The Fuse

Venezuela’s Slow-Motion Implosion Continues

by Matt Piotrowski | May 16, 2017

South American oil producer Venezuela continues to experience deepening social unrest and economic collapse. The country, which relies on oil revenues for 95 percent of its export earnings, has fallen into humanitarian and constitutional crises that show no signs of ending. Protests erupt on a daily basis, inflation has soared to as high as 720 percent, and oil production is continuing its decline, exacerbated by disastrous policies. Some analysts estimate that 2017 Venezuelan oil production could collapse by as much as 20 percent year-on-year. The country’s leadership is obviously desperate for higher oil prices and has even called for OPEC to deepen its production cut to a massive 5 million barrels per day (mbd).

Venezuela’s current state of affairs is a prime example of how oil demand cuts both ways, impacting both producers and consumers.

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The meltdown in Caracas is a precarious situation for the U.S., given that Venezuela is its number three crude oil supplier. A bipartisan Senate bill introduced recently calls for targeted sanctions against Venezuela and for the U.S. to block Russian giant Rosneft from acquiring Citgo, a U.S. subsidiary of Venezuela’s state-owned PDVSA. Rosneft and PDVSA now have a deal that would allow the Russian company to seize about half of Citgo if Caracas defaults on its debts.

The meltdown in Caracas is a precarious situation for the U.S., given that Venezuela is its number three crude oil supplier.

Another idea that has prompted speculation, although prospects are very slim, is a U.S. embargo on oil imports, an action that would shake up oil markets by pushing up prices and altering trade flows. The U.S., despite the boom in domestic crude supply thanks to shale, still relies on Venezuela for roughly 10 percent of total imports. Furthermore, shale output is light crude while Venezuela produces heavy crude, which U.S. Gulf Coast refiners are configured to run. An embargo would force Venezuela to send most of its crude volumes to faraway Asia, while the U.S. would have to increase imports from other countries.

Venezuela is a cautionary tale for a number of reasons. Oil producers can’t rely solely on oil for revenue because price volatility and market crashes harm their economies and prompt instability. Nigeria and Libya are other OPEC countries seeing turmoil, albeit not as grave as what Venezuela is now experiencing. Producers such as Saudi Arabia, Russia, and Algeria have had to burn through foreign-exchange reserves to keep their economies afloat.

Increasingly dire news from Venezuela comes at the same time Russian and Saudi Arabian officials confirmed that they are on board to extend production cuts—which total 1.8 mbd from OPEC and non-OPEC producers—through March of next year.

Venezuela also exemplifies the risks of consumers having to rely on unstable countries for crude supply, prompting economic vulnerabilities. PDVSA is a prominent example of an NOC that was made incapable of effectively investing in resources. The country’s production, which makes up about 2 percent of total global supply, has fallen rather sharply amid the price collapse. Since 2015, Venezuelan crude output has declined by almost 18 percent to below 2 mbd, while the country has also had to rely on imports of refined products from the U.S. Venezuela’s oil export revenues totaled $22 billion last year, down by a massive $51.6 billion from the record high in 2011, when international prices averaged over $100 per barrel.

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At a time when Venezuela should be pursuing oil control diversification, it has postponed such measures. PDVSA announced in October 2016 it will perform a debt swap instead of industry reforms. Under the deal, bond holders will be paid in 2020 with collateral being a majority share, 50.1%, in Citgo. Currently, oil prices are not projected to rebound to a level where Venezuela can repay its debts, which brings into question if the government would honor the agreement in 2020. Until Venezuela relinquishes its increasing control over the oil and allows for a free moving market, oil dependence will continue to cripple the country economically.

Increasingly dire news from Venezuela comes at the same time Russian and Saudi Arabian officials confirmed that they are on board to extend production cuts—which total 1.8 mbd from OPEC and non-OPEC producers—through March of next year. Benchmark prices may be stuck around the $50 per barrel level, but the global oil market is rattled by OPEC policy and instability in producer countries perhaps best demonstrated by today’s chaos on the streets of Caracas.

 

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