by Ambrose Evans-Pritchard
August 3, 2017
Venezuela’s oil industry is at risk of sudden collapse as funding dries up and the US tightens sanctions, threatening to shatter the beguiling calm in global crude markets.
West Texas crude briefly spiked above $50 a barrel for the first time since late May after Venezuelan leader Nicolas Maduro pressed ahead with a rigged election on Sunday (7/30) in defiance of the US, the EU, and the leading Latin American powers.
President Donald Trump threatened “strong and swift economic sanctions” before the weekend vote. On Monday (7/31), Washington followed through and imposed personal sanctions on Mr. Maduro but this is essentially gesture politics.
Mr. Trump’s own credibility is now on the line as the ‘Chavista’ revolution throws down the gauntlet.
Edwin Morse and Tina Fordham from Citigroup say a political showdown with Washington is now almost unavoidable. A core feature of the emerging ‘Trump Doctrine’ is “the sanctity of red lines”. This White House vows to deliver on its threats, insisting that it will not waver as Barack Obama did over Syria.
“Venezuela’s social, economic, and political crisis appears to have reached the point of no return, with dramatic impacts on the country’s oil sector,” they say.
The country boasts the world’s largest crude reserves, with an estimated 300bn barrels of oil sands in the Orinoco Belt.
Production is on a more modest scale. It has slid by a fifth to 1.9m barrels a day (b/d) over the last two years as the state oil monopoly PDVSA is cannibalized to pay for populist spending and the Maduro political machine. Yet Venezuela remains still a pivotal force in the global balance of supply and demand.
The risk now is that the entire system breaks down in chaos. The country is already down to 49 rigs on the Baker Hughes count, and this is certain to fall further. PDVSA has run out of money to pay wages and cover bills to foreign contractors. It is surviving on hand to mouth on help from China and Russia.
“The likelihood of a collapse in production has grown to the 50% range or higher, even without the imposition of further sanctions,” says Citigroup. They warned that output could fall by another 1m b/d in a hard-landing, with an outside risk of total shutdown.
Professor Ricardo Hausmann from Harvard University says the state oil company is caught in a downward spiral. As he told CNN’s Spanish channel:
“PDVSA is broke. It is not paying its operators or spending the money needed to maintain production. It has taken on debt at 48% interest rates and that means the scale of the bankruptcy will be worse later. Mr. Maduro is not behaving like somebody who expects to be in power for a long time.”
The situation is now desperate. An estimated 127 people have been killed in political violence and hundreds injured over the last four months. The International Crisis Group has begun to warn of famine in what was once Latin America’s richest country.
Helima Croft, commodity specialist for RBC Capital Markets, explained to CNBC last Friday (7/28):
“Many petro-states have seen their finances severely strained by the oil price slump. However, no country has experienced as fast and furious a fall as Venezuela has, and it now appears poised to earn the dubious distinction of being the first to fully fail.
The statistics are staggering. By the end of 2017, the Venezuelan economy will likely have shrunk by 30% in three years. The IMF forecasts that inflation will average 720% this year and top 2,000% in 2018.”
Over 95% of Venezuela’s export earnings and half of state revenues come from oil. This income is shriveling by the month. Some oil is already pre-sold to the Chinese. Standard & Poor’s says the budget deficit is running near 25% of GDP.
It is a textbook case of hyper-inflationary melt-down. The agency has slashed Venezuela’s rating to CCC-. Sovereign default looms.
Washington must move with extreme care as it calibrates sanctions, not least because this is turning into a proxy dispute with Moscow and Beijing.
Further, the current measures targeted at key figures of the Maduro regime are broadly supported in Latin America but any move that pushed Venezuelan society into deeper distress would touch raw historical nerves, and might cause a backlash in the Venezuelan military.
What such a backlash might be is questionable, however, as the Venezuelan military has never fought a war with another country in its entire existence (i.e., since Venezuela’s creation in 1830).
The ‘nuclear option’ is to block exports of Venezuelan crude to the US. These are running at around 750,000 b/d, less than half total foreign sales but more than 60% of actual earnings. Michael Wittner from Société Générale says a full ban would push oil prices to $60.
“A ban on Venezuelan oil exports to the US would likely be followed by an immediate default, as the regime would have no incentives to continue servicing its debt obligations,” says Carlos de Sousa from Oxford Economics.
It would be difficult for the country to find an alternative market for its ‘heavy sour’ crude. This is geared for US refineries where it is mixed with ‘light sweet’ oil and naptha. PDVSA would be treated as a pariah in such circumstances in any case.
In fact, it already is. Late last week (7/27), Reuters reported: U.S. oil refiners pare exposure to Venezuelan crude imports –
“U.S. refiners are shifting away from processing heavy crude, lessening the potential impact on their businesses and motorists of any supply disruptions from Venezuela as the Trump administration considers new sanctions on the country.
Refiners Valero Energy Corp and Marathon Petroleum Corp on Thursday said they plan to run more light and sweet crudes this quarter, continuing a trend away from heavy, sour crudes supplied by Venezuela and other OPEC producers. U.S. imports of Venezuelan crude fell 32 percent in June to a 13-year low of 491,000 bpd, according to Reuters data.”
David Fyfe from oil traders Gunvor says the White House will move cautiously. “The feeling in the markets is that the US will ratchet up the pressure. I doubt they will go for nuclear option as a first step,” he says.
Mr. Fyfe says the Trump administration might cut off sales of US light crude shipped to Venezuela for blending. This would be hard to replace, and alternative sellers would be reluctant to offer trade credit. Such a policy would amount to slow strangulation of PDVSA.
For the OPEC Gulf states, the Venezuela crisis is a Godsend. It is helping to erode excess crude inventories and offset some of the surging supply from Nigeria, Libya, and the US shale belt.
The worse it gets, the greater the likelihood that it will abruptly push world from glut to scarcity. Then again, perhaps not at all. As Forbes noted on Saturday (7/29): With Venezuela, Trump Has Leverage. And an opportunity to replace Venezuelan oil with US oil exported to the world.