The pending collapse of Venezuela poses serious short- and long-term challenges for oil markets, but it also contains a silver lining for the OPEC cartel.
Venezuelan oil production has been in decline for the past decade, but output has plunged rapidly in recent months as the OPEC member’s political and economic crisis intensifies bringing state oil company PDVSA to its knees. Venezuela production hit a three-decade low of 1.6 million barrels a day in January, down 20% from the same month a year earlier and off a whopping 600,000 barrels a day from its 2016 average of nearly 2.2 million barrels a day.
The country’s situation will only get worse.
Venezuelan production is likely to fall another 400,000 to 600,000 barrels a day this year – and that assumes President Nicolas Maduro’s beleaguered regime survives. Total collapse of the regime, which the United States could help bring about by imposing tough new sanctions on Venezuela’s oil sector, could see output ground to a complete halt.
Much hinges on Venezuela’s presidential elections on May 20. If Maduro uses the election to further consolidate his grip on power, it could prompt Washington to slap the harshest of measures on Caracas. These could include an outright ban on imports of Venezuelan crude, or, more likely, an embargo on U.S. exports of light oil and refined products to the South American country.
Venezuela’s woes have been flagged by the International Energy Agency as a major wild card in oil markets this year that have contributed to the recent firming of crude oil prices, which are sitting at comfortable $65 a barrel on the international benchmark.
Recent gains by crude have been supported by over-compliance by Saudi-led OPEC with its production cut deal involving non-OPEC producers, including Russia, which has helped tighten supply-demand fundamentals significantly. But much of OPEC’s stellar compliance lies with Venezuela’s faltering production.
In February, S&P Global Platts estimated OPEC’s production was 340,000 barrels below its target of 32.73 million barrels a day – but that Venezuela accounted for more than the entire production shortfall.
Venezuela’s meltdown comes at a convenient time for OPEC and provides a convenient hole for U.S. shale growth and keep it from crashing the market again. Because of this spare capacity, OPEC and shale could potentially co-exist profitably in a world of $60-to-$70 a barrel.
The total collapse of Venezuela could bring about a different set of issues. The ensuing chaos and confusion could see Venezuelan exports drop to zero while buyers try to assess who to trust in Caracas.
Venezuela’s precarious financial position has already hampered its oil trade. Courts in the Netherlands Antilles have already permitted PDVSA creditors to seize two of the company’s oil cargoes in recent months. Cash-strapped Venezuela was found to be in “selective default” in November and efforts to restructure its debt have gone nowhere in part because of existing U.S. sanctions restricting its access to financial markets. A regime collapse could see oil prices spike as much as $10 a barrel, but a combination of “on-command” Saudi spare capacity and release of strategic reserves would likely make that boost only temporary.
President Trump’s administration wields much power over Caracas because the United States is Venezuela’s largest crude customer – although U.S. imports of Venezuelan oil have fallen sharply over the past year due to the OPEC member’s upstream problems and, to a lesser extent, fears of violating existing sanctions.
According to the U.S. Energy Information Administration (EIA), we imported 442,000 barrels a day from Venezuela through February 9 of this year – a big drop from the 749,000-barrels-a-day level over the same period last year.
Refiners everywhere are complaining about the deteriorating quality of Venezuelan crude; here lies another area where we have leverage over Caracas. Washington could apply sanctions banning U.S. exports of the light oil PDVSA needs to mix as diluent into its super-heavy crude. Restrictions on sales of gasoline and diesel to Venezuela are under consideration, too. Some refiners remain wary of new sanctions, but many others say they could adjust by replacing Venezuelan crude with similar grades from Canada, Saudi Arabia, West Africa or elsewhere.
The bottom line is that there is no quick fix for PDVSA’s state of disrepair. For years it has suffered from an exodus of talent. The country’s humanitarian crisis and rapid inflation rate – which has risen to over 4,000% over the past year – has exacerbated the brain drain; Venezuelan refugees are now pouring into neighboring countries. Reviving the country’s oil sector will be a major endeavor, requiring not only massive investment but a bottom-up approach to rebuilding the state oil giant. PDVSA’s $65 billion debt makes Maduro’s promise of recovering 70% of lost oil production volumes in the first half of 2018 simply impossible.
It will take substantial time for Venezuela to rebuild trust with international oil companies and service contractors, who are owed substantial sums by PDVSA. Still, even as the national government teeters on the brink of collapse, Venezuela’s 300 billion barrels of reserves remain tantalizing to many international oil companies – and the reason why they stuck it out under difficult conditions under Maduro and his predecessor, Hugo Chavez. Under the right fiscal conditions, the oil industry insists that Venezuela’s reserves can be extracted profitably. For that to happen, though, a credible and creditworthy government must emerge in Caracas.