Venezuela is on the verge of oil collapse

Venezuela is on the verge of oil collapse

South America - the continent of extremes. The political and socio-economic structure of Latin American countries more often than anywhere else is either far-right or far-left. In the recent period, the pendulum swung toward the latter, and Venezuela turned out to be the most striking example. Whether internal stress, which is amenable to economic analysis, or external factors relied on by the authorities, led the country to a position that could not have been expected from the giant “oil reservoir” of the continent’s oil-poor continent.

The attempted assassination of Venezuelan President Nicolas Maduro on August 4 forces us to pay particular attention to the paradoxical fact that the state with the largest oil reserves in the world (302 billion barrels) is on the verge of an unprecedented collapse. Venezuela has been promising an inevitable collapse for years, and until now Caracas managed to keep afloat, despite the fact that every year the financial and social situation in the country became worse and worse. Since control over the oil industry, which provides approximately 50% of GDP and 95% of Venezuela’s export earnings, is the core of the Maduro regime, any drop in oil production will inevitably lead to the collapse of all economic life. This time, it seems, finally, all development indicators indicate that the collapse of the regime is not far off.

Oil production in Venezuela for the first half of 2018 fell by about half a million barrels per day, actually exceeding its liabilities (95,000 barrels per day) by the Vienna OPEC / OPEC + Agreement by 5 times. It may seem that behind this lies the strategic goal of the Venezuelan authorities to increase global prices, but in fact the decline in oil production is taking place despite the desire of official Caracas. In many ways, this trend is the result of the very short-sighted policy of President Nicolas Maduro, as a result of which the main feeding artery of the Venezuelan economy began to dry out. In a little over two years, oil production fell by 1 million barrels per day, reaching the lowest level in the last 70 years - all this with an unprecedented amount of oil.

The victory of Nicolas Maduro in the May presidential elections with a result of 67.7% against the background of the boycott of all the main opposition political forces is a dual episode in the history of Venezuelan statehood. Against the background of the food shortage that has already become routine, the shortage of medicines (two thirds of the country's rural population suffer from child malnutrition), the victory of President Maduro only confirmed the inability of the populist forces to offer the population a new agenda for growth. As the inflation rate broke through the 20,000% limit during the current year and the country's population seems to have finally switched to barter exchange, the Venezuelan leadership is trying in vain to find another source of income.

Over the past three years, Venezuela has repeatedly been on the verge of default, however, thanks to concessional loans from China, and, to a lesser extent, Russia (transactions for prepaying oil supplies through Rosneft), it has so far managed to avoid the worst. In general, over the past decade, China has invested about $ 50 billion in the decaying economy of Venezuela, however, it seems that the current rates of stagflation are of serious concern in the Middle Kingdom - this year Caracas received only $ 250 million to stimulate oil production. In this context, it is not surprising that the Maduro administration is trying in every way to introduce Petro cryptocurrency, allegedly backed by 5 billion barrels of Venezuelan oil.

In theory, the introduction of cryptocurrencies like “Petro” helps to circumvent one of the most painful restrictions for the Venezuelan economy - the sanctions of the United States of America. Although the period in which Hugo Chávez was in power was also marked by a number of restrictive measures, after the suppression of protests by Caracas in 2014, bilateral relations are developing strictly downward. Washington is gradually expanding the list of sanctioned Venezuelan officials allegedly involved in human rights violations, President D. Trump even mentioned the possibility of a military solution to the Venezuelan problem. Nevertheless, the US is still afraid to impose sanctions on the oil sector of Venezuela, as this measure would have hit their own economy.

Thus, at the moment, Venezuela is on the verge of all azimuths of development - the population is migrating or revolting, an assassination attempt has been made on the president, the economy is dropping and the country is in an ever deeper political isolation. What happened that the country, which was once one of the richest in Latin America, turned into the most dangerous place on the planet? In the process of examining the main causes of the current direst situation, it turns out that the settlement of surging troubles is quite feasible, however, it involves a radical review of the economic policy of Venezuela.

1. Oil & Gas as a cash cow of the economy

It may seem that excessive dependence on oil revenues is a relatively recent phenomenon, but the “Dutch disease” has been stifling the Venezuelan economy for decades. It is noteworthy that 70 years ago the share of oil in export earnings was at the same level as now (95%). The only thing that has changed during this time is the structure of building relations in the energy sector, hesitating between the predatory liberalism and the complete nationalization of the entire oil sector. The last round of development was given impetus in the early 2000s. President Chávez, who relied on oil revenues to carry out large-scale social reforms in Venezuela.

