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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 ‘’Election’’ Creates Opportunity For Oil Investors

Venezuela

On Sunday, an “election” occurred in beleaguered Venezuela, a member of OPEC and owner of the largest oil reserves in the world.

The result of this election was hardly in doubt.

Opposition political parties boycotted what can most generously be referred to as “massaged” voting results.

But the main result may end up being an unanticipated change in global geopolitics…

And a higher oil price.

Here’s what I mean…

Venezuela’s “Election” Guarantees U.S. Sanctions

In many areas, more votes were apparently cast in favor of the government than there are total voters.

As a result of this “election,” Venezuela’s President Nicolas Maduro has obtained a pliant new national legislature and a dramatic expansion of his presidential powers, all in the name of meeting a worsening national crisis.

He also gained guaranteed additional sanctions from the U.S.

Yesterday morning, Maduro’s political foes were already being arrested and draconian moves were being introduced to stem a rising tide of street unrest.

The country is quickly cascading into a failed state, the term for a country where central leadership is no longer able to govern within its own borders.

And that’s even before the American sanctions hit.

The Only Thing Worth Sanctioning is Oil

Washington’s direct reprisals against individuals – freezing Maduro’s private U.S. bank accounts, for example – have already taken place.

Admittedly, such actions have had only limited effect. But the next round is going to bite much harder.

In the process, the condition of life in the streets will get worse. It’s the cruelty of economic sanctions that the poor who can least afford them are usually the ones disproportionately harmed.

That will be the case again when the U.S. initiates its next round of sanctions, directed against the only asset of any value in Venezuela.

Oil.

Related: Shell Posts 700% Rise In Earnings, Prepares For ‘Lower Forever’ Oil Prices

Venezuela possesses the largest oil reserves in the world, greater than even Saudi Arabia. But this is heavy oil located in the Orinoco River belt. Such oil is difficult and expensive to produce and process.

The looming U.S. sanctions are about to make it even more expensive.

Caracas has for some time been importing lighter American crude to mix with its own volume, making its export blend lighter and allowing its largest refinery on the island of Curacao (Isla, having a daily capacity of 335,000 barrels) to produce oil products essential for both domestic consumption and export.

The latest figures (for the end of June) indicate that 105,000 barrels of U.S. oil are exported daily to Venezuela, while the Energy Information Administration (EIA) puts daily American imports from Venezuela averaging 741,000 barrels for all of 2016.

This latter figure is likely to continue to fall as more locally produced crude replaces imports here in the U.S.

The sole factor in determining import levels is cost. Despite the largess in domestic reserves, U.S. refineries will import to benefit their refinery margin.

This margin represents the difference between what it costs to produce oil products and the price commanded at the first level of wholesale (still called the “rack price.”), and it’s where the refiner makes its profit.

Crude oil remains the largest component on the cost side.

Well, the new U.S. sanctions will reduce the desirability of continued large imports from Venezuela. That’s because those sanctions will almost certainly curtail the sale of lighter U.S. oil to PDVSA.

Now, PDVSA could certainly obtain the oil they need for mixing elsewhere. Unfortunately, that will guarantee a rise in costs and a higher price required from the sale of the resulting refined products – meaning even less money for PDVSA.

PDVSA is also finding it increasingly difficult to honor its contracts with terminals in the Caribbean, some of which are owned by U.S. companies.

This is also another potential target for the sanctions.

Washington will tailor sanctions to target the aspects of PDVSA activities that it can most directly effect – those that involve U.S. corporate and market actions.

This could have dire consequences for Venezuela…

Venezuela is Already Struggling to Repay Its Debts

We’ve discussed the matter of Venezuela’s acute economic problems and the condition of PDVSA, the national oil company, here in Oil & Energy Investor before.

In short, both the central government and PDVSA have been taking up more and more debt, and are facing increasing difficulties servicing it. A default by either is likely to trigger the collapse of the other.

The oil company has some two months before the next phase of its payback hits. Somewhat over $3 billion is due and a recent survey of bankers estimated that there is a 62 percent chance of a default (sorry, we are not supposed to use “default” these days; it’s now called a “credit event.”).

Already, PDVSA is having acute difficulties because of a significant decline in production. Oil output now stands at only about 1.96 million barrels a day. To put this in perspective, that means production is down almost 30 percent in less than a decade.

Another 10 percent decline is developing.

While that further cut could be covered by other producers (both inside OPEC and out), it continues to whittle down the worldwide surplus as the balance between supply and demand increasingly takes hold.

This makes for a firmer floor for global oil prices. And it’s the price floor that determines the market.

The other immediate result of the coming U.S. sanctions is geopolitical…

Russia, Iran, and China Will All Join in to Help Their Ally

Years ago, a combined Russian, Iranian, Chinese, and Venezuelan investment bank was set up in Caracas. It was intended to fund Orinoco projects after Maduro’s predecessor Hugo Chávez threw out Western oil majors.

Related: Aggressive U.S. Oil Sanctions Could Bankrupt Venezuela

Initially, the five largest Russian oil companies came together in a consortium to develop the oil. The initiative also involves contract swaps and plans for longer-term financing. Ultimately, plans collapsed as the nation’s financial problems accelerated.

However, the investment bank remains in place.

Contacts are now telling me that U.S. sanctions against PDVSA will create a response in Moscow, Beijing, and possibly even Tehran. Some support for Venezuela from there is expected to offset the sanctions.

A response to Sunday’s vote in Venezuela, therefore, may well result in a return of high stakes Cold War-like politics to the Western Hemisphere…

In addition to stronger oil prices.

By Dr. Kent Moors via Oil and Energy Investor

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