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Kent Moors

Kent Moors

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment. His…

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Venezuela’s “Oil Fire Sale” To Benefit Russia, China

venezuela military

Venezuela is now on the brink of total collapse. As you’ve seen before here in Oil & Energy Investor, national oil company PDVSA looms large in this unfolding crisis.

The focus is the company’s ability to pay bond interest due in two months. Doing so is crucial. But as of this morning, that prospect is dwindling.

Along with it goes the ability of the central government to administer an entire population and avoid the country descending into outright civil war.

And PDVSA is at the center of it all.

Now, there’s talk of U.S. sanctions on PDVSA in particular.

Here’s how that may play right into Russia’s and China’s hands…

This is Venezuela’s Oil Supermarket

PDVSA is the vehicle for about 90 percent of Venezuela’s trade revenue and has served as a primary outside purchaser of all manner of staple commodities essential for the literal survival of a domestic economy rapidly sliding into oblivion.

While charismatic Hugo Chávez was in power, PDVSA was required to spend foreign hard currency export proceeds held outside the country to acquire food for import into Venezuela.

It prompted a colleague of mine at PDVSA to lament: “I thought we were an oil company, not a supermarket.”

Paying for the purchases abroad was supposed to minimize the adverse impact of exchanging currency under oppressive domestic inflationary pressures and a fractured infrastructure.

What it actually did was undermine any ability to use PDVSA’s revenues to buttress an increasingly insolvent central budget.

It also wasted money, as food was purchased and then transported through intermediaries at exorbitant prices. PDVSA, after all, operates oil tankers, not cargo vessels.

Nicolás Maduro, Chávez’s successor, complicated the matter even further by regularly raiding PDVSA coffers to pay for a wider range of imports, tied fundamentally unstable sovereign debt issuances to PDVSA bond futures, and relied on accelerating heavy-handed responses to local unrest.

As the crisis worsened, life in the streets became unbearable.

Contacts tell me that the few retail establishments in Caracas that managed to remain open often wouldn’t decide on the actual price of goods and services until you reached the counter.

Inflation was just that high, and the effective market value of the bolivar, the local currency, moved that quickly. Related: Forget OPEC, China Controls Oil Prices

It reminded me of when I was living through Russia’s currency devaluations. A dollar went a long way in Moscow then, and in Caracas now.

As Maduro’s repression increased, America launched some initial sanctions. Another, more concerted round came in response to Maduro replacing the National Assembly (controlled by the opposition) with a new legislature more bound to his will.

As I’ve sketched in some detail here in Oil & Energy Investor, Washington is now eyeing PDVSA specifically for sanctions, threatening, among others, to restrict or eliminate U.S. exports of lighter oil to PDVSA.

These exports are required to allow the processing of the much heavier oil from Venezuela’s Orinoco oil basin.

This area on either side of the Orinoco River may hold the largest oil reserves in the world.

But this is very heavy oil. I can personally attest to this. Years ago, I put some of this in the palm of my hand, turned the hand over, and it just sat there.

This oil makes molasses set speed records. It’s much more expensive to extract and process, requiring expertise and technology generally available only in the West.

If Venezuela were to lose the ability to process its oil products, the country’s domestic markets for gasoline, diesel, and other distillates would collapse. The resulting knock-on effect is certain to escalate inflation and make basic life intolerable.

And that’s not the only way in which PDVSA is under increasing pressure…

Russia is Silently Taking Over

The company has been delaying payment of vendors and, in some cases, even wages.

It’s also been unable to meet contract obligations at terminals in the Caribbean, forcing the introduction of storage and transit agreements that further increase costs and reduce revenues.

That has set the stage for one heck of a fire sale.

Russian companies have been moving in to cherry pick PDVSA assets. So far, the biggest prize – the large refinery complex on the island of Cura?ao – remains in PDVSA hands.

But it’s unknown for how long the company will be able to maintain an increasingly onerous working capital requirement.

Meanwhile, Rosneft, Russia’s largest and state-controlled oil producer, has been acquiring upstream and midstream assets inside Venezuela in return for a combination of straight payment and/or assumption of debt.

PDVSA desperately needs the funds, but Rosneft’s largess is not inexhaustible. And all of this still requires the expensive development of the Orinoco and its heavy oil.

Neither PDVSA nor Rosneft can shoulder this burden for long, especially at today’s global oil prices.

Nonetheless, control of upstream operations in Venezuela can provide Rosneft with contract swaps and targeted market penetration.