In the years of rising oil prices, there was still a chance that official Caracas would be able to combine the profitability of PDVSA, the national monopolist oil company, and the use of oil revenues for social payments to citizens. And this is despite the fact that gasoline in Venezuela for many years is cheaper than water. However, after the first call in 2008-2009. and the second, final, starting in 2014, the prospect of this political course has faded away, especially given the fact that in recent years PDVSA has allotted to the state an amount exceeding its own net income. Having no money for development, maintaining the infrastructure in proper condition, the position of the national company does not cease to deteriorate.

At the moment, foreign companies can not become the majority shareholder of any project in Venezuela, as this place is legally allocated to the state PDVSA. As always in similar cases, the national company does not have time to develop everything and the effectiveness of its activity falls. In addition, the PDVSA is constantly forced to re-organize its activities against the backdrop of political coups. For example, after a comprehensive reorganization of PDVSA in 2002-2003. - most of the protesting workers and the entire management were dismissed - the newly organized oil unions became one of the main sectors of support for W. Chávez. However, these unions are now losing patience, for a number of reasons.

2. Transfer of oil industry under army control

As the financial situation of PDVSA deteriorated, the oil industry in Venezuela gradually began to pass under the control of the military. First, high-ranking officials began to be appointed as vice-presidents of the company, then oil refining was relegated to Guillermo Blanco Acosta, comrade of Hugo Chávez in the army, then Ismel Serrano, formerly a little-known appointee of the vice-president of Venezuelan Tarek al-Ayes, became the new head of commerce, without a doubt or experience interacting with the energy sphere. The end of the trend was the removal of the former PDVSA head Eulochio del Pino (he was arrested on suspicion of fraud, to then be appointed a member of the board on the re-drafting of the constitution) and the appointment of Major General Manuel Quevedo to his post.

The appointment of military bureaucrats caused the greatest harm in the oilfield services company sector. A number of oilfield giants, since Schlumberger, have already left Venezuela for fear of the illiquidity of PDVSA. The Venezuelan authorities created their counterpart to the oilfield services company, CAMIMPEG, controlled by the military bloc, and in every possible way helped to ensure that contracts previously concluded with Western majors were renegotiated with the newly created Venezuelan CAMIMPEG. However, the involvement of CAMIMPEG is primarily a defense against the confiscation of rights to fields or other assets of PDVSA and, in terms of professional competence, has hit the oil production opportunities a lot.

3. Lack of liquidity

The lack of timely reforms has led to the fact that the state treasury of Venezuela is empty and unable to service numerous debt obligations. The government applies a kind of tactic to pay off certain obligations, completely ignoring others whose total value has exceeded $ 50 billion. It is noteworthy that during the current year, Venezuela redeemed only one single part of its obligations - paying interest on the PDVSA-2022 bonds, most of which belong to the investment bank Goldman Sachs. Thus, we should expect a number of lawsuits from US funds, especially since, according to US sanctions adopted this year, US citizens do not have the right to purchase Venezuelan bonds, depriving them of the possibility of restructuring.

Venezuela is not the first year promising an inevitable default - and although the situation in the country does not cease to worsen, so far the authorities have always found workarounds. One of the most popular options was advance payments for oil supplies, among others, the Russian giant Rosneft provided more than $ 6 billion to the treasury of Venezuela, while Chinese companies gave Caracas more than $ 50 billion. It is noteworthy that during the current year, Venezuela redeemed only one single part of its obligations - paying interest on the PDVSA-2022 bonds, most of which belong to the investment bank Goldman Sachs. Thus, we should expect a number of lawsuits from US funds, especially since, according to US sanctions adopted this year, US citizens do not have the right to purchase Venezuelan bonds, depriving them of the possibility of restructuring.

Venezuela is not the first year promising an inevitable default - and although the situation in the country does not cease to worsen, so far the authorities have always found workarounds. One of the most popular options was advance payments for oil supplies, among others, the Russian giant Rosneft provided more than $ 6 billion to the treasury of Venezuela, while Chinese companies gave Caracas more than $ 50 billion. However, as Beijing and Moscow realized the inability of PDVSA to send cargo with the necessary volumes of oil in time (due to idle ports, falling production and refusal of foreign contractors to transport Venezuelan oil), the circle of potential sponsors of Caracas slammed.

4. Brain drain and migration in general

The out-of-control emigration of Venezuelan residents further complicates the task of the administration of Nicolas Maduro. According to the UN, Venezuela has already left 1.5 million citizens by 2018 since the start of stagflation in 2015 and it is estimated that approximately the same number of people will leave the country this year. The loss of 10% of the population over 3 years is a serious omen of greater misfortune - those Venezuelan citizens who live in the border with Brazil and Colombia are in the most favorable position. It is hardly necessary to say that the experts in the field of oil and gas were among the first to leave Venezuela.

