The Fuse

Venezuela’s Output in Danger of Falling by Another 800,000 b/d

by Matt Piotrowski | October 27, 2017

The growing instability and political disarray in Venezuela pose major threats to the country’s oil production. Venezuela’s output is in danger of further declines just as other factors are reducing global supply. OPEC and its non-OPEC allies are cutting production, geopolitical risks are rising, and the global oil industry has decreased investments in long-term projects. This combination places upward pressure on oil prices over the medium to long term.

Output is just under 2 million barrels per day (mbd), down by more than 300,000 b/d since early 2016 and approximately 800,000 b/d below levels seen three years ago.

Venezuelan production could fall by as much as 700,000 to 800,000 barrels per day (b/d) to 1.2 million barrels per day (mbd), sources with deep knowledge of the country’s oil industry told The Fuse. Currently, the South American OPEC producer’s output is just under 2 million barrels per day (mbd), down by more than 300,000 b/d since early 2016 and approximately 800,000 b/d below levels seen three years ago. Not only is production falling; the crude’s quality has deteriorated so much that it often is not suitable for refineries.

“We are seeing a country that has refused to accept that it has an addiction to crude and to mismanage oil wealth.”

Venezuela’s crude output is declining as the country is undergoing a severe humanitarian crisis and deterioration of democratic processes. A mixture of ignorance, mismanagement, and corruption has led the country to its current situation. The country has a long history of undermining investment through price controls, nationalism, indebtedness, and “hyper-corruption.” From 1999 through 2013, Venezuela collected $1.3 trillion in oil revenues but it largely has vanished through corruption, massive social spending, and waste. “We are seeing a country that has refused to accept that it has an addiction to crude and to mismanage oil wealth,” said Raul Gallegos, associate director for Control Risks and the author of Crude Nation: How Oil Riches Ruined Venezuela, speaking at Cato in Washington, DC this week. “They are used to mismanaged oil wealth. They refuse to seek treatment. Just like any addict…the thing to do is to seek help. Unfortunately, Venezuela has not taken the steps to create a solid legal framework that will tie the hands of politicians and make it very difficult to go on a spending spree.”

Deep corruption in PDVSA

Caracas has used PDVSA as a social and political organization instead of managing it as an efficient oil company and re-investing profits to grow production. It has been the “victim of aggressive politicalization,” said Gustavo Coronel, a Venezuelan petroleum expert and founding member of the board of directors of PDVSA, also speaking at Cato. Venezuela currently holds the largest proven reserves in the world. However, production won’t grow again until a new government is formed and implements structural reforms through either radically revamping PDVSA or creating a new model that attracts foreign investment. PDVSA has a major bond payment due today. If PDVSA does not make the principal payment on the on the bond, it will be in default—though there is a 30-day technical window in which the default could be resolved. Moreover, it risks losing its Citgo assets in the U.S. that are being used as collateral for a loan from Russia’s Rosneft. (PDVSA said over the weekend that it made a principal payment on its bonds that were due.)

Since Hugo Chavez took power in 1999, production has declined by 40 percent and the number of PDVSA employees has fallen by more than half. The company’s debt has soared from $4 billion to $90 billion and its exports to the U.S. have dropped by two-thirds. PDVSA’s corruption runs deep. Some of its employees, for example, are involved in drug trafficking and money laundering, Coronel pointed out. In the oil fields, PDVSA pays $8 million to drill a 3,500-foot horizontal well, compared to the real cost of $1 million, according to an industry insider close to PDVSA.

Despite sharply declining exports, Venezuela has to import expensive refined products and light crude from the U.S., send crude to Cuba and other Caribbean countries, and make large debt payments to among other countries Russia and China.

As PDVSA falls apart, the country is also experiencing a massive flight of human capital and a deepening recession.

As PDVSA falls apart, the country is also experiencing a massive flight of human capital and a deepening recession. “This is the worst economic recession in Latin America’s history,” said Francisco Monaldi, a fellow in Latin American energy policy at the Baker Institute at Rice University, speaking at an event at the Council of the Americas this week. Worsening economic conditions have caused many Venezuelans to flee the country, mostly to Brazil, Colombia, Peru, and the Caribbean. Last year, approximately 200,000 people left the country. “Venezuela will deny there’s any humanitarian crisis,” said Russell Dallen, managing partner at Caracas Capital Markets, also speaking at the Council of the Americas. He pointed out that the average wage in the country is just $8 per day.

Approximately 1 mbd at risk

Output under PDVSA’s operation could decline sharply as a result of ongoing mismanagement, putting approximately 1 mbd at risk.

About half of the country’s production is operated by foreign companies and the other half by PDVSA. Production run by foreigners is mostly secure and less susceptible to corruption. Also, these companies, which include Total, Chevron, Statoil, CNPC, and Gazprom, are more effective in their operations and appear committed to remaining in the country. They want to receive payment for their operations and they are used to working in countries with political risk. The output under PDVSA’s operation, however, could decline sharply as a result of ongoing mismanagement, putting approximately 1 mbd at risk. Some experts don’t see Venezuela’s output declining as abruptly, estimating that the country will instead lose another 300,000-400,000 b/d. There’s little question the global market will lose more production from Venezuela in the coming months and years.

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