Years ago, five Russian oil majors set up their own joint venture to participate in the Orinoco along with PDVSA. There was also a joint investment bank established in Caracas for the same purpose. Related: The Caribbean Is Poised To Become The Next Major Oil Region

The venture collapsed and the bank languished. But they remain and can be resurrected on short notice.

The other likely outside beneficiary of this fire sale is China.

U.S. Sanctions May Play Into Russia’s and China’s Hands

Chinese companies have moved into Venezuelan upstream activities as well. However, here the primary play has been to control oil export revenues.

Beijing does this through repayment of large loans provided both PDVSA and the Venezuelan government. In an approach already used in Brazil and especially in Ecuador (the smallest OPEC member, where the Chinese now control oil payments), exports no longer return to the Chinese mainland.

Rather, they move anywhere national oil company Petroecuador (in the case of Ecuador) can attract the best price. But most of the sale proceeds are transferred into accounts under Chinese control.

Here as well the Chinese may make use of the oil investment bank in Caracas. Both China and Iran were parties in the bank’s creation, although aside from some Chinese correspondent accounts, foreign use of the bank has largely been Russian.

Washington needs to keep this in mind when determining the next sanctions. Coming down on both Maduro and PDVSA by assaulting oil may simply further Russian and Chinese plans already underway, pushing Venezuela further into their arms.

By Kent Moors via Oil and Energy Investor

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Leave a comment
  • Dan on August 25 2017 said:
    Most of the world has already left any Washington alliance, even Americans. As Washington now says as globalists they don't care what hurts American citizens. On record for all to see.
  • Naomi on August 25 2017 said:
    All contracts entered by a previous government may be declared null and void. Likewise the king of Saudi Arabia can nationalize Aramco as many times as he can issue stock.
  • Mannert on August 31 2017 said:
    @Naomi. You're missing the simple economics here. They can't default and go scot-free. PDVSA has no cash, and the operation of their business doesn't generate any sizable amount of cash at current oil price.

    Granted a government can in theory completely void their debt when it becomes impossible to wield, but the resulting fallout will be far worse than anything the government would have imagined. Because if they could imagine the fallout, they wouldn't void the debt.

    More reasonable options are declaring bankruptcy (a.k.a defaulting) followed by debt restructuring, or alternatively accepting foreign bailout often with austerity measures imposed and monitored by the foreign creditor-institutions. China has the cash to bailout Venezuela and oversee a do-over of the country, but they probably do not have such confidence on Venezuela.

    If Venezuela voids their debt. All future loans will cease. Cash influx ends immediately. Their foreign assets are seized, either by force or via lawsuits. Sanctions after sanctions, both official and unofficial, will flow out from China, Russia, US, and so on. The opposition groups within the country will suddenly receive massive funding from everyone, including Russia, China, etc. Maduro's battered body will be hanging from a rope in some street somewhere in Venezuela. Voiding is not possible. Defaulting is.
  • Canyonlobo on September 07 2017 said:
    It seems that all that Trump can do is threaten this or that. Why haven't we called for a serious sit down meeting with Venezuela's leaders and craft some kind of solution that will enable them to benefit from their oil production, as well as benefit the U.S. for their participation?
  • Tom Joad on September 17 2017 said:
    Once again, the CIA and American dictator have conspired to destroy the economy and the government of another country. We act like we have some duty to protect the poor people, and return the country to when the indigenous people were being slaughtered and their land stolen, and all of the oil and mineral wealth was going to foreign players and an elite few. So the CIA, US corporations, and the elite right-wing whites living there have mounted yet another insurgency, seeing Maduro as weaker than Chavez, whose CIA backed coup failed terribly. Undoubtably, US oil companies will gain control of Venezuala's oil fields, and the CIA of it's government, making it into a racist, fascist clone of the US, but a client state. Amazing how the US controls the world banking system, and can dictate to other countries what they can and can't do business-wise with a third country. Apparently only Israel is more powerful, because it controls the US government. The US is accumulating a lot of bad karma and ill-will. And as someone who lives here, I hate to see this. But I would love to see some embargos of some US industries. We are like Rome before the fall, or Italy under Mussolini. I am ashamed to be American.
  • sinbad on November 03 2017 said:
    Well I think it might be happening, Maduro has announced a restructuring of all loans, and I think China will pay out the $100 billion Venezuela owes, from it's $2 trillion of US dollars it has on hand.
    To China it's only 4 years of oil imports from Saudi Arabia, a bargain.

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