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US oil sanctions on Venezuela would escalate crisis

As Donald Trump threatens to introduce measures against the South American nation's exports, the outcome could be ruinous for all concerned

The Trump administration is ratcheting up its rhetoric against Venezuela in a bid to derail president Nicolas Maduro's efforts to rewrite the nation's constitution. The US has already imposed sanctions on high-ranking Venezuelan officials, including vice president Tareck El Aissami and a number of supreme court justices. But in recent days the US has floated the idea of targeting the Opec producer's oil exports if Maduro presses ahead with a July 30 constituent assembly election. Maduro aims to overhaul Venezuela's 1999 constitution, which would defang his opposition and solidify his hold on power.

Tough talk

Whether oil sanctions are a real policy option or simply tough talk to ramp up the pressure on Maduro is not clear, though the latter seems more likely. A senior US official said that while "all options are on the table", there are those in the administration that oppose the move. Imposing oil sanctions would raise the stakes for both sides, punishing Maduro's cash-strapped government and state oil company PdV, but also exposing US companies with ties to Venezuela and potentially US consumers.

Disrupting Venezuela's oil trade could prove a fatal blow to the country's crisis-wracked economy. Oil accounts for more than 95% of the country's foreign earnings, and the US is the country's largest and most important export market. In the first quarter of the year, Venezuela sent 0.724m barrels a day of crude to the US, accounting for roughly half of the country's oil exports. Crucially, sales to the US are vital to generating cash for Venezuela because much of the country's other exports go to China and elsewhere to repay loans or to Caribbean allies at a highly subsidised rate under the PetroCaribe programme.

Venezuela would seek to find new markets for its product. But given the large volumes involved and the uniquely heavy and sour makeup of Venezuelan crude it wouldn't be easy. The US Gulf Coast refiners have invested heavily to gear their facilities to be able to process heavy sour crudes like Venezuela's. China and India would be the most likely alternative markets for Venezuela. They have the heavy-oil processing capacity necessary, growing demand and an established trade relationship. Still, it's unlikely those nations alone could absorb all of the displaced imports.

Venezuela's perilous financial position would make even a temporary disruption in oil flows potentially ruinous. Venezuela's foreign reserves fell below $10bn this month for the first time in two decades, giving it virtually no cushion to deal with a cut in oil revenues. Imports have already been slashed to the point that food and medicine shortages are now commonplace, and broad economic sanctions would only worsen the nation's humanitarian crisis. The sanctions would also likely hasten a credit default, either at the government level or at PdV. The Venezuelan government and PdV face nearly $5bn in combined debt payments from August to the end of 2017 - nearly $3bn of which is owed by the state oil company.

Fallout

The fallout from such a scenario would be unpredictable and potentially dire. The ensuing economic chaos could force Maduro from power, but it isn't clear what would follow. A best-case scenario would see a broad multilateral diplomatic effort marshal a peaceful transition of power and an economic relief plan. However, the Maduro government has powerful allies in Russia and China, as well as some regional allies gained through its petrodiplomacy, that would likely oppose any effort to depose Maduro. The worst-case scenario would see a collapse of the state and a violent unruly transition spiral into civil conflict.

Avoiding such a worst-case scenario could sway the US away from harsh oil sanctions. So too would the potential pain at home. Venezuela has accounted for nearly 10% of total US crude imports in the first quarter of this year, and nearly 20% of imports into the Gulf Coast. Citgo, PdV's American subsidiary, Valero, Chevron and PBF Energy are the largest buyers of Venezuelan crude.

The market is well supplied and US stocks brimming, so consumers wouldn't likely see much of an impact from the absence of Venezuelan crude. But those refiners would have to scramble to find replacement heavy crude. Mexico and Colombia are other nearby heavy-oil producers, but both are seeing output fall and wouldn't be able to fill the gap. Canada's heavy oil output is growing, but pipeline capacity constraints would limit how much more crude could flow to the Gulf Coast. Saudi Arabian heavy crude grades could also substitute for Venezuela's, but it has said it is limiting exports to the US in an effort to draw down inventories there and boost the oil price.

Imposing harsh oil sanctions on Venezuela could also expose US companies in the country to retaliatory measures. Chevron, Schlumberger and Halliburton all have substantial economic interests in the country. Lashing out at the US companies would be self-defeating, but a nationalisation of their assets couldn't be ruled out. Venezuela could also stop importing US oil. Venezuela's uses light oil as diluent for its heavy oil output and has been an important outlet for US light oil exports, helping support tight oil growth, especially in the Permian.

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