Energy Security Intelligence Research

ESIR

VENEZUELA


"Petroloes de Venezuela (PdV)-the National Oil Company strategy of importing light oil to use as diluent at its Orinoco heavy oil is facing new challenges of building new facilities that will cost billions of dollars that cash-strapped PdV doesn't have, and could take years to finish."


Venezuela has earned its reputation as a basket case resource curse economy. Inflation is likely to top 200% in 2016 and shelves are often empty of everyday items like milk and eggs. The value of the currency has been decimated. At the widely used black market exchange rate, someone earning the minimum wage would only bring in the equivalent of around $220 a year.

The oil price downturn has exacerbated the country's troubles and investors are betting on a debt default. It is against the odds, then, that there are, at long last, glimmers of hope in the country's long struggling oil industry. Politicisation and under-investment have hampered the state oil company, Petroleos de Venezuela (PdV). Production has been on the decline for a decade as PdV's new projects in the vast Orinoco heavy oil belt, the world's largest crude deposit, have been slow to get off the ground. But the new leadership at PdV has quietly made a series of pragmatic decisions that could start to turn things around for the oil industry. It is a pragmatism born of necessity, but it marks a break with the past. PdV, for instance, has publicly called on its foreign partners to help it with billions of dollars in financing for the new Orinoco projects.

Therefore, It has given those companies, such as Chevron, Repsol and PetroChina, more say over where the money goes and how the projects are developed. As a result, badly needed cash is starting to flow into the Orinoco belt, where wells are being drilled at a faster pace and new pipelines are being laid to carry growing crude volumes to market. At the same time, PdV is finally starting to show some flexibility in its development plan to help boost output. The company was pilloried in 2015 when it imported a cargo of Algeria light crude. Critics claimed that the fact it needed to import crude--despite its own vast oil reserves--signalled PdV's inexorable decline. But PdV and its partners need a steady flow of light hydrocarbons to increase production of its heavy oil in the Orinoco. And light oil is cheaper than the traditional naphtha.

PdV plans to step up these light oil imports to allow for more heavy oil production before costly new heavy-oil upgraders are built. The new strategy is popular with PdV's foreign partners, and the state company hopes it will allow it to increase outputs by as much 500,000 barrels-a-day over the next few years. There is, of course, much that could derail these plans. Billions of dollars of investment will need to be sustained by PdV and its foreign partners even as Venezuela goes through a difficult financial crisis. If the political winds in Caracas shift, it could lead to changes at the top of PdV or even see the return of nationalisation to the oil industry. Still, the changes under way mean that Venezuela deserves a closer look.


ONES TO WATCH

Americas: Tension in Venezuela scales-up
Sectors: all
Key Risks: political instability; social unrest; political violence  

In Venezuela, political and social tensions are set to increase over the coming week with a potential for associated violent unrest across the country’s main urban centres. The opposition MUD coalition called on Venezuelans to peacefully take to the streets on 26 October 2016 to protest against the electoral authorities’ decision to suspend the process to launch a recall referendum against President Nicolas Maduro. On 23 October 2016 the opposition-led National Assembly declared Maduro had staged a coup d’état and broken constitutional law, and decided on plans to debate the constitutionality of Maduro’s presidency at an extraordinary session scheduled for 25 October 2016. The NA also urged the military not to respond to orders that would go against Venezuela’s Constitution. All rallies should be avoided due to the high risk of clashes between rival activists, and between the latter and the security forces.
 

PDVSA’s woes continue
Sectors:  hydrocarbon
Key Risks: non-payment; foreign exchange shortage; political instability; civil unrest
US federal prosecutors are preparing to charge several individuals and confiscate their property over the alleged looting of Venezuelan state oil company PDVSA. Those investigated are alleged to have taken bribes from third parties to award inflated contracts through PDVSA, leading to US$11bln being siphoned out of the country. The investigation comes amid a worsening financial position for PDVSA, despite the company’s repayment of a US$1bln 2016 bond on 28 October. The repayment came only days after PDVSA announced the completion of a US$2.8bln bond swap that exchanged bonds maturing 2017 for new notes maturing in 2020. The swap prompted S&P to downgrade PDVSA to ‘selective default’. Together with low oil prices, dwindling foreign exchange reserves, a heavy debt repayment schedule, and mounting political instability amid attempts to secure a recall referendum on President Nicolas Maduro, there remains a high risk of default over the short to medium term.

Moreover, Police in Venezuela arrested more than 300 demonstrators following protests in several cities over President Nicolas Maduro’s decision to withdraw the 100 bolivar note from circulation. Maduro blamed the crisis on international sabotage after the planes carrying the new notes were delayed, but postponed the removal of the bills until 2 January 2017. Meanwhile, the Colombian and Brazilian borders were shut, and are expected to remain so as disruption and protests continue. The opposition has sought to renew anti-government protests at the end of the year, although they no longer have a constitutional method of ensuring new elections given that the government’s obstruction of a recall referendum against Maduro this year. The delay means that he would now be replaced by his vice president in the event of a successful recall vote, rather than new presidential elections being held.


