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With only days to go…
Venezuela has piled on a…
The dramatic fall in Venezuela’s oil production has surprised many analysts, and has helped to tighten the oil market more than expected. The country’s economic outlook is grim, and the debate over what happens next is only over how bad it can get. Some analysts see a precipitous drop in Venezuelan oil production, and the country is often cited as one of the biggest geopolitical risks to the oil market this year.
Francisco J. Monaldi, Ph.D. is among the world’s top experts on Venezuela’s oil industry. He is a fellow in Latin American energy policy at the Center for Energy Studies, the Mexico Center and the Latin America Initiative at the Baker Institute at Rice University. He is a leading scholar on the politics and economics of the oil industry and oil wealth management in Latin America and developing countries. We spoke with him about Venezuela’s growing crisis.
Oilprice.com: The situation in Venezuela looks pretty bleak and a lot of the stories coming out of the country are pretty hard to stomach. The lack of food and medical supplies; the economy has ground to a halt. Yet there is a presidential election scheduled for April. Few expect it to be free and fair, and some countries, including Colombia, vow not to recognize the results. Do you expect President Maduro to prevail in these elections even with a country collapsing around him? And what happens after?
Francisco Monaldi: If the elections actually happen, as seems to be the most likely scenario, I think most of the opposition won't participate. Some in the opposition might participate but not as a unified force. That might allow the regime to claim some degree of legitimacy.
Bolivia, Nicaragua, El Salvador may recognize the elections. But they will widely be considered fraudulent. So, the question is: is Maduro going to survive? Combine that with the fact that this is probably the worst economic period in Venezuela's history. We will have hyperinflation this year. We will continue to have a massive recession despite the recent increase in the price of oil. We will have massive emigration from the country.
So it's going to be a hard year even if he's able to pull it off on these fraudulent elections. But at this point there is no sort of regime change on the horizon.
OP: As for Venezuela's oil production, Barclays recently put out an estimate that said output would average 1.43 million barrels per day, with output averaging 1.35 million barrels per day in the second half of the year. What do you make of that? Does that sound about right?
FM: The headline some people put was for a 700,000-bpd decline [in 2018], but that's with respect to the average from last year and you already had a collapse at the end of last year. So the decline with respect to December … it's in the same range that I had forecasted. I think that's reasonable.
Of course, it's very hard to have a precise estimate because there is a lot of opacity in government figures. But the reason why I don't think that it's going to be a collapse of production bigger than last year — leading to almost less than 1 million barrels per day like some people have suggested — is because a large percentage of current production is in the hands of joint ventures [with international companies].
Even though [these joint ventures] clearly are also suffering and their production is declining, it has always been declining at a slower pace than the national company, PDVSA.
And also, the remaining production is heavily concentrated on the extra heavy Orinoco belt. I think at this point there is spare capacity in some of the infrastructure there because of the decline we had recently. And it's relatively easy to sustain the Orinoco's production with investment that is not dramatically bigger than the one they had been able to do before. Related: Toyota Finds A Way To Make Cheaper EVs
Combine that with the fact that the price of oil is a little bit better, I think that the presumption should be that production will not continue to fall at the same rate ... I mean even if falls at the same rate, it's less barrels in absolute numbers. But I think that it's going to be a slightly lower rate than before. It will tend asymptotically to a level at some point around 1 million barrels, probably a little bit higher than that.
OP: So the remaining production, you are saying, is a little more resilient than what came off last year?
FM: I think so. Of course, that will depend. There are a couple events that will pose risks to this baseline scenario. One is if sanctions from the U.S. on oil exports and imports to and from Venezuela are initiated. Even worse - which is not an option on the table right now — would be if they designated PDVSA as a subject of sanctions as they did the Iranian National Oil Company. That will pose a significant additional problem for PDVSA.
Another one would be a full-blown default, which I think is also likely. That could affect the operation of the joint ventures in some ways. And so, there are scenarios in which things could get worse, but at this point, I still think that [production] will continue to decline at a significant pace, but it won't be a worse collapse than it has been.
OP: You just mentioned a couple of things that I wanted to dig deeper on. Several U.S. officials have floated the possibility of harsher sanctions or some sort of policy to impact Venezuela, which could come in different forms. Some ideas were a ban on Venezuelan imports into the U.S. or a ban on U.S. diluent heading to Venezuela. Do you have any sense of what's going to happen here?
FM: Yeah, you know, I thought that they had this idea that they would continue to tighten financial sanctions and that was the road that they were going to continue on. But there has clearly been a rethinking of the options that you just mentioned that were on the table before but that they had decided against.
