

Now there's a fly in the ointment. The drilling of new wells has been suspended because the Venezuela government (acting through state-run oil company PDVSA) has delayed approval of new drilling permits. What's more, the government wants to reduce Harvest Natural Resources' drilling program and production below amounts previously agreed upon in a contract.

Although the company is still permitted to pump at a rate of about 29,000 barrels of oil and 80,000 cubic feet of natural gas per day, it's unclear how long that production level can be maintained without additional wells. With no producing properties outside of Venezuela, Harvest Natural Resources' ability to grow is now pretty much at the mercy of Venezuelan policymakers.

This has all the makings of a squeeze play, in my opinion. Since taking office, Venezuelan President Hugo Chavez has been extremely critical of the oil and gas agreements that were signed by the Venezuelan government in the 1990s, claiming that they unfairly enrich foreigners at the expense of Venezuelans. As such, Chavez has tried to browbeat, cajole, and/or coerce foreign companies into scrapping those old agreements and signing new contracts under the 2001 Hydrocarbons Law -- a nationalistic law that clearly favors Venezuelan interests by giving PDVSA higher royalties and a majority interest in all partnerships. Since the law was passed, no foreign companies have signed any new agreements in Venezuela.

While the process will no doubt be frustrating and maybe even a bit nerve-wracking for investors, the odds favor an eventual resolution of this dispute. Venezuela is actually a bit under its OPEC production quota, and Chavez needs to keep the petrodollars flowing to keep Venezuela's economy on its feet. If Chavez squeezes the foreigners too hard, he could crash his economy and find himself ousted in a coup.

This whole episode highlights the trouble with drilling overseas -- many governments have less than a total respect for the rule of law or the sanctity of contracts. While many overseas drillers sport attractive valuations (Harvest Natural Resources now trades at about 17 times trailing earnings), investors must be alert to the risks that go hand-in-hand with dealing with rulers like Chavez.

Fool contributor Stephen Simpson is a chartered financial analyst and has no ownership interest in any stocks mentioned.