The Fuse

Crosspost: How Much Worse Can It Get for Venezuela’s State Oil Firm PDVSA?

by Amy Myers Jaffe | January 26, 2018

Amy Myers Jaffe is the David M. Rubenstein senior fellow for energy and the environment and director of the Energy Security and Climate Change program at the Council on Foreign Relations (CFR). This article was first published on CFR’s blog and can be found here

Venezuela’s latest attempt to raise capital by issuing a cryptocurrency, the petro, linked allegedly to its Orinoco oil reserves is problematical on so many levels, it is hard to know how to comment on it beyond pointing out the U.S. government has already said that trading in the new market could risk exposure to U.S. sanctions. Stopping the cryptocurrency could wind up being the easiest item for the Donald J. Trump administration to address in the steps that Caracas is taking to obviate Venezuela’s state oil company Petróleos de Venezuela, S.A’s (PDVSA) creditors. PDVSA is engaging in all kinds of no cash deal making to bypass oil cargo seizures. But the company could face even more difficulty this year as Venezuela’s financial woes have bitten into its capacity to keep its oil fields running. Citibank estimates that Venezuela’s oil production capacity could sink to one million (barrels per day) b/d over the course of 2018, down from 2.8 million b/d in 2015, as its access to credit worsens, sending even more of its facilities into disrepair. International service companies are limiting activities in the country as they take write downs on hundreds of millions of dollars in unpaid fees. Venezuela’s oil fields have a natural decline rate of 25% that requires constant attention to maintain capacity.

As the financial situation for PDVSA worsens, the oil market effects could widen, especially if it leads to the collapse of Citgo Petroleum.

Finding a soft landing out of the crisis for PDVSA’s U.S. subsidiary Citgo Petroleum could become increasingly complex for the United States as it seeks to manage Venezuela’s deteriorating situation. Washington has placed sanctions on critical members of the Venezuelan government but has been reluctant to take action that could spill over to Citgo’s ability to operate. Citgo operates three of America’s largest oil refineries for a total capacity of 750,000 b/d, including an important regional facility near Chicago. Citgo supplied fifteen billion gallons of gasoline in the United States in 2015. So far, Citgo has been shielded from creditors by its corporate structure. But recently, impatient creditors of state oil company PDVSA are starting to use more aggressive tactics, with one such group trying to seize an oil cargo ship in an attempt to get paid. To avoid such circumstances, PDVSA, which for all intents and purposes can no longer attain bank letters of credit, is “time swapping” ownership of some of the undesignated crude oil cargoes it can muster for export for exchange of later delivery of badly needed fuel and feedstock. The arrangements are designed to discourage creditors from trying to grab oil in international locations because, in effect, the oil is already owned by other parties before it sets sail from Venezuela.

Last year, Venezuela shipped about 450,000 b/d to China as part of a repayment of $60 billion in Chinese loans. That is less than half of the oil volume originally anticipated in the payback schedule. In fact, one of the largest lenders, China Development Bank, has been receiving barely enough oil and refined oil products from Venezuela to cover the interest payments on its loans, according to Energy Intelligence Group. China and Russia are still receiving repayments via oil shipments, with some small percentage of the value of the cargoes allegedly getting back to Caracas. Other buyers such as Indian refiners are still seen picking up cargoes on a F.O.B. basis (free on board) that gives immediate ownership on pickup.

The question is whether the status quo will prevail or whether Citgo’s operations will be affected as financial problems escalate. The fate of PDVSA’s bonds, which are also in a state of “quasi-default,” are particularly tricky because many diverse parties are laying claim in a manner that could foreclose on Citgo shares. A deal that pledged company stock to bondholders is creating an opening to hasten foreclosure. In another deal, Goldman Sachs purchased $2.8 billion worth of PDVSA bonds at thirty cents on the dollar back in 2017. The thesis behind the Goldman purchase, and most every other credit line extended to PDVSA is that the state firm has valuable assets, some of which are abroad, and giant reserves of oil. Governments come and go but eventually, so the thinking goes, that oil can be turned back into cash. The Venezuela case could test that kind of thesis, with implications for other oil producers trying to go to global markets to turn their oil reserves into cash.

The disruption of Venezuela’s oil exports from international trading has been gradual, perhaps somewhat muting its effect to date. The breakdown of the country’s refining system has created openings for U.S. refiners to export increasing volumes of gasoline and diesel to Latin America and elsewhere. To some extent, the drop in its crude oil exports has facilitated the ongoing collaboration between the Organization of Petroleum Exporting Countries (OPEC) and important non-OPEC producers to steady oil prices at higher levels. Higher oil prices are a bit of a help to the Venezuelan regime but with most of its oil having to be sold in barter format, convertible foreign exchange will be increasingly hard to come by, especially if oil field production problems leave it with fewer available barrels to trade.

As the financial situation for PDVSA worsens, the oil market effects could widen, especially if it leads to the collapse of Citgo Petroleum. U.S. policy makers should think about whether it’s advisable to develop a contingency plan now for the latter outcome. The Trump administration could consider being pro-active, perhaps offering a crude for products swap open tender for the U.S. Strategic Petroleum Reserve (SPR) with other U.S. refiners now to create at least a small government buffer stock of refined product that could be directed to Illinois or other affected markets in the spring, should Citgo’s operations get unexpectedly interrupted by financial problems or legal proceedings. Such a plan could ameliorate the effect on U.S. consumers from any sudden event related to Venezuela and give Washington more flexibility to respond to the ongoing crisis inside Venezuela. Should nothing go wrong in the coming weeks, the contingency planning could still be a win-win. The refined product stocks could offer the same protections ahead of next summer’s hurricane season and serve as a test case for how to modernize the SPR to include refined products at no government cash outlay.