Part of the reasons why I think they didn't do that in the past was, first, because of the notion of "let's be gradual and see if the government responds, and then add another layer." But the other was a significant backlash from the refiners in the Gulf Coast of the U.S. And, I thought also because Venezuela's exports to the U.S. are already declining and Venezuela's imports from the U.S. in some months have also suffered (and part of this is because of the financial sanctions that already have been put in place).
But, clearly because Venezuela is not budging at all and their recent negotiations with the opposition collapsed, and Maduro, moreover, as you pointed out, is going to continue with his plan for an election without any minimal guarantees. Then I think that [the U.S.] will probably turn to these additional measures. Maybe they will do one first and then the other.
Of course, the milder one is the restrictions on exports from the U.S. to Venezuela on both diluent and products that will force Venezuela to buy…from elsewhere like Europe, Northern Africa, or Russia, and that will be costlier and that could affect a little bit of the extra heavy production.
Similarly, they will have to import some product for the domestic market. Even though the domestic market has collapsed because of the terrible shape of the Venezuelan refiners, they still need to import some products. Also, as the Venezuelan baskets become heavier they need some lighter oils or refined products to supply the domestic market. So, that will be costlier for PDVSA.
Then, of course, the bigger one will be the import ban that will affect about 0.5 million barrels per day that go from Venezuela to the U.S. Venezuela would [have to send those barrels] to India or China at a significant discount I think, and of course with higher transportation costs. Eventually I think they will be able to sell them, but they're cash flow will suffer.
So, definitely if you add that to all of the bad things already happening to the company, I think that would probably lead to a full-blown default and to further problems.
OP: And there are some not-so-subtle comments from Secretary of State Rex Tillerson as well as Florida Senator Marco Rubio seemingly hinting at a military coup. How likely is that? How likely is it that the Venezuelan military would step in and oust Maduro? And are statements like these from U.S. officials somewhat reckless and would they backfire by bolstering support for Maduro?
FM: I think that, on the one hand, they have the following problematic implications. For Latin American countries military coups bring back a sort of history of very bad military governments that violated human rights, etc. So, that's not something that's welcome at all in the region.
It's harder to know what the impact is inside the Venezuelan military. There's no doubt that the Venezuelan military has been repeatedly purged of people that were not supporters of the regime. And moreover, they had been given a very significant role in the economy most recently by taking control of PDVSA. And very interestingly, the branch of the military that took control of PDVSA was not the one that everybody expected in the past that had been pushing for that, which was the army, but instead the national guard, which is the repressive part of the armed forces.
OP: What's the significance of that?
FM: Well, Maduro is giving a big piece of the pie, or the rents, to the branch of the army that is responsible for repressing protest and domestic control of the population. That had been, in the past, the branch of the military that was less relevant in Venezuela. That doesn't mean that you don't need the support of the army; don't get me wrong. The army is basically responsible for holding the government in power because without the army they would not be there.
There have been plenty of rumors in the past few years about some discontent inside the army, and more recently with the problems of the soldiers and low-ranking officers being really upset because the economic situation is also affecting them and their families, so it's hard to know.
They had been very effective up until now at controlling it. But the magnitude of the crisis is so bad that a combination of the loss of legitimacy, I mean you could argue that the regime already has zero legitimacy but it's also true that Maduro’s past election was recognized. This one will not be by most countries. So, it could lead to a fracture in the regime and if that happens it could lead to some sort of coup or pushover from one faction that can take Maduro out and bring in someone else from within the regime. That is clearly a scenario, but it is very hard to know.
OP: Venezuela's, and PDVSA’s debt situation this year — what do you foresee? Are there more debt defaults likely? Larger ones? And what would that mean for Venezuela's oil production?
FM: They just reported the financial debt of PDVSA, which has declined significantly, basically because they haven't been able to find any way to access the markets to refinance, so they have paid some debts and they haven't been able to get additional debts. Of course, it doesn't include promissory notes that they had given to service companies like Schlumberger or Halliburton — that’s not part of that. But it is clearly the case that they have not been able to issue some debt except Citgo a little bit. So that's a big problem.
All the issues of cash flow that we have seen … the fact that they have had to send a lot of barrels that do not generate cash ... the domestic market in which every barrel is not only sold at zero, but they have to put money into distributing it. So, it's a massive loss. The number of barrels supplied to the domestic market has declined but it is still about 400,000 barrels per day, so that's a massive loss from the, say, 1.6 to 1.7 million barrels per day that they produce.
But then, they have to send barrels to repay debts with Russia, China and other creditors. And they owe a lot of money to other companies. So, there are plenty of these non-financial arrears accumulated and I think it's very likely that they will be unable to continue to pay. Between PDVSA and the government they have to repay about $8 billion.
