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Venezuela in freefall

Caracas doesn't have an answer for the accelerating deterioration of the country's oil industry

If anyone should be cheering the oil price rally it's Venezuela. The country was an early agitator for the Opec deal that has finally helped deliver higher prices, and badly needed a price recovery to aid its crisis-stricken economy. But with oil output in freefall, operations paralysed by a military power grab at state-run PdV and the weight of US economic sanctions bearing down, even an oil bull run hasn't been enough to bring cheer to Venezuela.

Oil production enters 2018 in the sharpest decline in the country's history. At the end of 2017, Venezuela was producing around 1.62m barrels a day, the lowest point in decades outside the 2002 oil strike, according to figures the country reports to Opec. Production is down 0.65m b/d from the end of 2016 when output was 2.27m b/d—a stunning 29% collapse. Half of that decline came in the last quarter as the crisis deepened. Output is down 40% from mid-2014, when an upturn in Orinoco production sent output to just above 2.8m b/d.

The production declines are now extending beyond mature fields that PdV has long neglected to core Orinoco heavy-oil projects, an area the company has touted as an engine of growth for the past decade. Crumbling upgrader infrastructure and an inability to source sufficient amounts of light oil and other diluents to turn the Orinoco's tar-like reserves into a marketable crude grade have taken their toll. Orinoco production in 2017 fell to 0.88m b/d, from 1.2m b/d at the end of 2017, according to preliminary figures obtained by Argus. PdV has been lobbying its foreign partners for more support in helping lift output, but companies are largely unwilling to pump money into Venezuela.

Production looks likely to fall to less than 1.5m b/d in 2018, and some think a drop to just 1m b/d is possible

Collapsing production is offsetting any gains that could have been had from the oil market's early 2018 bull run. As Brent hit $70/b in early January, the Venezuelan basket of heavier crude reached $60/b, or 383.40 Chinese yuan, as Venezuela now reports its crude price. Venezuela's end-2016 output of 2.27m b/d would have generated the equivalent of $102m a day given a price at the time for Venezuelan oil of $45/b. That's almost exactly what it's bringing in at today's much higher $70/b price, but from lower production of 1.62m b/d. In reality, the situation is worse. PdV's cash crisis has forced it to take on even more oil-for-loan deals with Russia, which means more of its production is going directly to paying off debts rather than into its coffers.

This diversion of supply is evident in PdV's collapsing exports to US refiners, its main cash-generating clients. Crude exports to America averaged just 0.51m b/d in December, the lowest monthly average since the early 1980s, apart from a single month during the oil strike. Exports the first two weeks of January averaged just 375,000 b/d, one of the lowest weeks ever recorded and a catastrophe in the making for Venezuela if export levels remain that low. On top of the lower export levels, refiners in the US have grown increasingly concerned about the declining quality of exports, forcing many to start looking to Mexico, Iraq, Brazil and Canada for alternative sources.

Jobs for the boys

An anti-corruption campaign at PdV by President Nicolás Maduro and new PdV chief executive brigadier general Manuel Quevedo, which sources say is widely seen at the company as a thinly disguised power grab, is only making things worse. The two most recent PdV bosses, Nelson Martinez and Eulogio Del Pino, have been arrested on vague corruption charges. Their predecessor and the once all-powerful Hugo Chavez ally Rafael Ramirez is in hiding abroad after losing his UN ambassador post and being accused of corruption. Dozens of other high-ranking executives have either been arrested or ousted from the company.

Considering PdV's years-long decline, change isn't necessarily a bad thing. However, the executive ranks are being filled by loyalists to Maduro and Quevedo, rather than the sort of oil technocrats who might be able to stabilise the company. Remaining officials have been paralysed by the anti-corruption campaign, fearing that any documents they sign or decisions they make could be used against them, which has seized up daily operations. Production will almost certainly fall to less than 1.5m b/d in 2018, and some think a drop to just 1m b/d is possible.

The country, meanwhile, looks perilously close to a full-fledged default. The last couple of months have seen chaos in the markets for Venezuelan and PdV debt, which has sent near-term bond prices to record lows and put a chill on trading activity. Part of this is due to US sanctions, which have raised potential legal and reputational risks around trading Venezuelan debt and made everyday trades more difficult. But Venezuela's own actions have spooked investors more. The republic has defaulted on several payments, while PdV has gone deep into grace periods which are allowed on many of their bonds before eventually paying up.

The government is likely selectively missing payments on its sovereign debt to preserve cash to keep PdV current on its own debt, a sign of how tight funds are in the country. PdV generates most of Venezuela's hard currency and its international assets, including oil shipments and Citgo, would be subject to seizure if there was a default. The government has gone conspicuously silent on a mooted restructuring and has resisted calls for macroeconomic reforms. Maduro's latest idea to paper over the financial crisis, an oil-backed cryptocurrency called "The Petro", isn't likely to deliver much relief.

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