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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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Russia, China To Benefit From U.S. Sanctions On Venezuela

PDVSA

The White House recently slapped new sanctions on Venezuelan officials, banning them from entering the U.S.

That follows past, more general sanctions…

As well as rumors that, if true, could end up completely collapsing the South American country – sanctions on Venezuela’s national oil company, PDVSA.

See, Venezuela is now on the brink of total collapse, and PDVSA looms large in this unfolding crisis.

The focus is the company’s ability to pay its bond interest. Doing so is crucial, but prospects are grim.

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

And that’s pushing the Venezuelan government right into Russian and Chinese hands.

Here’s why…

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.

Related: The Next Big Offshore Boom Is About To Happen Here

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.

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, 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.

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

Related: Saudis Lead Gulf Movement To Diversify Away From Oil

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 Dr. Kent Moors

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  • Fred on October 02 2017 said:
    "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."

    Well not exactly. China and Russia don't pay Venezuela in cash for its oil, only the US does. In the case of an oil ban by Trump, they couldn't use the extra oil to get cash from Russia or China. Either country would happily accept more oil but it would simply be used to pay down debt.

    Some have speculated India could take up a small portion of the demand in that scenario, but most of it would end up stuck in the country and unprocessed. (As you stated in this article, only a few specific countries are even capable of processing the oil)

    US purchases of Venezuelan oil are the only thing keeping that current gov't afloat. If that gets cut, default is a guarantee and regime change is inevitable as Maduro's 1,000 overly fed fat Generals may not feel so "revolutionary" anymore when they start getting paid in worthless currency too as the rest of the country.

    Its doubtful in the case of this scenario that China and Russia would come in to drop more billions of dollars in loans to rescue the country. Sure both countries see spiting the US as a bonus for dealing with Venezuela but would they loan more billons to Venezuela just for that reason alone? Maybe, but I think not.

    China has already shown itself to be fed up and is made it clear its not doing any new deals (and probably unwinding and cashing out on any deals already there)

    Russia, specifically Rosneft is still hanging in there, seeing if they can keep acquiring more assets at firesale prices. However, as Venezuela is deeply indebted to them as well, its likely the largees is reaching an end there too, especially with US sanctions coming in, any government/business including Rosneft has to wonder if there is a default if they could get their hands on CITGO (probably not) or if any new loans will be honored under a new government being that these firesale loans were made by an undemocratic gov't under time of duress.

    Russia and China are not stupid and they will not keep throwing money at bad. Even if they do, all it does is push down the default and probable regime change scenario down the line.
  • gulag Pittsburgh on October 03 2017 said:
    Yes, pushing Venezuela oil into control of Russia and China is a risk, but one that increases the longer we wait to sanction PDVSA. Embargo of oil needs to be total and swift, crushing the Maduro narco-dictatorship by drying up cash flow and then turn the spigot back on when these thugs are gone.

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