They pushed the elections earlier so that they can try to avoid default before the elections, a full-blown default, but I'm not sure they will be able to pull it off. Of course, they already are in technical default because they haven't paid some interest on some of these bonds, but I think you will get to the point in which they will not be able to manage a full-blown default.
OP: And it only gets worse over the course of the year, right?
FM: It seems so. There can always be surprises, like a significant increase in the price of oil, that I do not foresee, that can give them some room to maneuver. Of course, the other sort of wildcard that I always hear is that China has to refinance the debt with PDVSA and therefore instead of sending 0.5 million barrels per day to repay debts, [Venezuela] has to send significantly less. That has to be renewed this year, but everybody expects it to be renewed. But say China, or Russia, which receives about 200,000 barrels per day, decides to give Venezuela a total pass, then they might have some opportunity. But the question is why would they do that? To allow Wall Street to get paid? I don't see it happening.
OP: Is there a scenario in which Venezuela's oil production surprises on the upside? If oil prices were to rise quite a bit, could they prevent some of these more dire scenarios?
FM: I think price will be the most important variable. Of course, part of the reason why the price has been on the upside is because of Venezuela's collapse. But, anyway … I don't see evidence that production is going up as the government claimed [in a report to OPEC].
There are some signs that it might slow down. For example, the number of oil rigs in operation increased in December, and in January it didn't go back to the previous levels. So, that seems a sign that they are investing a little bit more. And as I mentioned, the other thing is that the production that remains is the strongest production, for example, in the Orinoco.
It is true that the new head of PDVSA has met with it partners of the JVs and told them "let me know what we can do to help you increase production." He has been talking about all the right things. He has also promised to give [the JVs] more control over procurement and over the operations itself.
But, you know, these companies have heard that before, so I'm not sure that they trust there will be a big change.
Moreover, there are things happening like people [from PDVSA] leaving their jobs, and people with some higher skills actually leaving the country. And even at some of the lower levels of the ladder, some blue-collar workers in PDVSA are simply resigning because they don't make enough money.
So, you see some very problematic trends happening all over the place. And so, I'm very skeptical that such a scenario is possible. But if the price of oil goes up and they are at least able to give some of their partners some of the things that they want like a better exchange rate and control of operations, etc. and some of them are willing to invest, they might have a better scenario.
But a scenario of increased production as the one [PDVSA’s president is] arguing, a scenario in which they will produce 2.5 million barrels per day by the end of the year, I think it's very, very unlikely.
OP: What's going on inside PDVSA? As you said, there is a brain drain and I've read stories about political purge, so what's going on inside the company? And how is it impacted operations? I guess what I'm asking is, are there facilities that would be forced to be shut down because of lack of people or inadequate safety because workers are leaving? What's going on at the ground level?
FM: There are a lot of different kinds of rumors and it’s hard to verify all of them. Let's talk a little bit about before this new management team arrived … the company was already in disarray … a company that was already in deep trouble. That was already happening.
Then, of course, the corruption purge has had very significant effects because [the purge hit] some of the people that are experts in oil — some of the few executives that had survived the purge from Chavez in 2003 that had the training and experience and knowledge to manage the company. So they have been left with a very thin back bench of people that have any knowledge of the business. And now they have brought in a lot of military from the National Guard, which is the branch of the armed forces that has the lowest quality training and exposure to management, so the scenario looks pretty bleak in that regard too.
And the fact that [PDVSA president Miguel Quevedo] said that he would do an audit of every single contract and every single activity that was being done in the company to look for corruption … what that tells me is that the company has frozen. Nobody wants to sign anything, nobody wants to be responsible for anything for which they can be accused of corruption. So that’s leading to all sorts of additional difficulties.
Then you have the stories that are not unique to PDVSA, but the fact that they are happening in PDVSA is amazing. For example, there is no food in the lunch service of PDVSA. That people are not being given the basic tools to do their jobs. And of course, some of these jobs are risky jobs. Because of the issues related to safety some of them are saying "I'm not going to risk my life working in a facility in these conditions." You hear from partners of PDVSA that they are extremely worried about the safety conditions and some of them have put as a condition to continue operating that they are allowed to do some revamping of issues related to safety.
OP: Wow, scary stuff. In a scenario in which oil production falls much more than analysts expect, what would be the reason why that happened? Would it be something like Halliburton and Schlumberger leaving the country? A debt default? Any of these reasons? What would be the warning signs of a steeper decline in production?
FM: I think that strong sanctions from the U.S. would be a potential source, and by the way, at this point, I think that’s actually quite likely. But the most significant event is the one that you mentioned, which is that all the major oil service companies leave the country. That would be devastating.
