The Fuse

Conditions Deteriorate for OPEC’s Latin American Producers

by Matt Piotrowski | September 02, 2015

The two OPEC Latin American countries, Venezuela and Ecuador, have always held unique positions in the global oil market because of their geographical advantage of being close to the U.S.—the world’s largest consumer. But both have seen their importance fade dramatically against the backdrop of rising North American production and the drastic fall in oil prices, and these two former powerhouses are becoming increasingly irrelevant to global markets. Before the decline in prices last year, both countries, led by quasi-dictatorial regimes, were able to reap the benefits of high oil revenues and keep a tight hold on their populations. At the same time, however, they failed to provide enough reinvestment in the oil sector.

Venezuela: a Petro House of Cards

The circumstances in Venezuela appear dire with shortages of basic goods and services running rampant. The country is in massive debt and could soon default. Inflation has spiraled out of control and there is a lack of hard currency. Even before the oil price collapse, Caracas’ fiscal outlook was dim, but it has worsened considerably now that oil is in the $40-$50 range. With some 95 percent of the country’s export revenue coming from oil, the situation could indeed worsen.

Boston-based ESAI Energy puts the estimated fiscal break-even price, including discretionary spending, for Venezuela’s budget at just above $125 for Brent for this year, a level that will for sure not be reached. Venezuelan President Nicolas Maduro has taken a number of efforts to ease the economic and fiscal pain. Venezuela and China signed a deal this week for a $5 billion loan designed to boost the country’s oil production. The Maduro administration had already bought tranches of financing from China and secured financing and oil sector development funds from Russia’s Rosneft. It also received loan payments from Jamaica and the Dominican Republic. But these steps fall woefully short. “Whether the country defaults or not, it will remain exceedingly short of the hard currency required to purchase imports,” said John Galante at ESAI Energy in a recent report. “Social and political unrest could coincide with a default next year or in 2017—and lead to major disruptions in the operations of the oil sector in one of the world’s largest producers and exporters.”

“Social and political unrest could coincide with a default next year or in 2017—and lead to major disruptions in the operations of the oil sector in one of the world’s largest producers and exporters.”

If there are disruptions in Venezuela, would the global market see much of an impact? The humanitarian situation would unfortunately worsen, but the effects on oil markets would be minimal. Lower exports of crude from Venezuela would simply make room for more Canadian, U.S. shale and Saudi Arabian barrels in the U.S. market. Venezuela has already lost market share to large volumes of heavy Canadian crude reaching Gulf Coast refineries. In Asia, where Venezuela has shipped cargoes to lessen its reliance on the U.S., Russia along with West African and Middle Eastern sellers would easily step in, particularly with Iranian volumes coming back to the market.

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This is a stark contrast from last decade, when activity in Venezuela had direct impacts on the global oil market. In late 2002, labor unions, oil workers and industry leaders coordinated an oil strike to protest President Hugo Chavez, causing the country’s output to fall from 3 million barrels per day to about .63 mbd. Oil prices subsequently shot up by 40 percent, as exports to the U.S. plunged by 1 mbd. During the price rally from 2004-8, threats from Chavez to curb supplies to the U.S. gave oil markets jitters. And in 2006, Caracas hosted an OPEC meeting where the country took the opportunity to show off its massive reserves to other members of the cartel.

Now, even though the country has the largest proved reserves in the world, production remains stagnant at 2.5 mbd, and is unlikely to improve anytime soon given the fiscal situation and the low oil price. Unless there are major outages in other oil-producing countries, Venezuela will remain a footnote in the global market.

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Ecuador: ‘Very Difficult’ Times

Ecuador is not seeing the internal turmoil that Venezuela is, but the OPEC member—which rejoined the group in 2007—is hurting from the lower oil price. President Rafael Correa said last week that the country was fetching $30 per barrel for its crude, below production costs of $39. “We are going through a very difficult year economically because the price of oil collapsed,” Correa said in a speech.

“We are going through a very difficult year economically because the price of oil collapsed.”

Lower prices ought to lead to a period of underinvestment, hurting production.

Ecuador, which exports about 70 percent of its oil, has the lowest production capacity of any OPEC member, although Libya is now producing less as a result of civil war. The South American producer is pumping about .55 mbd, and sends about 40 percent to the U.S. Last year, Ecuador exported .21 mbd to the U.S., down from .28 mbd at the peak in 2005.

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Volumes to the U.S. could fall some more, as increasing volumes of shale produced in the U.S. Midwest are sent to the West Coast, Ecuador’s main outlet. In 2014, two-thirds of Ecuador’s shipments to the U.S. headed to the West Coast, with the remainder going to refiners on the Gulf. While Ecuador relies on the U.S. to buy its crude, it also depends on the U.S. heavily for refined products as it is short refining capacity. Ecuador took in .154 mbd of refined products from the U.S. during the latter part of the second quarter of this year. By contrast, a decade ago, it imported just .015 mbd from the U.S.

While the two Latin American OPEC countries have made smart moves going beyond the U.S. for relationships surrounding energy, they are having a difficult time remaining consequential to the global oil market.

Like Venezuela, Ecuador has developed a strong relationship with China in order to diversify its customer base and secure loans. As a result, most of Ecuador’s exports that do not head to the U.S. go instead to China. State-run Petroecuador agreed to export 130 million barrels of crude to China over a six-year period, which is part of a deal linked to a $2 billion loan.

While the two Latin American OPEC countries have made smart moves going beyond the U.S. for relationships surrounding energy, they are having a difficult time remaining consequential to the global oil market.