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Venezuela: Opec's heavy lifter

The Latin American producer's sharp fall in output has helped hold the cartel’s deal together

Opec's leaders have spent plenty of time in recent months patting themselves on the back for the group's steadfast commitment to the 2016 supply-cut deal. Overall Opec production has often been even lower than the target output—and for much longer than sceptics expected. Almost never mentioned, at least publically, is why the cuts have been so effective: the collapse in Venezuelan output, which has freed up space for other producers to cheat on their quotas without undermining the deal.

It's hard to overstate how important Venezuela's production declines have been to the market and Opec's effort. Since the 2016 deal was reached, the country's supply has fallen from around 2.1m barrels a day to about 1.5m b/d at the end of March, a stunning 600,000 b/d, or nearly 30%, drop. Venezuela had agreed to cut just 95,000 b/d under the 2016 Opec deal. Involuntarily, it's gone much further.

If Venezuela had instead held fast, and others had followed the same course they have to date, Opec's production would be 500,000 b/d higher, well above the agreed cut level. The market narrative in this scenario would be far less bullish for prices. The focus would be on the inability of Opec and non-Opec countries to keep a lid on output, while inventories would be draining far more slowly, a recipe for much lower prices than today's. Saudi Arabia might have stepped in and done the heavy lifting for the cartel, as it has in the past. But in early 2017, the kingdom was already warning markets that it wouldn't play the cutter-in-chief role forever. In short, Opec can thank Caracas for its good run.

It's hard to overstate how important Venezuela's production declines have been to the market and Opec's effort.

What comes next is a new and potentially tumultuous period in Venezuela—as it hurtles towards presidential elections on 20 May. The contest will pit President Nicolás Maduro against a one-time ally turned political foe, Henri Falcón. While most the main opposition coalition decided to boycott the elections-expecting that Maduro would just rig the results anyway—Falcón broke ranks and threw his hat into the ring.

The decision initially drew wide suspicion and criticism among the opposition. But Falcón has pulled together a credible team and put forward an aggressive agenda. His highest-profile get was the well-known Venezuelan Wall Street economist Francisco Rodríguez from Torino Capital. Rodríguez is pushing for radical economic reforms to stem the hyperinflation that is gutting the economy, as well as to bring a broad debt restructuring deal with foreign bondholders and the IMF. Falcón has also floated the idea of offering a broad amnesty to those in Maduro's government and in the military for abuses and corruption. Many in the opposition have decried this as impunity—but it may be the most sensible step to ease any potential transfer of power.

Yet a Falcón win is still a longshot. Maduro holds all levers of power and showed in last year's gubernatorial elections that he isn't shy about using that authority to ensure victory at the polls. If Maduro goes it will be by his choice—or because the military turns against him and either topples the strongman or enforces a fair election in which Falcón comes out on top. Even the slightest glimpse of an off-ramp to Venezuela's economic and political crisis has been enough to fuel renewed optimism in the opposition and among international bondholders.

Whatever happens, there won't be a quick turnaround in the oil industry. A broad-based production decline has taken hold, with output both from mature fields and new Orinoco heavy-oil projects falling.

The decline is being driven by an array of problems that will be difficult to overcome. The economic crisis is at the root. The economy has shrunk by around a quarter over the past few years and hyperinflation has made doing business in Venezuela nearly impossible.

Investment has collapsed as state-owned PdV's cash flow has dried up and foreign companies—both Western international oil companies and politically allied Chinese and Russian national oil companies—have stopped pumping money into the crisis-gripped nation. Investment from PdV this year will likely only be around $5bn, a third what it was a few years ago. Sustained underinvestment has led to a gutting of vital infrastructure like refineries, ports, platforms in Lake Maracaibo and pipelines, which has gummed up the company's supply chain. Upstream, the country can only afford to drill a fraction of the wells it needs to fend off production declines.

Strike threat

PdV has also been unable to keep up with salaries. That has led to many PdV workers simply walking off the job, or directly confronting management, as was seen in a dramatic showdown last month captured by videos uploaded to Twitter and other social media showing workers clashing with national guard troops in the lobby of PdV's Caracas headquarters. Another large-scale strike of the kind that paralysed PdV in 2002 can't be ruled out.

US financial sanctions have also hit the industry, possibly harder than their architects intended. International banks have been wary about doing any business involving Venezuela, making it difficult for the country to trade oil and carry out financial transactions like making bond payments. These sanctions won't be lifted while Maduro remains in power, making a significant oil recovery very difficult without a transition of power.

Add to this that Venezuela is already in default on a number of its internationally traded bonds: a true nightmare-in-waiting. This threatens to blow up into a full-blown debt crisis later this year when major PdV bond payments are due. At its worst, this could precipitate a steep fall in production towards 1m b/d or even lower as bondholders went after PdV's assets.

Unwinding these threads will be a monumental task for Venezuela's oil industry. In the meantime, production will continue to slide, possibly by at least another 300,000 b/d or so this year. In other words, Venezuela will continue doing the heavy lifting for Opec.

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