However, what would lead to that? I think it would be a combination of either problems for them to simply operate because it is becoming legally and financially problematic. The other is their expectation that PDVSA would not be able to pay them in the foreseeable future at all. And sanctions could be problematic in that regard. A full-blown default without any organized attempt at restructuring would also be problematic for them. Politically, also, if you have default and if you have a situation in which you have an embargo and strong sanctions, the regime will fall into the hands of Russia and China. And we will have to figure out how much those two countries are willing to take over control of the exports of Venezuela and managing, you know, the cash payments and all these things to avoid creditors and sanctions.
I think PDVSA realizes that they need these service companies, but they might get to a point at which they say "Well, we are in survival mode. We know that we are going to be totally excluded from the international community. So, let's rely on Chinese service companies."
At this point, one of the reasons why the number of oil rigs in operation in Venezuela doesn't collapse further is because you have some Chinese rigs operating and because a few of the rigs that operate in Venezuela are very specialized ... and don't have an easy place to go. So that's maybe a reason why they don't collapse to zero.
But yeah, definitely, the companies leaving the country would be a big one.
OP: And finally, kind of a big picture question. What would it take to turn things around? What would it take for Venezuela's economy to stop the downward spiral? And, for oil production, what would it take to rebound? I guess that's kind of a tough question for the near-term, but…
FM: Most of the things that have to happen are very unlikely with the current administration. Some of them might happen with a change within the regime that allows for some sanctions to be lifted that leads to do some of the things better required on the macroeconomic side like an adjustment program, you know, stopping the hyperinflation with, say, dollarization or another type of alternative that has been done elsewhere to stop hyperinflation that would typically require help from the international community and a restructuring of the debt.
All of those things are sort of almost necessary conditions to allow for a recovery in the oil industry.
But then, the oil industry's recovery is the most important element for a recovery program of Venezuela otherwise. So, you need the two pieces of the puzzle to work together.
What will be needed on the oil side? Basically, the crucial variable is to dramatically increase investment. You need to triple the amount of investment that they are investing today and you need to do it in a way that is much more efficient. That could allow, according to estimates, an increase in production anywhere between 120,000 and 170,000 per day, per year.
So, it will be slow. It will take a decade to get back to the levels that Venezuela had just before Maduro came to power. It's not going to be easy at all. Some people claim that because you can significantly escalate production in the Orinoco belt that it will take less time, but Venezuela has never — in any period in its history — increased production by more than about 160,000 barrels per day on average for more than three or four years. That's why I'm really skeptical it can be done faster.
But it's true that the Orinoco belt, if you have massive investment, it's zero geological risk. It's just building infrastructure and drilling. And drilling, drilling, drilling. That's a very different scenario then in other countries. For example in Mexico, if you want to increase production you need discoveries. You need basically to add reserves. In Venezuela, you can dramatically escalate production with zero geological risk. So it is true that it's different, but I'm skeptical that it can be done at a much faster pace.
So what do you need to do to get these higher levels of investment, say, $4 billion for every 100,000 barrels that you add, plus about $6 to $7 billion to maintain existing level of production? Well, you need to make it much more attractive for the private sector because PDVSA will not be able to put in most of that money. Venezuela is broke; PDVSA is broke.
Today, about 80 percent of the money is supposed to be put in by PDVSA and 20 percent from the private sector. In reality, the foreign partners put in more because they are giving loans to PDVSA. But this has to shift to the opposite — like 80 percent of the money has to be put in by foreign companies. And to do that you need some changes to the institutional framework. Maybe not as radical as you see in other countries. Maybe with some minor changes it can be done. But that would require political stability, and some political consensus, and of course, the macroeconomic program to make this possible — to have a free exchange rate, so that the companies do not fear their money getting back to them. You need, of course, workers willing to come back to the country and service companies coming back to the country.
It's going to be hard to do. But the advantage that Venezuela has is that it has the resource base of proved reserves, at least in extra heavy.
OP: Hm. So, a lot of preconditions that seem a little out of reach at least in the near-term?
FM: I think that most of them are very unlikely to happen because they would require a regime change and many other variables to come together. The less successful sort of scenario of just stabilizing production could happen with less dramatic reforms like a macroeconomic program that helps to stabilize the macro economy, some flexibility with private companies ... that could at least lead to some positive movement.
But it would require the service companies to stay in the country. That would mean that the Venezuelan government would have to negotiate some things. Because otherwise how can they stabilize the macro economy and make it possible for these companies to continue to operate in the country?
OP: Francisco Monaldi, thank you very much for your time.
FM: You’re welcome; happy to do it.
(This transcript was edited for brevity and clarity.)
By Nick Cunningham for Oilprice.com
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Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.