The Fuse

Venezuela’s Problems Mount, Output Continues to Fall

by Nick Cunningham | May 16, 2018

Oil prices have climbed to their highest levels since late 2014, with most commentary suggesting that recent gains have been spurred by renewed sanctions on Iran that threaten to disrupt a significant portion of oil supply.

However, the continued meltdown in Venezuela is having a more immediate impact on the market. While supply losses from Iran are potentially significant, the size and timing are unclear. Venezuela, though, is already responsible for an enormous volume of production losses, which are ongoing. Moreover, the crisis is accelerating as creditors are laying claim to the few remaining productive energy assets in the country, while a sham election in a few days could be a critical point if the United States follows up with stiffer sanctions.

Production losses mount

Venezuela’s oil production fell by 41,700 barrels per day (b/d) in April, according to OPEC’s secondary sources, plunging to just 1.436 million barrels per day (Mbd), or down more than 700,000 b/d from 2016 levels. The reasons for the decline are well-known by now: Lack of cash to invest in maintenance, a worker exodus from PDVSA, a shortage of diluent to blend with the nation’s heavy oil, and operational problems at the country’s dilapidated refineries, processing facilities and oil fields.

On top of the ongoing myriad issues plaguing the country’s oil sector, some recent events threaten to accelerate production declines. The persecution of Chevron employees highlight the threat to oil production from the joint ventures in Venezuela, which account for over half of the country’s oil output. The desperation from the government, and the heavy hand by the general who now runs PDVSA, are exacerbating the problems plaguing the oil company.

An international arbitration court awarded ConocoPhillips $2 billion in compensation related to the expropriation of oil projects in 2007 by the Venezuelan government.

More recently, the prospect of actions from creditors looking for compensation threatens to add to the country’s woes. In late April, an international arbitration court awarded ConocoPhillips $2 billion in compensation related to the expropriation of oil projects in 2007 by the Venezuelan government run by the late Hugo Chavez. ConocoPhillips responded to the ruling immediately, laying claim to a series of assets owned by PDVSA in the Caribbean, including a 10-million-barrel storage terminal on the island of Bonaire, in addition to storage and export facilities on the islands of Curacao and Aruba.

The claims by ConocoPhillips have clearly unnerved PDVSA and could undercut operations even further. PDVSA recalled some of its oil tankers back into Venezuelan waters and is trying to shift operations to inside the country to avoid more asset seizures. But that will be difficult, if not impossible, according to analysts. Roughly 16 percent of Venezuela’s oil exports are stored at the terminals in question, before they move on for export to the U.S., China, and elsewhere. As Argus Media notes, PDVSA has “limited functioning domestic storage, and floating alternatives are out of financial reach.” PDVSA will have a difficult time using supertankers from terminals in Venezuela, according to Francisco Monaldi, a fellow at Rice University’s Baker Institute. That could force the company to shift more exports to the U.S., although at much deeper discounts.

Moreover, the asset seizures make it much more difficult for PDVSA to blend in lighter oils and diluents with domestic heavy oil because some of that processing is situated at those Caribbean facilities. As a result, upstream production at heavy oil fields may be at risk of not being available for export.

ConocoPhillips is presenting a large threat to PDVSA.

ConocoPhillips is presenting a large threat to PDVSA, which is likely why the Venezuelan oil company struck a conciliatory tone recently, suggesting that it wants to reach an agreement. However, any payoff to ConocoPhillips may only spur more creditor action. PDVSA and the sovereign government are in arrears to a wide range of creditors, having skipped payments on some $50 billion worth of bonds beginning last year. The debt defaults could balloon this year as billions of dollars in bond payments fall due. “Creditors are now saying to themselves, ‘Look, we now have confirmation that you can go out and embargo PDVSA,’ and many of them are going to rush into court to ask for their own seizures,” Antonio De La Cruz, executive director of Inter-American Trends in Washington, D.C., told the Florida-based El Nuevo Herald.

Venezuela problems tighten global oil market

Analysts say the asset seizures could lead to the loss of another 500,000 b/d.

There is a great deal of uncertainty over the ramifications of the asset seizures, although some analysts say it could result in the loss of another 500,000 b/d. To make matters worse, President Nicolas Maduro has scheduled a presidential election for May 20, a vote most see as a sham. The U.S. has already signaled that it may slap new sanctions on Venezuela as punishment for the illegitimate vote. While the details are still in flux, the sanctions could take the form of a ban on Venezuelan oil imports into the U.S. or prohibit U.S. diluent shipments to Venezuela, either of which would exacerbate financial and oil production problems for the country.

Although U.S. oil imports from Venezuela have plunged alongside Venezuela’s output, the South American nation is still a significant supplier for U.S. refiners. In February, the U.S. imported 472,000 b/d from Venezuela, down roughly 30 percent from the 2017 average, and down 70 percent from the typical import levels in the mid-2000s. U.S. refiners are adapting by buying heavy crude from elsewhere, although declining production in Mexico, combined with pipeline bottlenecks in Canada, has made heavy oil harder to come by for refiners on the Gulf Coast. Nevertheless, it’s clear that rallies in the oil futures contracts over the past year have in large part stemmed from OPEC cutting production—and the slow deterioration of Venezuela’s supply.