Oil prices have surged by more than 80 percent since February on the back of unexpected supply disruptions. But the market could be missing yet another potential supply disruption that could push up prices.
Venezuela’s oil production could fall by a half million barrels per day in 2016, according to a recent estimate from Barclays. Electricity blackouts, financial distress, lack of maintenance, and a shortage of imported light oil for processing could lead to faster declines in the South America nation. Venezuela has already seen 120,000 barrels per day knocked offline because of blackouts, an outage that comes on top of years of gradual declines because of underinvestment in the country’s oil fields. The economic crisis could even force the state-owned PDVSA to default on debt later this year, according to a recent assessment from Moody’s. The oil markets are not yet pricing in this potential supply outage.
Venezuela is home to the world's largest oil reserves – at 298 billion barrels of proved oil reserves, Venezuela even exceeds Saudi Arabia in terms of the sheer size of its resource base. But unlike Saudi Arabia, much of Venezuela’s oil comes in the form of heavy oil, which requires much higher levels of investment and processing. On top of the lack of investment and maintenance in the nation’s oil fields, Venezuela has also run low on light oil that it needs in order to dilute its heavy crude for processing. Without the cash to import light oil from abroad, PDVSA could have trouble maintaining output.
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The economic crisis that has seen riots, desperate food shortages, and horrific conditions in the country’s hospitals, is also hitting the oil sector in other ways. Venezuela’s oil industry is running low on spare parts, making maintenance difficult to conduct, and the withdrawal of several international oilfield service companies also threaten a deeper contraction in output. The crisis is also crushing morale among PDVSA’s workforce, as hyperinflation erodes their pay. "Workers' moods are in the dumps," Francisco Luna, a union leader in the oil-producing area of Lake Maracaibo, told Reuters in mid-June. "Every day it's worse. Maintenance is lacking, equipment is lacking."
Venezuela is running out resources that it needs to meet debt payments to creditors. The government has prioritized meeting bond payments, but the crisis is so deep that the country is in talks with China to extend repayment terms.
Barclays laid out several scenarios for Venezuela’s oil sector. Its worst-case scenario sees output falling by 500,000 barrels per day in 2016, taking overall production down to 1.7 million barrels per day.
This would have profound implications for global oil prices. Notably, the oil market was only oversupplied by about 500,000 barrels per day before the outages in Canada in Nigeria, Barclays estimates. Although it is hard to know in real time, the oil market is arguably already in balance. The return of Canadian production could prevent sharp price increases, but with the markets naturally moving towards a more decisive balance later this year, unexpected disruptions from countries like Venezuela could tip the global market into deficit. Related: NASA May Have Just Transformed Aviation With 100% Electric Plane
“It definitely tightens the balance and raises the call on shale oil,” Michael Cohen, an analyst at Barclays, said of Venezuela’s falling oil production. “During the peak summer months, people will see how much inventory has been drawn down.”
A sizable outage from Venezuela would, as a result, mean that oil prices could rise much faster than expected. Although notable forecasters such as investment bank Goldman Sachs see little upside to oil prices in the near-term, not everyone agrees. Raymond James took a more bullish note this week, projecting $80 per barrel by the end of 2017.
If Venezuela cannot stop its economic and political crisis spreading deeper into its oil industry, the forecasters at Raymond James will be closer to the mark than Goldman Sachs.
By James Burgess of Oilprice.com
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