Venezuela Could Push Oil To $80

Friday August 4, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Venezuela crisis deepens

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- Venezuela proceeded with a highly controversial vote to rewrite the constitution last weekend, granting more power to the President in what many are calling a step towards dictatorship.

- The U.S. slapped sanctions on President Nicolas Maduro and hinted at forthcoming sanctions on Venezuela's oil sector.

- The country is in a full-blown crisis, with many expecting a default as soon as this year.

- The implied probability of a default over the next year has climbed to nearly 70 percent.

- The value of Venezuela's bonds have plunged.

2. Venezuela's importers at risk

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- The U.S. government is mulling harsher measures against Venezuela, which could disrupt oil imports from the South American nation into the Gulf Coast.

- Several refiners are major importers of Venezuela's heavy oil. The largest - Citgo - is obvious because it is a subsidiary of Venezuela's state-owned PDVSA. Citgo imported 66 million barrels last year. But it wasn't alone. Valero (NYSE: VLO) imported 57.5 million barrels, making it vulnerable to the spiraling crisis in Venezuela.

- Opposition from refiners like Valero, Phillips 66 (NYSE: PSX), Chevron (NYSE: CVX) and PBF Energy (NYSE: PBF) convinced the White House to hold off for now.

- But these refiners could lose big if the Trump administration decides to lower the hammer on Caracas.

3. Venezuela default risk spikes

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- The Venezuelan government and the state-owned oil company PDVSA owe a combined $5 billion in principal and interest payments that mature between now and the end of 2017. An interest payment of $725 million is due this month.

- October and November are the real test, when $3.6 billion is due.

- Ominously, the country only has about $3 billion in foreign exchange, according to S&P Global Ratings, a pittance given its liabilities.

- "We really do think a disorderly default is on the cards for Venezuela," RBC's Helima Croft told CNBC. RBC says that Venezuela's default and the subsequent plunge in oil production could send oil prices up to $70 to $80 in a few months.

4. Shell's returns eroded over time, but could be at a turning point

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- Royal Dutch Shell (NYSE: RDS.A) is one of largest oil companies in the world but it also has one of the largest debt piles in the world.

- The oil major spent heavily in the years before the oil price crash - in 2013 alone, Shell spent $40 billion.

- This strategy started to erode returns on investment even while oil traded north of $100 per barrel, as Bloomberg Gadfly notes.

- Shell is in the midst of a dramatic pivot towards lower risk, short-cycle projects. It is assuming oil prices remain "lower forever," and will proceed with caution. It has cut spending, withdrawn from Canadian oil sands, and paid down debt, while only moving forward on lower risk projects.

- The earliest signs of progress are the fact that the return on capital employed has climbed to 4.2 percent, up from 2.9 percent last year. It is a far cry from the 18.3 percent rate the company posted in 2008, but it is progress.

5. Red flags in the shale patch

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- U.S. shale drillers often boast about the extraordinary efficiency gains they have achieved in recent years.

- But there are signs that the shale industry is eating itself. According to Bloomberg, some drillers are placing wells too close to each other, which can cause pressure to drop and can permanently damage the well's potential.

- In other words, shale E&Ps are cannibalizing themselves through too much drilling. Output from legacy wells - those already online - is declining by 350,000 bpd each month. The only way that overall U.S. oil production can continue to rise is through higher and higher drilling rates. But drilling too close together is inflating that legacy decline rate.

- The Permian alone has seen its legacy decline rate jump from less than 100,000 bpd month-on-month in 2016, up to nearly 160,000 bpd more recently.

- The upshot is that the shale industry could be doing lasting damage to its long-term potential by being too aggressive today.

6. EV surge to create winners and losers

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- Electric vehicles are expected to capture an ever-larger share of the vehicle market going forward, which will put pressure on the supply chains of several key metals.

- Lithium - used in lithium-ion batteries - is the most obvious. But copper, nickel and cobalt will also see a jump in demand.

- EVs contain three times the amount of copper as a traditional gasoline or diesel-powered vehicle.

- "For some of the metals, it's a complete game changer," Simona Gambarini, a commodities economist at Capital Economics Ltd., told Bloomberg. "We've already seen a big impact on some metals like cobalt and lithium, which have soared over the past couple of years."

- Prices are soaring for lithium, cobalt and copper, offering investors appetizing possibilities.

7. Shale industry cuts spending

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- The latest earnings season in the shale patch showed a clear trend: the industry is cutting back as the hopes of higher oil prices have all but disappeared.

- Six companies in the past two weeks have cut a combined $950 million from spending levels for 2017.

- The cuts came from Anadarko Petroleum (NYSE: APC) at -$300m, ConocoPhillips (NYSE: COP) at -$200m, Whiting Petroleum (NYSE: WLL) at -$150m, Sanchez Energy (NYSE: SN) at -$100 m, Hess Corp. (NYSE: HES) at -$100m and Pioneer Natural Resources (NYSE: PXD) at -$100m.

- The spending cuts suggest that the shale industry is slowing down, which could mean lower-than-expected production growth for the rest of this year and next.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.