Considering that the Venezuelan authorities have ceased to publish statistical data, we can only assume to what extent PDVSA is threatening the loss of personnel. According to Reuters, over the past year and a half, about a quarter of the 146,000 personnel available as of January 2017 resigned. The situation is exacerbated by the uncompromising nature of the new PDVSA leadership in relation to its own employees, as the search for pests and saboteurs continues. As a result, a number of wells in the oil-belt of the Orinoco River and the ports need specialists and at the Venezuelan oil refineries the incidence of fires caused by the improper handling of process plants has increased.

5. Inappropriate development of deposits

The leakage of qualified specialists and the departure of foreign companies from the Venezuelan market adversely affects the efficiency of oil production. A good example is the El Furrial field, whose reserves at the time of its discovery in 1985 were more than 4 billion barrels. After its nationalization in 2009 and the expulsion of all oilfield services companies from the project, production fell during 2010-2015. more than half. Despite repeated promises to create its own, Bolivarian, analogue of the American Halliburton, PDVSA did not cope with the complex geological structure of the field, one of the few in the country containing light oil.

Venezuelan migrant specialists are in great demand - among others, oil production growth in Colombia in the period 2012-2016. associated with their involvement and the introduction of new methods of enhanced oil recovery. At the same time, it should be re-emphasized that not only the fields are operated in an inappropriate way, but also the Venezuelan oil refineries, which already operate at 30-40% of the nominal capacity. The authorities tried to sell oil refining assets (refineries in the cities of Amuay and Cardon) to Russian Rosneft and Chinese CNPC to avoid their seemingly more realistic closure, but they refused because of the unpredictable situation in the country.

The consequences of Venezuela's slide into the financial abyss will affect not only the country and its citizens, but also the entire oil market. PDVSA runs the risk of completely losing its assets in the Caribbean, which have become significant elements of the Hugo Chávez Petrocaribe program, in which island states were given economic preferences in exchange for political loyalty. The oil terminal on Bonaire will likely be closed due to the inability of PDVSA to finance its modernization, following the example of the Aruba refinery, which is no longer suitable for launch. Almost all joint ventures with Latin American countries - the construction of an oil refinery in Ecuador or joint exploration with the Cuban national company Сupet - already exist only on paper, waiting for official confirmation of complete collapse.

Heavy, high-sulfur oil will rise in the markets of the Western Hemisphere. Having lost a significant part of the traditional supply flow from Venezuela, US refineries along the Gulf of Mexico were forced to increase imports of Canadian Western Canadian Select, contributing to a significant increase in the cost of WCS (up to $ 6 per barrel below WTI, instead of the usual $ 10-11 per barrel) . Canadian suppliers will be able to cover most (an additional 500,000 barrels per day) of the needs of the American oil refining market, however, in case of a complete collapse of oil production in Venezuela, the situation may entail enormous difficulties for their refineries.

Leading oil powers produce lighter grades of oil than Venezuelan ones, therefore neither Russia nor Saudi Arabia is able to influence this trend (for comparison, the API gravity of standard Russian Urals grade is about 31 °, Saudi Arab Light 32-33 ° , while the Venezuelan Merey reaches only 16-17 °). At the same time, Venezuela will increasingly need light grades of oil in order to export its own - the main part of the oil produced in Venezuela is extremely bituminous and has a density of 9-10 ° API. It has to be diluted in order to create a mixture that is easily digestible for trade, but due to the inappropriate exploitation of its own fields and the effect of the American sanctions, PDVSA has to import light varieties.

For Venezuela, there are still ways to settle - liberalization of the oil sector, refusal of state-fixed prices (which are meaningless under conditions of stagflation), attracting foreign investors by providing them with guaranteed long-term conditions, ending the campaign of persecution of progressively minded figures. At the same time, it is necessary to find any modus vivendi with Washington, which, due to ideological incompatibility, will never become an allied state of Venezuela. However, US companies need Venezuelan oil — as of April 2018, the US imported 630,000 barrels of oil a day — and that is what stops Washington from imposing sanctions on Venezuelan oil.

At the same time, the administration of President Nicolas Maduro will most probably find it very difficult to make a sharp turn of the political course, fearing further reputational losses — too much effort has been made to be eradicated in a single movement. But with the continuation of the previous line, the economic, and then the political collapse of this oil giant is a matter of time.
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