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Desperate Venezuela

Oil output is falling and the state company is struggling to pull itself out of a dangerous tailspin

Venezuela, Opec's worst performer in 2016 when output losses will have amounted to as much as 300,000 barrels a day, ended the year facing simultaneous economic, financial, social and political crises. In 2017 it is unlikely to escape them. Production declines will persist. State company PDVSA has restructured some of its debt, but its cash position - and Venezuela's - remains desperate. Despite recession - the economy will have contracted by about 10% in 2016 and about 5% again in 2017 - and the decline in domestic oil demand, exports between January and October 2016 were down by about 200,000 b/d. At 2016 prices, every 100,000 b/d drop equated to $1.5bn less in annual export income. Unable to soften the impact of weak oil prices with more exports or international financing, Venezuela's and PDVSA's bonds remain the riskiest in the world and the country is still shut out of financial markets. The country has very little inward direct investment, and exports almost nothing except oil, meaning its dollar liquidity is really a function of oil-export income.

A $10-increase in the price of oil raises export revenues by about $6bn-7bn a year. To cope with the country's dollar financing needs - its bond-debt servicing needs in 2016 and 2017 average about $10bn - Venezuela has had no choice but to tap into its international reserves. By October 2016, they had fallen by about $5.5bn - still insufficient to make dollar payments. Oil export revenues for the year aren't likely to have exceeded $25bn-30bn. After servicing debts, just $20bn has been left aside for imports - about half the amount available in 2015.

The private sector, starved of dollars and therefore of raw materials and intermediate goods, has borne the brunt of this - just when the economy needs it to pick up slack. The outcome has been all too predictable: soaring inflation - 481% in 2016 and forecast by the IMF to be 1,642% in 2017 - and scarcity of goods and services. Political and social tensions are rising. Despite trying to restructure some arrears, PDVSA still owes money to international oil-services firms, which are scaling down operations. China, Venezuela's most important creditor, has offered some relief by reducing oil demands which are in place to pay off debts. But the rig count has plummeted and so 2017 will bring more output decline anyway.

Worse still, Venezuela's oil basket is now heavier thanks to a policy of tapping vast bitumen deposits to compensate for declining conventional output. This is self-defeating because Venezuela needs to import light oil and diluents to make its heavy grade saleable internationally. These imports add a $10-12-a-barrel mark up to the overall cost of producing the Orinoco's heavy oil. In other words, to increase exports Venezuela first needs to import oil - hardly ideal in a country starved of dollars. No wonder oil purchases now account for a fifth of the shrinking import bill, leaving even less space for imports of basic staples.

Compounding all this are severe macroeconomic imbalances, the acute scarcity of goods and services, the brain drain, rising social tensions and political instability, and a worsening of security - all making it very difficult for companies to operate in the country. In Venezuela, which is on the verge of hyperinflation with a severely distorted exchange-rate regime, and where the parallel market is 1,000 times the official rate, no company can accurately price goods and services in the local currency. This will lead to the dollarisation of prices.

Is a recovery possible next year? PDVSA controls 100% of the country's oil production, although 40% of it is managed in joint ventures with international oil companies. The data show that the joint ventures consistently outperform sole PDVSA projects. So, in theory, Venezuela could build on an existing infrastructure and joint-venture system to eventually increase production.

But first the macroeconomic situation needs stability, the political crisis in the country needs resolution and the critical dollar-liquidity crisis needs to be fixed. Otherwise, the vicious circle keeps turning: PDVSA's severe cash flow predicament leads to deeper oil-output declines, in turn worsening its cash flow position, and so on.

Unless the oil price rises significantly, the risk that the company will default will remain high in 2017. If it occurs, it'll bring political instability and could lead to steeper production falls. Conversely, a solution to the country's political standoff that unlocks a change in the macroeconomic framework and unblocks international financing could, eventually, be positive for oil production.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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