US oil sanctions on Venezuela would escalate crisis

The Trump administration is ratcheting up its rhetoric against Venezuela in a bid to derail president Nicolas Maduro's efforts to rewrite the nation's constitution. The US has already imposed sanctions on high-ranking Venezuelan officials, including vice president Tareck El Aissami and a number of supreme court justices. But in recent days the US has floated the idea of targeting the Opec producer's oil exports if Maduro presses ahead with a July 30 constituent assembly election. Maduro aims to overhaul Venezuela's 1999 constitution, which would defang his opposition and solidify his hold on power.

Tough talk

Whether oil sanctions are a real policy option or simply tough talk to ramp up the pressure on Maduro is not clear, though the latter seems more likely. A senior US official said that while "all options are on the table", there are those in the administration that oppose the move. Imposing oil sanctions would raise the stakes for both sides, punishing Maduro's cash-strapped government and state oil company PdV, but also exposing US companies with ties to Venezuela and potentially US consumers.

Disrupting Venezuela's oil trade could prove a fatal blow to the country's crisis-wracked economy. Oil accounts for more than 95% of the country's foreign earnings, and the US is the country's largest and most important export market. In the first quarter of the year, Venezuela sent 0.724m barrels a day of crude to the US, accounting for roughly half of the country's oil exports. Crucially, sales to the US are vital to generating cash for Venezuela because much of the country's other exports go to China and elsewhere to repay loans or to Caribbean allies at a highly subsidised rate under the PetroCaribe programme.

Venezuela would seek to find new markets for its product. But given the large volumes involved and the uniquely heavy and sour makeup of Venezuelan crude it wouldn't be easy. The US Gulf Coast refiners have invested heavily to gear their facilities to be able to process heavy sour crudes like Venezuela's. China and India would be the most likely alternative markets for Venezuela. They have the heavy-oil processing capacity necessary, growing demand and an established trade relationship. Still, it's unlikely those nations alone could absorb all of the displaced imports.

Venezuela's perilous financial position would make even a temporary disruption in oil flows potentially ruinous. Venezuela's foreign reserves fell below $10bn this month for the first time in two decades, giving it virtually no cushion to deal with a cut in oil revenues. Imports have already been slashed to the point that food and medicine shortages are now commonplace, and broad economic sanctions would only worsen the nation's humanitarian crisis. The sanctions would also likely hasten a credit default, either at the government level or at PdV. The Venezuelan government and PdV face nearly $5bn in combined debt payments from August to the end of 2017 - nearly $3bn of which is owed by the state oil company.

                                                 Fallout

The fallout from such a scenario would be unpredictable and potentially dire. The ensuing economic chaos could force Maduro from power, but it isn't clear what would follow. A best-case scenario would see a broad multilateral diplomatic effort marshal a peaceful transition of power and an economic relief plan. However, the Maduro government has powerful allies in Russia and China, as well as some regional allies gained through its petrodiplomacy, that would likely oppose any effort to depose Maduro. The worst-case scenario would see a collapse of the state and a violent unruly transition spiral into civil conflict.

Avoiding such a worst-case scenario could sway the US away from harsh oil sanctions. So too would the potential pain at home. Venezuela has accounted for nearly 10% of total US crude imports in the first quarter of this year, and nearly 20% of imports into the Gulf Coast. Citgo, PdV's American subsidiary, Valero, Chevron and PBF Energy are the largest buyers of Venezuelan crude.

The market is well supplied and US stocks brimming, so consumers wouldn't likely see much of an impact from the absence of Venezuelan crude. But those refiners would have to scramble to find replacement heavy crude. Mexico and Colombia are other nearby heavy-oil producers, but both are seeing output fall and wouldn't be able to fill the gap. Canada's heavy oil output is growing, but pipeline capacity constraints would limit how much more crude could flow to the Gulf Coast. Saudi Arabian heavy crude grades could also substitute for Venezuela's, but it has said it is limiting exports to the US in an effort to draw down inventories there and boost the oil price.

Imposing harsh oil sanctions on Venezuela could also expose US companies in the country to retaliatory measures. Chevron, Schlumberger and Halliburton all have substantial economic interests in the country. Lashing out at the US companies would be self-defeating, but a nationalisation of their assets couldn't be ruled out. Venezuela could also stop importing US oil. Venezuela's uses light oil as diluent for its heavy oil output and has been an important outlet for US light oil exports, helping support tight oil growth, especially in the Permian.

Americas: Further US sanctions against Venezuela expected
Sectors: all
Key Risks: non-payment; FX shortage; civil unrest; deadly violence; political instability

In Venezuela, further US sanctions are expected following the controversial 30 July 2017 vote to elect a National Constituent Assembly (NCA) that will be tasked with rewriting the constitution, a move expected to further entrench President Nicolas Maduro’s power and officially upend what is left of Venezuela’s democracy. It remains unclear what the scope of the new sanctions would be, but reports suggest that they are not yet expected to include a ban on lighter US crude that Venezuela needs to dilute its extra-heavy crude to export. Additional sanctions could target regime-affiliated individuals, and financial restrictions could be placed on state oil company PDVSA. Broader sanctions could push Venezuela closer to default. The opposition has vowed to continue to take to the streets despite increasing deadly security-force repression. Further clashes should be expected across the country over the coming weeks.