UPDATE:Gold Reserve prefers amicable settlement to arbitration route in Venezuela

In the last few months Venezuelan strongman Hugo Chavez has nationalized the assets of oilfield-services providers, announced plans to take over the hot-briquetted iron industry, and taken control of pasta and rice plants owned by U.S. foodmaker Cargill Inc.

This week Chavez dissolved Gold Reserve‘s (GRZ-T, GRZ-X) rights to part of the Brisas project in southeastern Venezuela, about 30 km from the border with Guyana. Brisas has proven and probable reserves of 10.2 million oz. gold and 1.4 billion lbs. copper.

“The Venezuelan government and the state mining companies already have near control over bauxite, coal, iron and nickel and with this they have added gold to that group,” Patrick Esteruelas, a Latin American analyst at Eurasia Group in New York, said in an interview.

“The government already announced last fall that the state mining company, CVG-Minerven, would recover and mine the giant Las Cristinas gold deposit and also hinted that Brisas would be next on the list.”

Canadian gold miner Crystallex International (KRY-T, KRY-X) and Gold Reserve have concessions to develop adjoining gold deposits. Crystallex had tried to move the Las Cristinas project into production since it acquired it in 2002 but failed to get the required environmental permits.

Esteruelas argues that the government wants to take over both deposits and develop them as a giant joint-venture project with Vancouver-based Rusoro Mining (RML-V, RMLFF-O), which is owned by the Russian Agapov family.

Rusoro “has been piggy-backing on Venezuela’s desire to reach out to U.S. diplomatic and economic rivals and tighten relations with Russia,” Esteruelas wrote in a research note late last year. “Rusoro has agreed to partner with the state to develop these projects as joint ventures, with the state paying nothing for its stakes, in order to protect itself against union worker demands and better navigate Venezuela’s complex and unpredictable regulatory structure.”

In late 2007 Rusoro purchased the Choco 10 gold mine from South Africa’s Goldfields (GFI-N) and in June 2008 picked up the Venezuelan operations of U.S.-based Hecla Mining (HL-N).

Esteruelas notes that Venezuela has been working on a new mining law since 2006 that will force all existing and prospective private investors to set up new joint ventures with the state “where the government will exercise full control while the companies do all of the heavy lifting.”

The mining law was passed by the National Assembly in its first debate in June 2006, Esteruelas says, but has since “fallen off the legislative agenda” and awaits ratification by Congress. In the meantime, the government has not granted concessions and has reevaluated existing projects. The result: “Weakening private property rights have taken a toll on private mining participation, which has dwindled to next to nothing.”

Douglas Boulanger, Gold Reserve’s president, told The Northern Miner his first choice was to settle the dispute “amicably” but if that wasn’t possible he would “go through the arbitration route” based on the bilateral investment treaty signed between Canada and Venezuela and Venezuela and Barbados.

Gold Reserve has invested about US$250 million over the last seventeen years in Venezuela on drilling, metallurgical development work, technical and feasibility studies, environmental and social impact statements and assessments, and detailed engineering. In a statement the company said it expects to make a claim for in excess of US$5 billion representing the fair market value of its investment.

Wayne Wilson, a managing director in the litigation, restructuring and investigative services practice of Protiviti Inc., a global business consulting and internal audit firm, says historically companies that have gone to international arbitration and have won their cases typically have received just 20% of their damages claim, or “pennies on the dollar.”

International arbitration tribunals like the International Centre for Settlement of Investment Disputes, or ICSID, “have not shown a tendency to grant large awards,” Wilson said in an interview from his office in Houston. In Gold Reserve’s case, he added, there is a big difference between the US$250 million stake the company has invested in Venezuela and the US$5 billion it has indicated as the value of its investment in the country, and if a tribunal takes the difference between those numbers you end up with a number that is probably closer to US$2 billion.

Moreover, in addition to terminating its right to its concessions, the government has also asked the company to turn over intellectual property, specifically its technical information on the Brisas copper-gold project to the Venezuelan Ministry of Mines. Gold Reserve has refused. Says Wilson: “That information is extremely valuable and could provide them with an excellent tool in negotiations.”

It’s difficult to predict what might happen with arbitration results involving Venezuela because none of the nationalization-related cases filed in the last few years have worked their way through the adjudication process yet – which typically takes about three years, Wilson calculates.

The first rulings are likely to involve Exxon Mobil and ConocoPhillips, which have filed claims with ICSID. The two oil companies are seeking compensation for oil ventures that Chavez seized in 2007.

Whether one wins a case that goes to arbitration or not is based on a number of criteria but perhaps the most important one Wilson says is whether a foreign investor has received treatment less favorable than a domestic investor. If foreign investors are being discriminated against more than local investors are, that may breach the terms of a bilateral investment treaty. Significantly in Gold Reserve’s public statements so far, the company is alleging that the Venezuelan government is failing to follow its own laws.

If Gold Reserve does end up going the arbitration route, Wilson says, it must also be prepared never to do more business in the country. “If you move forward with international arbitration in a country it’s unlikely you’ll continue to do business there,” he says. “Chavez has publicly been very negative about international arbitration and is not a big fan, although he is still a signatory to the ICSID convention.”

Some of the things companies that have sought arbitration in Venezuela in the past have discovered are that the authorities have revoked their travel and work visas and effectively prevented them from returning to the country. Companies that have assets in Venezuela and some other countries have often found it difficult to repatriate assets such as equipment or other property.

But Belanger says it would be very difficult to remain profitable in Venezuela even if the company was producing gold there at the moment.

“Companies are having unbelievable problems” in Venezuela getting access to foreign currency needed to import supplies, he said. A new law on gold sales passed about three weeks ago has made it even more difficult for gold producers. The new law allows the central bank to buy 60% of a gold company’s production in local currency. At today’s exchange rate that would be equivalent to about US$312 per oz. gold, Boulanger estimated.

“We’re not a producer but [if we were] …this law effectively would eliminate any profitability.”

Venezuela has also increased its VAT, Boulanger indicated, which is currently at a 12% rate. “The effect is that sellers are offering a 12%-15% discount off the international gold price,” he explained, on top of the disadvantageous gold sale law.

In Toronto, Gold Reserve shares are trading at about 65¢ apiece.

The junior has a 52-week trading range of 29¢-$2.05 per share.